Fertiliser stocks: A Matter Of Faith?

Fertiliser stocks have been outperforming market benchmarks, so far. But things do not appear too bright going ahead, as the industry’s fortunes are wedded to policy reforms

STOCKS OF fertiliser companies have been rising steadily for over a year now and have also outperformed the broader market benchmarks in the current turbulent times. While the problems faced by the industry are hardly a secret, expectations of a better policy environment are driving up valuations. In face of the shortage of fertilisers in the country, the government is mulling policy changes to induce investments in the sector, which are likely to be introduced in the near future. A few policies have been already announced, which are favourable for the industry. However, considering the nature of the industry and political compulsions, radical changes are not expected. Hence, doubts remain as to whether fertiliser manufacturers will be able to sustain their current rich valuations. Investors are advised to observe extra caution while dealing in these scrips.

GROWTH PANGS:
The government took a number of policy decisions for the fertiliser industry in June ’08. It has reduced the prices of complex fertilisers while maintaining the retail prices of urea, muriate of potash (MOP), diammonium phosphate (DAP) and single super phosphate (SSP). The recent policy on potassic and phosphatic fertilisers recognises a number of costs while calculating subsidy for the industry, which will enable the companies to recover their costs fully. Although these policies will not improve the industry’s operating profits, companies can benefit from higher production. The industry is still waiting for the investment policy on brownfield and greenfield expansions.

The expectations of an improved policy environment are reflecting in the performance of most fertiliser scrips. Over the past 12 months, the ET Fertiliser index has outperformed the BSE Sensex by a wide margin. The ET Fertiliser index has generated over 56% returns since June ’07, while the Sensex returns are at a mere 6%. In the same period, the ET Fertiliser index witnessed a steady growth in its price-to-earnings (P/E) multiple, indicating growing investor confidence. The P/E of ET Fertiliser index grew from 8.5 in June ’07, peaked at 25 in the first week of January ’08 before easing down to 12 currently — still higher than the level in June ’07. On the contrary, the Sensex P/E, which was at 20.7 in June ’07 and crossed 28.5 at its peak in January ’08, has fallen to 17.2 now — below last year’s level.

While investors have been betting on a better future for the fertiliser industry, the growth in its aggregate results has not been impressive. For the year ended March ’08, the aggregate net profit of 15 fertiliser companies was almost flat at Rs 1,477 crore, despite a 17% growth in sales. Even the growth in operating profits was restricted at 5%, indicating a pressure on operating margins. The industry, which had posted operating margins of 12.7% during the year ended March ’06, recorded a margin of 10.5% in FY07 and just 9.4% in FY08.

Due to rigid policies, the fertiliser industry has become highly unattractive for fresh investments. As a result, rising demand has outpaced stagnating supplies and India today has to depend on costly imports for its fertiliser needs. The unsustainability of the current scenario is forcing the government to introduce policy reforms, which are likely to benefit both the industry, as well as the government. Considering the expected spurt in the availability of natural gas in India, the policy reforms appear long overdue.

IT’S ALL ABOUT GAS:
Over the next six months, as Reliance Industries’ (RIL) KG basin starts producing gas, the domestic availability of natural gas will go up by nearly 75%. Sufficient and continuous supply of natural gas will ensure higher production of fertilisers — particularly urea — and reduce the government’s subsidy burden. Natural gas is an important feedstock for manufacturing urea and the lack of adequate availability forces domestic manufacturers to use naphtha, which is a costly feedstock. Similarly, natural gas can also replace expensive fuels such as fuel oil and low sulphur heavy stock (LSHS). However, cheap natural gas will lead to a reduction in the government’s subsidy burden and no significant benefit will accrue to the manufacturers.

National Fertilisers, Gujarat Narmada Valley Fertilisers (GNFC), Gujarat State Fertilisers (GSFC), Tata Chemicals, Chambal Fertilisers, Rashtriya Chemicals and Fertilisers (RCF), Southern Petrochemical Industries (SPIC) and Mangalore Chemicals are the important urea manufacturers in India. Fertiliser and Chemicals Travancore (FACT), SPIC, TCL, Coromandel Fertilisers and Rama Phosphates manufacture phosphatic fertilisers. Higher availability of natural gas will provide volume-led growth to companies, expanding the capacity of companies like Tata Chemicals and Aditya Birla Nuvo. Tata Chemicals is expanding its urea capacity to 1.2 million tonnes (mt) from the current 0.875 mt by October ’08. But the plant will remain shut for a month subsequently for integration purpose.

Again, not everyone is likely to get access to natural gas in the near future. Fertiliser plants located in South India do not have any gas connectivity. The government plans to provide gas connectivity to all fertiliser plants by FY12. Fertiliser companies such as Goa-based Zuari Industries, Kochi-based FACT, Mangalore-based Mangalore Chemicals & Fertilisers (MCFL), Tuticorin-based SPIC, Chennai-based Madras Fertilisers and three plants of National Fertilisers — at Panipat, Nangal and Bhatinda — are awaiting gas connectivity.

GREENER PASTURES:
Over the past few years, most fertiliser companies have diversified into other chemical businesses to create value for their shareholders, as the fertiliser business stagnated. The most noteworthy example is probably Nagarjuna Fertilisers, which is setting up a petroleum refinery in Tamil Nadu.

Similarly, companies such as Deepak Fertilisers and Oswal Chemicals have ventured into the real estate business. Chambal diversified into textiles, shipping and food processing, while Rama Phosphate entered the soya oil business. Today, almost all the domestic fertiliser companies, barring National Fertilisers and Coromandel Fertilisers, have diversified into chemicals or other businesses to improve cash flows and drive growth.

The fortunes of fertiliser companies depend on the government’s policy reforms. The changes introduced so far, which encourage domestic manufacturers to produce more, have met the industry expectations. However, investors must realise that considering its nature, the fertiliser industry is unlikely to become fully de-regulated in the foreseeable future. Hence, the current prices of fertiliser stocks appear to have a downside risk.

ONGC Q4 net slips 2% on subsidy burden

Rise in Crude Prices Fails To Lift Profit As Employee Costs Too Show Huge Spurt

SOARING crude oil prices did not help India’s largest oil producer as expected, as ONGC fell short of crossing the Rs 20,000 crore annual profit mark in FY08. ONGC’s fourth quarter profits slipped 2% below year ago levels to Rs 2,627 crore. A huge spurt in employee costs, subsidy burden and heavy write-offs were the culprits. The oil major reported consolidated profits of Rs 19,872 crore on sales of Rs 1,01,835 crore during the year ended March 2008.

The company provided nearly Rs 2,000 crore for the pay revision including gratuity thereon, which was pending since January 2007. “We have made a provision of Rs 1,050 crore towards the arrears of employees on account of pay committee recommendations. Also, Rs 850 crore has been earmarked towards gratuity liabilities. This has impacted profit, as 80% of the spending would have gone to the topline if pay committee recommendations were not there,” ONGC director finance DK Sarraf said while addressing a post result conference in New Delhi.

“There is lot of confusion due to ONGC’s changes in accounting policy regarding employee costs. However, one thing is for sure that their net realisation has fallen to around $52,” an analyst working with an international investment bank commented.

In the same quarter, the company wrote off Rs 610.5 crore spent over last three years on a deep-sea oil block, on account of abundant prudence as the block needed more time for completion of appraisal programme. This oil block in the Krishna-Godavari (KG) basin was taken over in 2005 from Cairn for Rs 371 crore. ONGC has found in-place hydrocarbon reserves in this block last year making it India’s first ultra-deep water discovery at 2,841 metres of water depth. The conceptual development plan for this field is underway and appraisal programme is expected to begin in October this year.

The subsidy burden proved to be the other villain. ONGC’s subsidy burden during the quarter shot up 82% to Rs 8,473 crore. This took the total discount offered to the oil marketing companies during the entire year 29% higher to Rs 22,001 crore. “There is a lot of uncertainty because of the ad hoc subsidy mechanism. I would request the government to move to ad-valorem cess instead of the present ad-hoc mechanism,” said ONGC chairman and managing director Mr RS Sharma.

The company witnessed a sharp rise in its other expenditure, which rose to 24.6% of net sales from 18% in corresponding quarter of previous year. This was mainly on account of increase in hiring cost for rigs, floaters and other materials.

Employee, staff costs take toll on Tata Chemicals

IN THE quarter when the soda ash major was much in the limelight for its $1 billion acquisition in the US, Tata Chemicals (TCL) had faced severe pressure on its operating performance. TCL’s normalised net profits halved during the quarter ended March 2008 to Rs 40 crore, while operating profit margins tumbled by a massive 820 basis points to 12.2%.
Consolidated sales grew 18% to Rs 1,460.3 crore. It was the profit of Rs 487.47 crore on sale of investments that boosted its net profit to Rs 527.68 crore. Incidentally, the company had a poor Q3 with topline stagnating and net profits down 42%. Rise in staff and fuel costs was the main reason behind erosion of operating margins.
Staff costs as a percentage to net sales jumped to 9.8% from 4.9% earlier. Due to the US acquisition, TCL had to provide for pension liabilities of Rs 34.54 crore, whereas in the corresponding previous quarter, it had written back an equivalent amount due to reduction in pension liabilities. Thus, staff costs rose nearly two-and-a-half times to Rs 160 crore. A rise in fuel costs led to the fuel bill rising 50% to Rs 290 crore. As a result, the fuel cost in proportion to net sales grew 370 basis points to 17.7%.
TCL’s chemicals business had a tough time while the fertilizer segment did well, something similar to the preceding quarter. Profit margins in TCL’s inorganic chemicals business crashed 1160 basis points to just 5.8% while the margins in fertilizers inched up slightly to 14%. Thus, despite a 20% growth in chemicals sales its profits fell by 60%. As against this, the fertilizers segment grew 15% and 20% in sales and profits, respectively.
The company is debottlenecking its Babrala urea plant to increase its rated capacity to 1.2 million tonne from 0.8. The process is expected to be complete by October 2008. However, the entire plant will remain closed for one month for the integration and commissioning work.
The company has progressed on its new businesses. It commissioned the Khet-Se project with the first collection-cum-distribution centre near Ludhiana in May 2008. The second distribution centre will come up at Kalyan, near Mumbai. TCL has also commissioned a 50,000 tonne per annum sodium bicarbonate plant in the Netherlands. Similarly, civil construction at site for the ethanol project at Nanded has commenced with completion expected by the end of this year.

ONGC to clock windfall profits

Despite Output Stagnation, Soaring Crude May Help Co Post Rs 20,000-Cr FY08 Profit

SCALING a major milestone, ONGC — India’s largest oil and gas producing company — is expected to report a net profit in excess of Rs 20,000 crore for the year ended March 2008 — a feat no other Indian company has enjoyed so far. ONGC will be publishing its results for FY08 on June 25, 2008.

While ONGC’s production of oil and gas continues to stagnate, its performance will get a boost from higher crude oil prices. “Crude oil price moved up to $100/barrel in Q4FY2008 from $60/barrel a year ago, which more than offset the negative impact of 10% Y-o-Y appreciation in rupee against dollar,” noted a research report by Karvy Stock Broking. The brokerage house expects ONGC to post net profit of Rs 20,755 crore for the financial year ended March 2008.

Another factor which will boost the company’s performance is the improving performance of its subsidiaries. Thanks to improved business environment, MRPL — a 72% subsidiary of ONGC — reported 142% spurt in profits for FY08 to Rs 1,272 crore Similarly, net profit of its wholly-owned subsidiary ONGC Videsh (OVL) jumped 44% to Rs 2,397 crore in FY08 assisted by higher production. OVL’s crude oil production jumped 18% to 6.81 million tonne during FY08 as against 5.77 million tonne in previous year. However, OVL has not benefited fully from the rising crude oil prices. “In the regions where OVL operates, the governments take away a significant chunk of the price benefit. That’s why OVL is not able to draw full benefit of the high crude oil prices,” said a senior research analyst with an international broking firm. The firm projects per share earnings (EPS) of Rs 95 for ONGC for the whole year, which is 14.5% higher on Y-o-Y basis.
At ONGC’s current market price of Rs 845, this will translate in a price-to-earnings multiple (P/E) of 8.9 — a level last seen four years back in June 2004. The company has already paid interim dividend of Rs 18 per share and considering the Rs 31 dividend paid last year, is likely to declared another Rs 13 as final dividend.

ONGC has to share the burden of subsidy to the oil marketing companies by way of discounts on sale of crude oil. During the year ended March 2008, discounts offered by the company increased 29% to Rs 22,000 crore.

Bears go hammer and tongs at RIL

Pull Down Scrip Below Rs 2,000; Stock’s Now 37% Off Its All-Time Peak In January

AN ELEMENT of frustration was inescapable among thousands of retail investors watching the Reliance Industries stock getting hammered by the bears. After nine months, the shares of India’s largest private sector company — Reliance Industries (RIL) — once again slipped below the Rs 2,000-mark amid heavy volumes. Though at the close of trading, the stock crawled back over Rs 2,000, it had lost over 37% from its peak in January, with market capitalisation falling below the Rs 300,000 crore-mark. The Mukesh Ambani-controlled RIL is India’s most widely-owned company with around 2.1 million retail shareholders.

In October 2007, Mr Ambani, while addressing shareholders at the company’s AGM, had said, “Between March 2002 and October 2007, the market capitalisation of RIL has grown from Rs 41,989 crore ($8.6 billion) to Rs 3,82,259 crore ($97.3 billion).” Despite the erosion in value since then, some find the scrip attractive at current levels. For instance, Lalit Thakkar, director (research) at Angel Broking, said: “The stock has corrected significantly from its highs. The company would benefit out of the commercialisation of the KG Basin and the RPL Refinery, expected by second half of FY09. This would provide fillip to the overall earnings of the company going forward. Thus the correction provides a good opportunity for the retail investors to buy into the scrip.”

Although RIL’s future growth is not in doubt, not everyone feels that the worst is over for the scrip. A research head at a large domestic research institution said, “RIL is an over-owned stock; owned not just by retail or institutional investors but by speculators as well, which made it fall steeply on weak sentiments. We do not yet know if the stock has bottomed out. On the other hand, despite weak sentiments in the markets, RIL’s fundamentals remain strong.” RIL is more susceptible to fluctuations when the market swings, which is reflected in its beta at 1.12.

At the current market price of Rs 2,022, RIL is now trading at a price-to-earnings multiple (P/E) of 15.1 — a level last witnessed in August 2006. In comparison, the 32% fall in Sensex has been less severe, which has left the Sensex P/E at 17.4 — higher than that of its largest constituent.

Indraprastha Gas: The Right Choice

A very low beta, high dividend yield and stability in its growth outlook make Indraprastha Gas an ideal investment choice in these uncertain times

INDRAPRASTHA GAS (IGL) is a Delhi-based city gas distributor promoted by GAIL, Bharat Petroleum (BPCL) and the government of Delhi together holding 50% stake. The company distributes compressed natural gas (CNG) and piped natural gas (PNG) in Delhi and nearby region. With high inflation and slowing global economic growth, the company is expected to grow steadily over the next few years, thanks to its mature business model, strong cash flows, healthy returns on capital and assured supply of natural gas.

BUSINESS:
Under the administered pricing mechanism, IGL gets a total allocation of 2 million metric standard cubic meters a day (mmscmd) of natural gas from GAIL, which is nearly 25% more than the company’s current gas sales.

The company derives over 90% of its revenue through the sale of CNG for automobiles, while the rest comes from PNG. During FY08, CNG sales volume increased by 12.3% to 3,862 lakh kg and PNG sales volumes increased by 17.2% to 43 million standard cubic meters (mscm) over FY07. On an overall basis the sales volumes grew 12.6% to 549 mscm during FY08.

With a number of new commercial and retail customers shifting to piped natural gas, the company has witnessed a strong cumulative annual growth of 39% over the past six years in this segment. In comparison, the sales in the CNG segment have grown at a slower rate of 25%.

GROWTH FACTORS:
After witnessing fast growth in initial years after its incorporation, the company is expected to see a steady growth in the years to come. CNG and PNG being highly cost efficient options to petrol and LPG, consumer acceptance for these alternative fuels is growing fast. Also, expansion in adjoining regions will provide the company access to other lucrative markets. For this, the company will invest around Rs 250 crore annually over the next couple of years.

Commissioning of the Petroleum and Natural Gas Regulatory Board (PNGRB) earlier this year and its recommendations afterwards had created doubts about IGL’s future profitability. However, the marketing margins charged by the company remain out of regulatory control and hence the company is not required to change its tariff rates. This ensures the sustenance of IGL’s profit growth in future.

FINANCIALS:
IGL came out with a marginally improved performance for the quarter ended March ’08. It earned a net profit of Rs 48.2 crore on net sales of Rs 187.4 crore. Sales were 14% higher yearon-year (y-o-y), while the net profit was up 20%. For the whole year, the company posted 26.5% growth in net profit to Rs 174.5 crore while its sales grew 15% to Rs 706 crore.

IGL has reported consistent growth in operating profit margin over the past few years. It closed FY08 with an operating margin of 42.5% against 41.2% in the previous year. However, the last quarter of FY08 witnessed a slight erosion in margin to 41.8% from 43.3% in the corresponding period in the previous year.

The company holds a healthy track record of dividends. The rate of dividend has increased consistently over last six years to reach 40% in FY 2008. At the current market price of Rs 118, this translates in a dividend yield of 3.4%.

VALUATIONS:
The price-toearnings (P/E) multiple of Indraprastha Gas at the current market price of Rs 118.7 works out to 9.5. Its peer Gujarat Gas is trading at a P/E of 9.9. The current high inflation is expected to favour the company, which offers low-cost alternatives to highcost petroleum products. Considering the growing number of CNG vehicles in the Delhi region and the fact that high prices of LPG are forcing retail consumers to shift to PNG, we expect the company to grow at 20% per annum over the next two years. A very low beta, high dividend yield and stability in its growth outlook make it an ideal investment choice in these uncertain times.

Higher margins keep BPCL in the black

IN the current difficult times, India’s second-largest oil marketing company Bharat Petroleum (BPCL) achieved what its peers failed to do. Defying the problem of rising under-recoveries, the company has posted a net profit for the March ’08 quarter. The industry leader IOC had reported net losses in the latest quarter, while HPCL’s pre-tax losses got converted into profits, thanks to onetime write back of tax provisions.

While giving the positive performance, BPCL had to battle a few odds, apart from the perennial problem of under-recoveries. BPCL’s other income halved in the fourth quarter against the corresponding quarter of previous year while the production at its Mumbai refinery was 9% down due to a maintenance shutdown in March. However, a spurt in the gross refining margins (GRMs) and higher support from upstream companies and the government came to BPCL’s rescue. Particularly, the performance of its Kochi refinery, which accounts for nearly 40% of the company’s total production, was stronger. Improved business environment helped the GRMs at its Kochi refinery move beyond $9 per barrel during the quarter from $7.2 earlier. However, its Mumbai refinery, which suffers from 3% octroi charges, witnessed stagnant GRMs.

During the quarter BPCL’s net sales (excluding oil bonds) moved up 23% to Rs 28,607.1 crore. The amount of oil bonds received during the quarter was nearly four-and-a-half times higher from corresponding previous quarter at Rs 3,971.5 crore. The discounts received from upstream companies such as ONGC, Gail and Oil India doubled to Rs 2369.20 crore. However, as the other income halved and interest and depreciation costs increased, the pretax profits were just 40% of what were reported in last year. After providing for taxes the net profits at Rs 58.40 crore were less than 10% of last year.

For the entire year ended March 2008, the company posted a net profit of Rs 1,769.6 crore on a consolidated basis, which was 17% lower against year ago levels. During the year, the company received Rs 8,589.5 crore (up 64% on y-o-y) as assistance from the government and Rs 5,975.1 crore (up 34% on y-o-y) as discounts from upstream companies such as ONGC, Gail and Oil India.

The company completed the formalities of transferring its participating interests in 24 blocks in India as well as abroad to its wholly owned subsidiary Bharat Petro Resources (BPRL). The company plans to invest around $200 million in these assets during the current fiscal year.

Going forward, the company’s refinery operations are likely to benefit from improving GRMs, thanks mainly to globally high petrol and diesel prices. However, its marketing operations continue to reel under the pressure of under-recoveries. Despite the price increases earlier this month, the company continues to lose Rs 11.9 per liter on petrol, Rs 23 per liter on diesel, Rs 36 per liter on kerosene and Rs 288 per cylinder on LPG.

WANNABE STARS

There’s a lot happening, away from the glamorous & glitzy world of high-visibility sectors. Ramkrishna Kashelkar digs deep & unearths some uncut diamonds

THEY SAY, more than a tonne of dirt needs to be shifted to find every single carat of diamond. The same applies to the vast universe of small companies. It is a daunting proposition to sift through an endless list of obscure industries in the hope of hitting on some gems. No wonder, most of the analysts stick to companies in the more glamorous sectors such as IT, pharmaceuticals, FMCG, capital goods and infrastructure among others. ETIG undertook this difficult task long ago. We have so far covered small industries such as solvent extraction, food processing, chemicals and sugar. This week, we thought of researching a few more small and obscure industries just to check on the kind of action taking place there. We find that away from the limelight, quite a few companies in these sectors are thriving and waiting for their time to come. However, there is a caveat: most of the companies operating in these sectors are small-caps and, as such, may be subjected to erratic price movements from time to time. So, due caution must be exercised while investing in them.

DYES & PIGMENTS
The dyes and pigments industry provides colourants to textiles, paper and leather industries. Besides, pigments are also used in paints and printing inks. This industry exports a chunk of its products and has long been suffering due to Chinese competition. However, the worst may be over for this industry. Chinese competition has receded as the Chinese government has cut back on fiscal benefits to its exporters, while tightening of environmental norms weeded out many marginal players. With energy costs going up substantially, the industry is now finding that global customers are ready to accept higher prices.
In India, a number of large players are operating in this industry such as Clariant India, Atul Industries and Sudarshan Chemical, among others. Hardly any capital expenditure is taking place in the industry currently, due to global oversupply in some of the major types of dyes. As a result, domestic players are investing in backward integration. Recently, Kiri Dyes & Chemicals raised funds from the primary market to build capacities for raw materials. Similarly, Atul completed the expansion of its facilities for key dye intermediates in September ’07. Diversification into related chemical businesses has proved to be another way out for dye manufacturers. Companies such as Meghmani Organics and Atul derive a chunk of their revenues from agrochemicals. The pigments industry has witnessed some capacity expansions over the past couple of years. Asahi Songwon Colors and Shreyas Intermediates have expanded their capacities of blue and green pigments.

A number of these companies have been paying dividends consistently and are currently trading at attractive dividend yields. Companies like Ultramarine & Pigments, Atul, Bhageria Dye Chem, Bodal Chemicals and Metrochem Industries witnessed higher dividend yields.

PESTICIDES
The pesticides or agrochemicals industry continues to remain an obscure one, as its dependence on several factors makes it almost impossible for anyone to predict its growth. The companies in the sector are directly dependent on the agriculture industry. However, a number of factors such as the pattern of the monsoon and pest attacks affect the industry directly. A change in the area under cultivation for crops that require maximum pest protection, such as cotton, will also affect the industry performance. Apart from all these, agrochemical companies require a wide distribution network, strong brands, and a comprehensive product portfolio backed by extensive market research to sustain in this highly competitive industry.

United Phosphorous has emerged as an Indian MNC in this space through major acquisitions over the past 2-3 years. It now figures among the top three global generic agrochemical companies and has a wide range of products, besides subsidiaries expanding in the seeds business.

The other leading players such as Excel Crop Care, Punjab Chemicals & Crop Protection and Rallis India are also taking various steps to sustain their growth. Rallis has performed particularly well by restructuring its business by selling off extra assets and focusing on its core business. The companies are diversifying their portfolios by adding other farm inputs such as seeds, nutrients and bio-pesticides to their agrochemicals portfolio. Punjab Chemicals & Crop Protection, which was hitherto predominantly a bulk manufacturer, is now moving into selling formulations in the retail segment. It further plans to grow inorganically and is looking for suitable opportunities.

The monsoon this year is predicted to be better compared to the previous couple of years. Similarly, strong agri-commodity prices and the farm loan waiver scheme announced by the government are expected to improve the liquidity situation of small farmers, all of which augur well for the agrochemicals industry in general.

INDUSTRIAL GASES
A variety of industrial gases such as oxygen, carbon dioxide, argon and nitrogen are required in a host of industries such as steel, fertilisers, glass, automobiles and healthcare. The industrial gases industry is slated for a strong growth over the next few years, thanks to a number of expansion projects in user industries. New capacities are planned in industries such as petrochemicals, steel, glass and food processing, which augurs well for the industrial gases industry. Additionally, gas application in the electronic sector has opened up new growth possibilities.

BOC India is the largest industrial gas manufacturer in India, which is currently investing in building storage and transport infrastructure for liquid and compressed gases. Gujarat Fluorochemicals is India’s largest manufacturer of refrigerant gases.

The Unsung Heroes
HOWEVER, Amajor chunk of the company’s revenues come from the sale of carbon credits, other chemicals and power. Refex Refrigerants is a new entrant in this space dealing in nonozone-depleting refrigerant gases. Bhagawati Gases, which was so far totally dependent on Hindustan Copper for selling oxygen, has now relocated one of its plants to supply oxygen to a steel manufacturer in Maharashtra.

INDUSTRIAL EXPLOSIVES
Industrial explosives are required in industries such as mining and infrastructure. Solar Explosives, Premiere Explosives and Keltech Energies are the leading players in this industry. Pune-based Deepak Fertilisers is also trying to give a strong push to its ammonium nitrate business, which is used as a commercial explosive. Increased investments in coal mining by Coal India, as well as private mines for power, steel and cement industries and road and other infrastructure projects, are driving demand for explosives.

CERAMICS
The ceramics industry mainly comprises floor and wall tiles and sanitary ware. The growth in this industry is being driven by the boom witnessed in India’s real estate sector. India’s real estate sector has been growing at over 30% per annum over the past few years, which has resulted in the booming demand growth for the ceramics industry. The growth in the hospitality industry and new commercial complexes, malls and multiplexes coming up in India also lend support to the growth prospects of this industry. Despite the current lull in the housing industry, there are a number of real estate projects —particularly integrated township projects —under implementation, which are expected to keep the demand for ceramics industry strong in the months to come. Several expansion projects are being executed by most players. Euro Ceramics had raised around Rs 92 crore through its IPO last year and has commissioned a plant for manufacturing calcarious tiles. Now, the company has embarked upon the next phase of investments with plans to spend Rs 575 crore. Hindustan Sanitaryware is setting up a container glass plant and has entered the retail business through its wholly-owned subsidiary.

SPECIALTY CAPITAL GOODS
Among capital goods companies,there are several which cater to a specific industry or have their own niche area. For example, Kabra Extrusion and Rajoo Engineers manufacture machines used by plastic product manufacturers. Manugraph Industries makes machinery for printing presses and Lokesh Machines specialises in CNC machines required in all the manufacturing plants.

Lokesh Machines had come out with an IPO in early ’06 to fund its expansion. Some of its expansion plans got pushed to the first half of ’08. Hence, the real benefits of this expansion will accrue over the coming quarters.

Kabra Extrusion Technik has been a major beneficiary of the booming demand for plastic pipes in India. The company manufactures extrusion machinery needed in manufacturing pipes, sheets and films from various polymers such as polyethylene (PE), polyvinyl chloride (PVC) or polypropylene (PP). The company, which is expanding its product portfolio, is trading at an attractive dividend yield

Manugraph Industries, which manufactures printing machinery, has emerged almost a debt-free company with healthy return on capital employed. Despite being fundamentally strong, lack of substantial growth opportunities have made the company languish with a price-to-earnings (P/E) multiple of 5.4. The dividend yield is attractive at 3.3%.

To wrap up things, there are interesting companies operating in highly niche areas, which are not too well-known in the market. Some of these industries have the tendency to fall out of fashion for long periods. However, a keen researcher may still hit upon a multi-bagger, if he acts in time.

Nowhere To Run

No industry is likely to gain from last week’s fuel price hike. As such, the entire endeavour proves to be a zero-sum game

LAST WEDNESDAY, after prolonged deliberations, the government finally hiked prices of petrol, diesel and LPG. While the market’s immediate reaction appeared confused, it now seems the price hikes mattered little to the market, which was anyway on a downslide. Though the impact of price hikes — Rs 5 per litre on petrol and Rs 3 per litre on diesel — on various industries is easy to gauge, as transportation costs will go up, it’ll be interesting to study how the duty cuts will play out. Besides the price hike, the government cut excise duty on petrol and diesel by Re 1 per litre and customs duty on crude to nil from 5%. Import duty on petrol and diesel was cut from 7.5% to 2.5%, and on other petroleum products from 10% to 5%.
These changes are a mere quick-fix as far as the problems of oil marketing companies (OMCs) are concerned. They will not suddenly turn the OMCs profitable, but will only improve liquidity and ensure their sustenance for a longer time. As in the past, OMCs will continue to depend on the timely arrival of oil bonds to report profits. In fact, if state governments do not reduce state-level taxes, a chunk of this price hike will just flow out to them. For example, if VAT in a state is 30%, out of the Rs 5 price hike in petrol, Rs 1.5 will go to state coffers, leaving Rs 3.5 for OMCs.
It was feared the cut in customs duty may hit gross refining margins of standalone refiners. In fact, there will be some erosion of margins on most petro-products. But import duty on kerosene, LPG and naphtha has already been reduced to zero. For these products, standalone refiners were suffering from negative duty protection — they were paying customs duty on import of crude oil, but could not recover the same on these products. But now, this anomaly has been rectified, which will expand the margins on these three products, compensating for the loss on petrol and diesel. Crude oil producers like ONGC and Cairn will suffer slightly due to the removal of import duty on oil. The subsidy burden for ONGC has been set 73% higher, at Rs 38,000 crore, next year. But the company will still derive some benefit from high crude prices. ONGC’s realisations, which stood at $55 per barrel during FY08, may jump 23% to around $68, if current crude prices hold throughout the year.
The aviation industry has gained, with the customs duty on aviation fuel being halved to 5%. This will lead to savings of over Rs 3,000 per kilolitre of fuel consumed by local players. Cut in customs duty on fuel to 5% will benefit a wider range of industries. Experts believe this will compensate for the rise in costs due to petrol and diesel price hikes. These changes are a zerosum game as far as profitability of domestic industries is concerned. But the impact on the government’s exchequer will be quite huge. How the economy reacts to this

OMCs: Life a tad better, but losses remain

OMCs will have to absorb losses of Rs 20,000 crore

With the government coming out with some sort of a solution to the problem of mounting under-recoveries, the investors should feel relieved that the uncertainties are finally over. At the same time, they should avoid any excessive exuberance. Despite the price increase and duty cuts, the marketing operations of the oil companies such as IOC, BPCL and HPCL will continue to incur hefty losses. “It’s just that the life has become somewhat better. The immediate danger is averted, but our profitability will still depend on the oil bonds and discounts,” commented a senior officer in one of the oil marketing companies. “We estimate a net gain of Rs 8000 crore from the price increases and duty cuts for the remaining 10 months of the current year. However, the annual under-recovery is estimated at Rs 52000 crore,” commented Bhaswar Mukherjee, finance director of HPCL. As the profitability growth in these oil cos will continue to remain under pressure, high dividend yield is the only thing that will make the investors stay invested.
Of the Rs 2,45,000 crore of projected under recoveries, OMCs will realise Rs 21,123 by fuel price hike, Rs 22,663 crore from cut in duties, Rs 45,000 crore from upstream oil companies and will have to absorb losses of Rs 20,000 crore. The government has indicated that the balance Rs 1,35,000 crore shortfall will have to be financed through oil bonds. However, the issue of oil bonds will be subjected to periodic review. The adjacent table shows a likely break-up of under-recoveries of the three OMCs and the share of benefits. When asked if OMCs will continue making losses Deepak Mahurkar, associate director from PricewaterhouseCoopers says, “Difficult to guess. Losses of the refining & marketing companies will also depend on factors like cross subsidies from other products, crude oil price arbitrage, government support and cross company subsidies.”
For the investors in the standalone refiners and the private players, no bad news itself is good news. Unlike the oil marketing companies, the standalone refiners are able to sell their products at the market related prices and hence do not suffer losses. Today’s announcements about cutting Customs duty on crude oil and products would ordinarily be a negative development for this lot. “However, we stand to benefit from the rectification of the negative duty protection anomaly in case of kerosene and LPG. Till now, LPG and kerosene carried no customs duty as against 5% duty on import of crude oil,” informed L K Gupta, director finance of Mangalore Refinery. The rectification of this anomaly will more or less compensate the loss of independent refiners on reduced duties on petrol and diesel. Hence, the investors can stay invested in these companies whose gross refining margins will continue to rule firm in line with the global trends.

Not Oil’s Lost

Ramkrishna Kashelkar takes a different view of the oil sector and finds that it offers interesting investment opportunities to retail investors

OIL IS all over the place. All talk everywhere trickles down to nothing else, but crude. Even as the man on the street frets over the snowball effect of rising prices, number-crunchers work at a hypnotic pace to figure out its next milestone. And governments across the world, especially those in the developing world, shudder over the fast-narrowing options at their disposal to deal with a catch-22 situation. While the current spike in crude oil prices is hurting the industry and the economy, there are sections of the industry, which are actually gaining from the same. The market capitalisation of Cairn India has risen 18% since the beginning of May ’08, against the 7.5% fall in the BSE Sensex during the same period. Cairn India, which is developing its oilfields in Rajasthan, is likely to gain from high crude oil prices. Similarly, there are quite a few companies operating in the petroleum value chain which are likely to benefit from rising crude prices. ETIG does a value check.

India’s largest crude oil producer, ONGC, has long suffered the burden of sharing subsidy and this reflects in its stock performance. However, the company is slated to benefit from the oil production of its subsidiary, ONGC Videsh (OVL), and its share in joint ventures in India, as it can sell this oil and gas at market prices. OVL contributed over 13% to ONGC’s total production of 60.8 million metric tonnes of oil & oil equivalent gas (O&OEG) during FY07, which is expected to go up to around 20% during FY08.
Smaller companies operating in the crude oil exploration and drilling business, such as Selan Exploration, Hindustan Oil Exploration and Assam Oil, will also benefit from rising crude prices.

However, important factors, including the rate of production, in-place reserves and the government’s share under the production sharing contract (PSC), must be studied before investing in these scrips.

As the prices of petroleum products such as petrol and diesel have gone up globally in line with the spurt in crude prices, the petroleum refining business continues to earn higher refining margins.

Gross refining margins (GRMs) represent the difference between the realisation through sale of petroleum products and the cost of crude oil required to produce them.

Strong refining margins will help standalone public sector refiners such as Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery and Petrochemicals (BRPL). However, BRPL is currently facing problems of sourcing crude oil and is not able to utilise its capacities optimally. Similarly, the ratio for its merger with IndianOil (IOC) has already been fixed, which limits the returns available on the scrip.

Essar Oil has commenced commercial production at its refinery at Vadinar in Gujarat, which will start reflecting in its quarterly results from June ’08 onwards. While this will boost Essar Oil’s revenues substantially from the current levels, a similar spurt in interest and depreciation costs is also expected. Further, the refinery has a limited ability to process lower grades of crude oil and its profitability is expected to remain under pressure.
The 580,000-barrels per day (bpd) refinery being set up by Reliance Petroleum under the special economic zone (SEZ) at Jamnagar is expected to be commissioned before the end of ’08. This will not only bring in additional revenues and profits for RPL, but will also improve the bottomline of its parent company, Reliance Industries (RIL).

With the petroleum refining business remaining outside the subsidy-sharing mechanism of the government, a number of new projects are coming up in the country. BPCL’s 6-million tonne per annum (mtpa) refinery in Bina, Madhya Pradesh will get commissioned next year, while HPCL’s Bhatinda refinery in Punjab will go onstream in ’11. Considering the very high costs and delivery delays, two players, viz Cals Refineries and Nagarjuna Oil, have decided to set up refineries from second-hand equipment. Cals will set up a 5-mtpa refinery in Haldia in West Bengal, which is expected to be commissioned by ’10 and Nagarjuna Oil will set up a 6-mtpa refinery in Cuddalore in Tamil Nadu.

Even as crude prices soar to unprecedented levels, exploration activities worldwide are gathering pace. As they say, the only people who made money in the great Californian gold-rush were the suppliers of spades. Similarly, the firms helping oil companies in their exploration efforts are benefiting from the rush for crude. Over the past couple of years, these companies have been increasing their asset base, which is likely to pay off in the next couple of years.

Black Gold
ABAN OFFSHORE, which operates a fleet of 25 offshore drilling rigs required in petroleum exploration and production (E&P) activities in the deep seas, is growing fast. As the demand exceeds the availability of rigs, the charter rates for its vessels have more than doubled over the past couple of years.

Jindal Drilling, which acquired a 49% stake in Singapore-based Virtue Drilling, has posted stagnant profits over the past three quarters.

However, the company has contracts worth over Rs 2,500 crore and the arrival of its new rig in the next couple of months is likely to boost its future profitability. Seamec’s March ’08 financial performance suffered heavily as one of its clients in the US went bankrupt and two of its vessels remained dry-docked. However, things may take a turn for the better as its fourth vessel commissioned operations in March ’08. Dolphin Offshore has better prospects with three new vessels expected to join it by the end of ’08. Shiv-Vani Oil, which is India’s largest services provider for onshore exploration and production activities, is currently operating 32 rigs and expects to add another eight rigs by end ’08. The company is currently carrying orders worth Rs 3,200 crore, which are likely to go up further. Considering its FY08 turnover of Rs 410 crore, the growth opportunity is significant. Deep Industries, which originally provided solutions in natural gas compression and transmission, has now diversified into mainstream petroleum exploration. The company has obtained two marginal gas blocks and is developing them. At the same time, its charter hire business of compression equipment and work-over rigs is growing fast.

While the rise in crude oil prices has put one section of the industry under immense pressure, retail investors can find lucrative investment opportunities in other segments.

Besides the standalone refining and petroleum E&P companies, companies providing support to the E&P players also hold excellent growth prospects.