Tata Chem posts 22% lower Q1 net profit on forex losses

INDIA’S leading inorganic chemicals and fertilisers manufacturer Tata Chemicals (TCL) came out with better results for the quarter ended June 2008 compared to the same period last year. Profit from operations nearly doubled to Rs 505 crore on a consolidated basis. However, notional forex loss of Rs 129 crore has hit its net profit. The resultant consolidated net profit was 22% lower on y-o-y basis at Rs 107 crore.
The company had borrowed $825 million earlier this year to finance its acquisition of USbased General Chemical Industries (GCIP). With the rupee weakening against dollar during this quarter, the company had to provide for a notional loss on this liability. “These are notional losses and not cash expenditure. Nothing goes out due to this. We had to provide for it just because the accounting standards recommend it. Since the repayment of these borrowings begins only from 2012, we don’t find any need to hedge this position. Besides, we have dollar earnings flow from GCIP to pay off these liabilities. Hence, this is not going to affect our operationally excellent results,” said PK Ghose, finance director, Tata Chemicals.
Both inorganic chemicals and fertilisers performed well during the quarter. Operating margins in the chemicals business remained strong at 24% while fertiliser margins jumped to 20% from just 13% earlier. Homi Khusrokhan, MD, Tata Chemicals, said: “The recent change in the fertiliser policy allowing phosphatic fertilisers to receive subsidy based on import price parity, helped the company in improving margins.”

PMT gas boosts Gail profits

GAIL, India’s largest natural gas transporter and marketer, reported a 31% jump in its net profit to Rs 897 crore for the quarter ended June 2008. The supply from Panna-Mukta-Tapti (PMT) fields boosted Gail’s performance in this quarter.
Gail was appointed the government’s nominee since April 2008 to market 17.3 million cubic metres a day (mcmd) gas produced from these western offshore fields. On the other hand, high petroleum prices helped the company’s LPG and petrochemicals segments perform better.
Gail’s subsidy burden for the quarter jumped 43% to Rs 388 crore compared to the corresponding quarter of the previous year, however, it remained stagnant over the immediate preceding quarter.
Thanks to the availability of additional gas, Gail’s natural gas sales jumped 17.2% to 79.81 mcmd during the June quarter while the natural gas transmission volumes grew 7.4% to 84.48 mcmd.
This helped the natural gas trading business to post 284% jump in earnings to Rs 95 crore. The growth in the transmission business was lower at 18% to Rs 433.7 crore.
The soaring prices of petroleum products helped the petrochemicals and LPG businesses to post healthy growth figures despite stagnating volumes. LPG and liquid hydrocarbons sales volumes dipped 2.3% to 3,46,000 tonne during the quarter as Gail had to shutdown its Vijaypur plant for around 15 days for maintenance. The profit in this segment reported a 60% jump on the back of just 25% growth in sales.
Similarly, the growth in PBIT (profit before interest and tax) for the petrochemicals division was higher at 28% compared to the sales growth of 20%. The sales volumes of polymers were down 1% at 1,04,000 tonnes.
Gail reported a 35% growth in net sales at Rs 5,731 crore with operating profit margins staying flat. Other income jumped 26%, while interest and depreciation charges stagnated.
The resultant pre-tax profits were 40% higher on year-onyear basis. However, as the effective rate of tax rose to 33.7% from 29.3% earlier, Gail’s net profit grew by 31% to Rs 897 crore.

Vinati Organics to hike specialty chem capacity

VINATI Organics, a Mumbai-based chemical manufacturer, is tripling its capacity of specialty chemicals that are widely used to make high grade polymers for the exploration industry, at a total cost of Rs 40 crore. “We will become the world’s second largest producer of 2-acrylamido 2 methylpropanesulfonic acid once our capacity triples to 12,000 tonnes by October this year,” said executive director, Vinati Saraf. The company will finance the expansion through a combination of a $6-million FCNR loan and through internal accruals.
The specialty chemical is the main raw material used to make water-soluble polymers for the enhanced oil recovery process in petroleum exploration and production. Demand in India for ATBS is limited and about 95% of the total production of the chemical is exported. Acrylonitrile and isobutylene are the key inputs for this chemical which are derivatives of petroleum crude, the price of which has shot up globally. “Our contract with clients are linked to the cost of raw materials. Hence, higher costs can be transferred to customers,” said Ms Saraf.
On Friday, Vinati Organics said it will increase its product prices by Rs 25 per kg from August 1, due to a 25% rise in prices of raw materials such as toulene and propylene, potassium carbonate and also due to a rise in energy costs.
The company has already emerged as the world’s largest producer of isobutyl benzene, which is the key raw material in the manufacture of ibuprofen, a widely used anti-inflammatory drug. The total demand of ibuprofen is estimated at around 22,000 tonnes globally, translating into a consumption of around 17,000 tonnes of IBB. VOL’s IBB sales totalled 11000 tonnes or 65% of the global demand last year. Ibuprofen is mainly manufactured in India, China and the US.

Subsidies to take the sheen off ONGC’s windfall gains

INDIA’S largest profit making company — Oil & Natural Gas Corporation (ONGC) — is not likely to generate much excitement when it publishes its June 2008 quarter numbers on Monday. Since the company has to share a chunk of the under-recoveries suffered by the oil marketing companies by offering discounts, it will not gain much from the high crude oil prices during the quarter. For example, during March 2008 quarter ONGC reported a 2% fall in profits, despite a 65% jump in crude oil prices compared to the year-ago period.
Although the company has to share the subsidies, the unpredictability and ad-hoc nature of the subsidy sharing mechanism creates a major problem in projecting ONGC’s quarterly results. Almost all the brokerages are expecting just a single digit growth in the quarterly profits of the oil behemoth.
Brokerage firm Prabhudas Lilladher said in a report: “ONGC is in a sweet spot as crude prices continue to touch new highs. Cash flows remain very strong, although 80-90% of the upside is taken back in the form of subsidising the losses of marketing companies.” However, Religare Securities expects ONGC’s subsidy burden to rise if the crude oil prices continue to rise. “According to the latest policy, the upstream sector is expected to share a total subsidy burden of Rs 45,000 crore in FY09. However, this was calculated at a price of $123/ barrel, which has risen to over $146. We thus expect the subsidy burden from upstream companies like ONGC to go up,” mentioned one of its recent reports. The current crude prices are around $125 but were much higher during the April-June quarter.

Interview-Tata Chemicals: The Right Equation

Fertilisers are India’s lifeline. With enhanced availability of natural gas, India can create new capacities in urea, become globally competitive and reduce its dependence on imports

A BILLION-DOLLAR acquisition, capacity expansion and diversification into biofuels — Tata Chemicals (TCL) has seen it all in a short period of time. In a free-wheeling chat with RAMKRISHNA KASHELKAR, TCL’s managing director HOMI KHUSROKHAN discusses what lies ahead for the company...

Rising soda ash prices don’t seem to have improved the performance of your chemicals business in FY08. How does the scenario look like in the current fiscal?
There were three specific reasons for the deteriorating performance by the chemicals business in FY08. First, a provision of Rs 75 crore had to be made for pension funds in the UK. This issue was not connected to the company’s operations. Second, there were delays in ramping up volumes at the new pharma-grade sodium bicarbonate plant in the Netherlands, as well as delays in starting the pure ash plant in Kenya. And finally, last year, the production at our Mithapur facility was affected due to an excessively heavy monsoon, which diluted the brine. These one-time problems are now past us and going forward, we see favourable trends emerging, such as the appreciation of the yuan against the US dollar and rupee, and relatively higher energy prices compared to freight rates. On both these counts, we stand to gain as an integrated global business.

What is your outlook on the global soda ash industry?
The spot price of soda ash has jumped to as high as $450 per tonne, thanks to healthy demand growth. The outlook is still very positive as the slowdown in the US economy has been compensated by growth in developing economies, where demand is being driven by the requirements of the glass industry, particularly architectural glass. Some of the Chinese capacity, which had been flat over the past two years due to relocation of some companies, is expected to be back on stream by the end of this year. But so far, indications are that all the incremental capacity in China is being absorbed internally due to the country’s brisk economic growth and its ambitious plans for infrastructure development. We expect the current demand-supply scenario to be maintained for at least another couple of years.
However, here one needs to understand that high soda ash prices are attributed only to the spot market. Most of the business in this industry happens on long-term contracts. Over 80% of our European soda ash business and nearly half of our Indian soda ash business is on yearlong contracts. Hence, the benefit is proportionately lower. Further, one cannot ignore the rising costs of inputs and freight, which are also responsible for driving up prices. We have succeeded in maintaining absolute margins, but percentage margins have fallen.

How are the soda ash plants in Kenya progressing? Have you reached full capacity utilisation levels?
We have two plants in Kenya, one produces natural ‘standard ash’ and the other produces ‘pure ash’, where we eliminate the naturally occurring sodium flouride in the trona (which is the naturally occurring soda ash in mineral form). The older standard ash plant has performed extremely well, at over 100% of its capacity, but we have had a series of problems with the new plant even after it was commissioned. The political disruptions towards the end of ’07 delayed commissioning and the plant operated at less than a quarter of its rated capacity during FY08. Today, the situation has improved and on an average, we run at between 55% and 60% of capacity. So, overall, we now operate at around 75% of the total capacity at Magadi, which is much better than last year. Additionally, out of our overall capacity of 5.5 million tonnes (mt), about 0.7 mt or 12.7% (i.e. 0.35 mt in the Netherlands and 0.35 mt in Kenya — the new pure ash capacity) is being affected by high energy costs, which depresses performance to some extent. We are taking steps to switch the new pure ash plant — which was earlier powered by fuel oil, the price of which has risen considerably over the past few months — to solid fuel.

How do you view the fertiliser industry in India?
This is a lifeline industry and its importance will grow with time, as the demand for food rises across the world. With the enhanced availability of natural gas, India can now create new capacities in urea, become globally competitive and reduce its dependence on imports (which have been rising of late). The industry has been assured that a new urea policy — which encourages fresh investment in urea capacities — will be announced soon. In case of the phosphatics policy in June, the announcement of import parity pricing was most welcome and will provide the industry much-needed relief. It will also give the domestic fertiliser industry an opportunity to grow by aligning itself to the global market place. However, the industry’s ability to tie up key raw material supplies such as rock phosphate or phosphoric acid will be critical, since these inputs are not available in India.

Tell us more about your ‘Khet Se’ initiative…
For several years now, we have seen ourselves as a company that does more in the rural space, than just manufacturing and selling fertilisers. In our 600-odd ‘Tata Kisan Sansar’ outlets, we have now widened our offerings to services like soil-testing, farming advice, facilitation of crop loans, insurance, etc. Moreover, by building new businesses like ‘Fresh Produce’ on this platform, we will, in effect, be co-creating value with farmers, which is the actual purpose for our being in this business. Our model for the ‘Fresh Produce’ business goes far beyond just wholesaling of agri-produce. We work with farmers to improve the quality and yield of their produce. We advise them on better farming practices, correct harvesting time, cleaning and quick transfer to our cold storages etc. We also help to reduce wastage and most importantly, we ensure that farmers receive the right value for their produce. As of now, only one centre is operational in Punjab, and the other is being set up in Maharashtra. We partnered with Total Produce of Ireland because it has over 100 years of experience in this business and its learnings have been very valuable for us. We plan to set up around 30 such centres over the next three years. In some states, there are restrictions on a corporate marketing agricultural produce and hence, our progress will depend on obtaining the required permissions. On an average, these centres will need investment of Rs 10-20 crore each, depending on their size.

You are also setting up India’s first sweet sorghumbased ethanol plant. What were the reasons behind entering the biofuels space?
Biofuels is an area which will become increasingly important for energy security, as reserves of fossil fuels diminish and prices climb. After experimenting with various feedstocks, we found that sweet sorghum was an excellent choice as a starting material. It is a four-month crop, grows well in semi-arid climates and uses far less water than sugarcane. Our initial choice of this feedstock was also based on the premise that our bio-ethanol will be competitive even at crude oil price of $65/barrel. However, over the long term, we feel that the best feedstock for bio-ethanol will be biomass from agriwaste, and conventional feedstock like sweet sorghum will help us gain an early entry into the bio-ethanol segment. The ultimate goal for most companies engaged in biofuels today will be the enzymatic conversion of lingo-cellulosic material and our innovation centre is working on these new technologies. We are setting up a pilot plant with a capacity of 30,000 litres a day in Nanded, where the feedstock is easily available. The plant can be further scaled up to 100,000 litres per day, based on its success.

RIL net fails to sparkle despite oil price rise

INDIA’S largest private sector company Reliance Industries’ (RIL) June 2008 quarter results were nothing to cheer about. The company posted a 13% growth in net profit to Rs 4,110 crore on revenues of Rs 41,579 crore, up 41%. The operating profit margin took a hit, as both its major segments — petroleum refining and petrochemicals — registered a fall in margins. The company apparently did not book any inventory gains during the quarter despite a nearly 30% jump in crude oil prices during the quarter. Oil and gas, mainly from the Panna-Mukta fields, was the only segment which performed well. The performance of RIL’s refining business did not benefit from the rising prices of crude oil and petroleum products. Gross refining margins (GRMs) were almost flat during the quarter at $15.7 per barrel compared to $15.4 in June 2007. While revenues from the refining business jumped 46% during the quarter, profits from the segment rose just 19%, indicating an erosion of margins. The refinery operated at a 98.5% capacity utilisation level, with the crude throughput rising 1.5% to 8.13 million tonne. As expected, RIL’s petrochemicals business witnessed a fall in profit, thanks to higher naphtha prices, which spurted nearly 40% during the quarter to $1,230 per tonne. The segment profit fell 14% despite a 13% increase in sales revenues. The ratio of PBIT-to-netsales fell 340 bps to 10.6% while the volume increased 4% to five million tonne. As global energy prices shot up, RIL’s revenues and profits from the oil and gas segment, too, rose. This was the only segment, which witnessed a gain in profit margins, going up to 63.9% from 56% in the corresponding quarter of the previous year. Low-tariff play helps Bharti Airtel
THE game of reducing tariffs seems to have worked in favour of Bharti Airtel, the largest mobile operator in the country. Though it reported a 2% drop in average revenue per user (ARPU) during the June 2008 quarter, the higher minutes of usage more than compensated this fall. This helped Bharti maintain its growth momentum in topline, which was well above the expectation.
Despite impressive numbers, Bharti’s scrip witnessed a selling pressure in a weak market on Thursday. On BSE, the stock declined 2.2% compared to a 1.1% fall in the Sensex.

Govt looks to dip into RIL’s diesel exports

2 MT OF DIESEL TO FEED DEMAND

FACED with unprecedented growth in the demand for diesel, the government is examining the possibility of diverting to the domestic market 2 million tonnes out of the 11 million tonnes a year of diesel that Reliance’s Jamnagar refinery exports. The proposal also envisages extending deemed export status to such domestic sales, on the lines of the benefit extended to the Jamnagar refinery’s sales of cooking gas (LPG) to the domestic market. The proposal envisages a sale price for such diverted diesel which is below the price of imports, offering savings to the oil marketing companies, and higher than the export price, offering gains to Reliance as well.
This proposal has been put forth by the oil industry body, Petrofed, which has urged both the commerce and finance ministries to examine the issue. RIL’s Jamnagar refinery is a 100% export-oriented unit (EOU). It enjoys tax concessions on exports. RIL would lose some EOU benefits if exports were to be diverted to domestic sales, without giving such sales deemed exports status.
It may be recalled that the Samajwadi Party general secretary Amar Singh had included the cancellation of EOU status for refineries as one of the measures to resolve the domestic oil crisis. The proposal on the table does not tamper with the refinery’s EOU status. Petroleum ministry officials are not opposed to the idea put forth by the industry. “We have no issues on the proposal of diverting some amount of diesel from the EOU refinery to the domestic market. It is up to RASHMI the commerce and finance ministries to work out the arrangement,” an official said. Sources said the matter had been discussed informally with RIL which is willing to consider the proposal if it is tax-neutral. Said a senior petroleum ministry official: “The tax incidence for RIL would work out to be around Rs 2.71 per litre on diesel. This will have to be waived if we were to ask RIL to sell in the domestic tariff area.” Normally, domestic sales from an EOU have to bear Customs and excise duties on the product, besides income tax on their profits. “We have written to Director General of Foreign Trade to examine whether a small amendment can be made by which RIL could help meet some part of the growing diesel demand,” a PSU oil honcho said. Diesel demand has been growing at over 25% over the past 3-4 months. A portion of the shortage, to the extent of spot purchase from the global market, is what the industry wants to procure from RIL.
Oil companies, which have been importing cargoes to meet the increased diesel demand, say that getting the fuel from the spot market often turns out to be more expensive and may even not be available. “RIL can divert about 2 million tonnes as of now to plug this gap,” a source said. The industry would like RIL to sell diesel in the domestic market at a weighted average of export and import prices, called the trade parity price. For the PSU oilcos, buying from RIL at trade parity prices would mean a saving of Rs 1,000 per tonne on the cost. For RIL too, selling at trade parity should be higher than exporting.

FREQUENT FUEL PRICE REVISION
The BK Chaturvediheaded panel on fuel subsidies is believed to have concluded that fuel prices should be revised more frequently, but in modest measures to keep domestic prices in line with global trends.

Inventory gains to lift RIL profit
INVESTORS and analysts are keeping their fingers crossed as they await the quarterly results of India’s largest private sector company — Reliance Industries (RIL). Analysts expect RIL’s profit growth to vary substantially between 9% and 30%. In fact, a customary Bloomberg survey revealed that analysts expect a 24% profit growth over the year-ago period, while a similar exercise by Reuters came out with a much lower profit growth expectation of 14%. A lot will depend on how the company has treated its inventory gains and whether it has suffered any forex losses. Although there are differing views on RIL’s Q1 profits, most agree that RIL’s refinery business will put up a good show, while the petrochemicals business will suffer. While gross refining margins (GRMs) have remained strong globally during the quarter, margins in petrochemicals business have weakened due to high naphtha prices. Petroleum refining contributed around 64% to the company’s total revenues in FY08 against 34% from petrochemicals. “We are expecting RIL to post $16/bbl GRM in the June 2008 quarter. The petrochemicals margins will be lower due to high naphtha prices, but the net profit should jump 27% to Rs 4,150 crore. The future outlook is positive for the company due to production from KG basin and Reliance Petroleum (RPL) to start production from Q3FY09,” said Sudeep Anand, research analyst working with Religare Securities. The private sector refiner is expected to benefit from the rise in the prices of crude oil and petroleum products during the June 2008 quarter, allowing it to book inventory gains. “It is mainly inventory gains that are pushing up GRMs of Indian refiners. When RIL publishes Q1 results on Thursday, we believe they may choose not to account for these inventory gains because of fear that high profits could invite a tax on windfall gains,” felt an industry observer.
“We are estimating $18-$19 as GRMs for RIL. However, they could cross $20 depending on inventory gains.
On the other hand, profit from petrochemicals should be lower than the previous quarter,” said a research analyst working with a Mumbai-based international investment bank. Going forward, two major projects are scheduled for commissioning over the next six months, which will drive profit growth for the company. RIL’s 70% subsidiary, RPL, is set to commission its 580,000 barrels per day (bpd) refinery, while its KG basin natural gas fields are likely to commence production anytime soon. On Wednesday, RIL scrip gained 5.16% to Rs 2,265 in a euphoric market, when the Sensex spurted 5.94%.

REFINED PLAY
Analysts expect net growth to vary between 9% & 30% Co to benefit from rise in prices of crude oil and petroleum products Refinery business to put up a good show, but petrochem may suffer, feel analysts

Reliance Petroleum: As Good As It Gets

Though Reliance Petroleum’s upcoming Jamnagar refinery enjoys many advantages, its current valuations have limited upside left

DESPITE A DECLINE in investors’ confidence in the stock market and the turmoil in global financial markets over the past six months, there remain a few events which are eagerly awaited by all. One such event is the commissioning of Reliance Petroleum (RPL)’s refinery in Jamnagar special economic zone (SEZ) — which is being tracked not just by its 2 million shareholders and stock market experts, but by global energy analysts as well.
The project is expected to serve as an example for its speed of execution, low capital cost and high complexity. However, the strength in global gross refining margins (GRMs) is unlikely to persist going forward, due to rising refinery capacity across the world. Though the positives associated with RPL’s refinery are obvious, we believe its current valuations have limited upside left.

ADVANTAGES GALORE
• Low Capital Cost: RPL is being set up at a capital cost of only Rs 27,000 crore, i.e. around $6.5 billion, but a similar-sized refinery will currently require almost twice this amount. This is due to the fact that over the past three years, a number of refinery projects have been launched across the world, resulting in higher costs of equipment and engineering services.
• Fast Project Execution: The project was originally scheduled to be completed in 36 months by September ’08, with commercial production due to start in December ’08. However, the company intends to prepone the deadlines. It has already completed more than 90% of the work and the pre-commissioning activities in the main process units are progressing rapidly.
In fact, Mukesh Ambani assured shareholders at the company’s annual general meeting (AGM) last month that “the refinery is expected to be completed ahead of schedule.” • Ability To Earn Higher GRMs: RPL’s refinery will have the ability to handle very heavy and high sulphur crude to produce the best quality products. Similarly, its product slate will be better, thanks to its ability to totally eliminate lowvalue products such as fuel oil. Considering that the heavy-light differential in crude prices has reached $20 a barrel, RPL will be able to earn higher GRMs compared to its peers.
• Tax Sops: The SEZ location and focus on exports will exempt RPL’s profits from income tax (IT) fully for the first five years. The I-T exemption will be 50% for the next five years.

LIMITED UPSIDE
After enjoying a high tide in the past few months, Asian GRMs are now weakening. The International Energy Agency (IEA) in its monthly report for June ’08 elaborated on this fact. “While diesel remains highly profitable, gasoline cracks remain subdued and fuel oil cracks have reached record lows.” Even production of naphtha is generating losses. When overall GRMs turn weak, it is feared that commissioning of RPL’s refinery will lead to a glut situation, thereby further bringing down GRMs. The supply from RPL’s new refinery will represent almost 50% of the estimated incremental global oil demand in ’09. Nearly 2 million bpd of global refining capacity (including RPL) is expected to commence in ’09, which will weigh heavily on the GRMs. RPL operates in a business where there is little scope for volume-led growth compensating for a fall in margins. Hence, if GRMs turn weak from the current levels, the company’s bottomline may shrink.

VALUATIONS
We estimate the refinery will earn a premium of around $9 per barrel over Singapore benchmark complex refining margins, which are expected to remain at around $8 per barrel during FY10.
Considering interest and depreciation charges, the company’s full-year net profit at 85% capacity level will stand at Rs 6,365 crore. This translates into a price-to-earnings (P/E) multiple of 10.9 on the current market price of Rs 154. Since petroleum refining is a capital-intensive cyclical business, it has traditionally commanded a single-digit P/E globally.
Another way of looking at valuations, is the replacement cost of the refinery. RPL’s current market capitalisation of Rs 69,300 crore is around 38% higher than the estimated cost of setting up a similar refinery. Similarly, at current m-cap, RPL’s enterprise value (EV) is 8.5 times its estimated EBIDTA for FY10, which is slightly on the higher side compared to the global average. Hence, we believe that the upside in RPL’s scrip is limited in the short run.

DOLPHIN OFFSHORE: Swim With The Tide

Dolphin Offshore has scaled up its business, with new vessels set to join its fleet in FY09.The stock offers growth opportunities for long-term investors

DOLPHIN OFFSHORE (DOL) provides marine engineering services to the offshore oil & gas industry. It had a tough FY08 due to unpaid dues by its key customer, weak dollar and adverse weather. But it has scaled up its business, with new vessels set to join its fleet. This offers good growth opportunities in future. Long-term investors can consider the stock.

BUSINESS:
DOL executes offshore engineering turnkey contracts for petroleum companies, involving installation, inspection, maintenance, repairs etc. From being a provider of diving services, it has become an independent EPC contractor. It owns 14 vessels and has ordered two workboats and one construction barge, to be delivered in H2 FY09. It has seen a rise in average ticket size of contracts. It has a long list of successful contracts, mainly with ONGC. It has also tied up with foreign companies for technical support. It plans to diversify into ship building and repair, and obtained the Gujarat government’s nod for a shipyard at Jafrabad. Total investment outlay for its ship venture is Rs 400 crore.

GROWTH DRIVERS:
Due to a boom in offshore exploration, demand for DOL’s services is strong. ONGC is investing $3 billion to overhaul its ageing infrastructure. Considering DOL’s proven track record, eligibility to bid and arrival of new marine assets, it’s likely to emerge as a major beneficiary. It will also be able to bid for contracts in the Middle East. The rupee’s recent depreciation is favourable for DOL. It expects to recover Rs 38 crore outstanding from L&T on account of an ONGC contract.

FINANCIALS:
The company has posted a CAGR of 78% over the past five years, while its revenues grew 49%. DOL’s RoC has declined, as the $15 million it raised via FCCBs is tied up in the new vessels it ordered. Despite a boom in offshore exploration, DOL suffered in FY08. Outstanding dues from a couple of ONGC’s contracts increased its debt burden, while adverse weather cut the offshore working season to 5.5 months, against the normal 7-8 months, leading to delays. Profit growth mainly came from extraordinary profits from sale of two vessels.

VALUATIONS:
We expect DOL to put up a better performance this year. It is likely to post a turnover of Rs 320 crore in FY09, with operating profit margins of over 18%. Net profit is set to grow over 62% to Rs 25.5 crore. The CMP of Rs 169 discounts the projected FY09 earnings 7.9 times, considering fully diluted equity of Rs 11.96 crore. This is less than half its five-year average P/E of 16.2 and lower than P/E of Garware Offshore (8.6) and Great Offshore (11).

RISKS:
DOL has a debt-equity ratio of around 2. Timely delivery of new vessels, success in recovering dues from L&T and securing new contracts will affect DOL’s profit growth.

Interview- ONGC: Oiling The Wheels

ONGC CFO DK Sarraf feels the co’s biggest challenge is the uncertainty & opacity surrounding huge oil subsidy

Being the finance director of the biggest oil producer in the country, can you elaborate on the immediate challenges ONGC is facing?
We are currently passing through a unique phase in our history. On the one hand, crude prices are going up, raising investors’ expectations regarding topline and bottomline growth, in line with the returns generated by other domestic or global oil producers. On the other hand, the company is burdened with subsidies, even as domestic production is stagnating partly. In fact, even maintaining the production from our old fields requires heavy investments.
Competition in the exploration business is growing, while the assets carrying out exploration work have become scarce. Scarcity of talent has also emerged as a key issue with substantial increase in exploration activity globally. Liaisoning with the government for various issues such as subsidies is another challenge.

You have been in talks with the government over the issue of subsidies for a long time. When can we expect a solution for this issue?
Yes, subsidy-sharing remains a bone of contention between the government and ONGC. However, disagreement is more on the method, rather than its validity. With crude oil prices soaring, we are generating additional profits.
Hence, we do not mind sharing a part of that with the government. However, what we seek is a transparent mechanism. Today, we get to know our share of subsidy some time after the quarter ends, which we want to change.
We have proposed that the government should decide a level of crude oil prices for which no subsidy will be required. And whatever be the incremental realisation, let the government retain a large portion of that as subsidy.
This way, we will have sufficient revenues to take care of increasing costs and bring in visibility on our future earnings and profits. Visibility on future earnings is important for investors as lack of it increases risk. This clarity will attract better valuations for ONGC. The government is paying attention to our problem and it has set up the Chaturvedi committee to look into the matter. Mr Chaturvedi was earlier the petroleum secretary and is well aware of the industry’s problems. We have already sent our recommendations to the committee with supporting data. We are hopeful of a solution soon.

Crude prices have nearly doubled over the past one year and continue to increase by the day. What is your view on the current crude price rally? Is it sustainable in the long run?
It is difficult to hazard a guess on crude oil prices. While demand-supply forces are affecting oil prices, speculation is certainly adding fuel to the fire. However, I think that crude oil prices will remain firm, as we don’t see any big increase in supply in the near future. Ultimately, crude prices will fall for sure, because when they increase beyond a point, the burden will be shifted to consumers. Once that happens, consumers will shift towards conservation — either improving efficiencies or cutting down on consumption altogether — and this will bring down prices, though it is difficult to guess to what extent.

Despite being out of the subsidy-sharing burden, why didn’t ONGC Videsh (OVL) gain much from rising crude oil prices in FY08?
Higher crude oil prices did benefit OVL. Its profit after tax (PAT) for FY08 rose 44% to Rs 2,397 crore. And this was despite paying Rs 725-crore interest to ONGC, which was not paid in the previous year. Further, OVL wrote off Rs 627 crore of depreciation on pipelines due to a change in accounting policy last year. Also, some provisions were created for its exploration projects, mainly in line with our conservative accounting policy. These provisions can be written back in future, based on the exploratory successes. If you consider these factors, you will notice a big jump in OVL’s profit.

Are high crude oil prices affecting OVL’s investment plans in oil fields?
High oil prices are creating many complications in valuation of assets. The sellers are asking for higher valuations, while as a buyer, we have to be more prudent. In that respect, it has become more difficult to strike a deal as a buyer. However, the deals are still being struck, though it is becoming more and more difficult to convince sellers of the valuations. Again, convincing ourselves of the new reality is also difficult.

What is your outlook on OVL’s production?
OVL’s production has been growing at a fast pace over the past few years. In FY03, it didn’t produce anything, but today, OVL’s production has crossed 8.8 million tonnes of oil equivalent (mtoe). During FY08, OVL’s crude oil production grew by around 18% to 6.81 mtoe and total production was up 11% to nearly 8.8 mtoe.

It’s A Balancing Act
HOWEVER, PRODUCTION may stagnate in FY09, as the existing fields have reached a plateau and no new fields are scheduled to commence production. That is, of course, provided we don’t make any acquisition. In the first half of FY10, OVL’s Brazil block is likely to start production. Similarly, our blocks in Egypt and Myanmar will commence production over the next couple of years. Besides, there are a number of exploration blocks in various stages of development and the option of acquisitions is always open.

OVL has been acquiring oil fields in the past. What is your financial strength for similar acquisitions in future?
ONGC’s balance sheet is quite strong with net worth of Rs 75,000 crore. It is a debt-free company with high cash reserves. This gives us a strong leverage of over Rs 1 lakh crore to finance our growth plans as well as acquisitions.

ONGC’s production has remained stagnant for the past few years. How do you expect your crude oil production to increase in India?
All of ONGC’s producing fields are old, wherein the production is naturally declining. Hence, a lot of investment is needed just to maintain the production. The costs of production, repair and maintenance are also high. Despite this, ONGC is wonderfully maintaining its production. Due to our exploration efforts, we have achieved a reserve replacement (RR) ratio of over 1. Higher reserve accretion than our production means that we won’t run out of oil soon. Going forward, we have three long-term strategies to improve our production.
Firstly, we want to add 20 billion tonnes of oil equivalent reserves by ’20. Secondly, we will take the oil recovery factor to 40% from 28%. So, we will produce more oil from each of our current fields.
Thirdly, we are looking at overseas assets for production growth. Our stated goal is to produce 20 million tonnes overseas by ’20, but we may even achieve this goal earlier. For the short term, redevelopment of older fields, marginal fields and Rajasthan fields, wherein we hold 30% stake, will lead to production growth for ONGC.

What is your dividend policy? Considering that ONGC is a cash-rich company, will it continue to declare hefty dividends as in the past?
As per government guidelines, we need to pay 30% of our profits as dividend. However, our dividend payout ratio is close to 50%. We are the largest dividend-paying company in India and since we have surplus money, we follow a liberal dividend policy. Going forward, we intend to maintain our dividend payout ratio.

Considering that the government has imposed restrictions on the company’s profitability, what is your message to ONGC’s retail investors?
If we compare ONGC with global oil majors, most of them do not have a high RR ratio. Our RR ratio has stayed above 1 in the past four years, which indicates that we are adding more to our reserves than our annual production. This ensures long-term future production growth.
While global oil companies are witnessing a fall in production, ONGC’s total production is increasing. The only problem is ad-hoc subsidies, which we are trying to do away with.
However, if we club together the profits of ONGC, OVL and Mangalore Refinery and Petrochemicals (MRPL), we see our consolidated profits growing steadily in future. Besides, we also have a consistent dividend policy. Hence, I believe retail investors should not be concerned with the short-term fluctuations in ONGC’s share price.

Crude woes to hit oil cos’ June numbers

THE petroleum industry has been in the limelight for most of the last quarter, thanks to the sustained growth in crude oil prices which gained nearly 30% between April and June 2008. In the first week of June, the government allowed some increase in retail prices of petroleum products and adjusted duty structure to absorb a part of the impact of rising crude oil prices. However, this is hardly going to benefit the Indian petroleum industry, when they publish their quarterly results for the period ended June 2008.

Upstream Oil
India’s largest petroleum producer ONGC is unlikely to emerge a winner, as it needs to share a part of the subsidy. Most brokerage houses, including Prabhudas Leeladhar, Religare and CLSA, among others, expect a single-digit growth in ONGC’s net profit in the quarter ended June 2008.
High crude oil prices are likely to benefit private sector producer Cairn India in improving its quarterly profit. However, they will have little meaning, considering the fact that the company’s valuations mainly depend on its crude reserves and future production from its Rajasthan fields.

Standalone Refining
The gross refining margins (GRMs), which represent the differential between petroleum product prices and the cost of crude oil, remained strong during the June 2008 quarter due to high diesel prices, benefiting the standalone PSU refiners such as MRPL and Chennai Petroleum, besides Reliance Industries and Essar Oil in the private sector. The analyst community is expecting sterling performance from RIL, which derives nearly two-thirds of its revenues from petroleum refining business. “We expect RIL to report GRM of around $16.5/bbl,” mentions a Motilal Oswal report. Most brokerage houses are expecting RIL to turn in profit growth of 23-27%. However, weak margins in the petrochemicals business could eat into RIL’s profits. Hence, taking a cautious view, CLSA and Morgan Stanley have projected just 9-12% profit growth for RIL in Q1 FY09. Essar Oil’s refinery commissioned commercial production this quarter, which means it will start reporting profits. Similarly, companies such as MRPL and Chennai Petroleum would report healthy results in the quarter.

Refining and Marketing
India’s state-owned oil marketing companies — Indian Oil, BPCL and HPCL — continue to suffer from under-recoveries and their profitability will remain unpredictable till the timing and quantum of oil bonds are known. “For the past two years, the government did not issue any oil bonds in the first quarter. It issued oil bonds in the second quarter for both first and second quarters,” noted the Motilal Oswal report. As a result, most brokerage firms expect the losses of OMCs to widen. CLSA mentions, “We expect the R&Ms to report aggregate losses of Rs 24,000 crore despite higher refining margins and inventory gains due to spiralling under-recoveries and lack of oil bond support." Exploration support industry
The companies providing support to petroleum companies in exploration activities are likely to post good numbers. Companies such as Aban Offshore, Shivvani Oil, Asian Oilfields and Deep Industries may turn out surprises. Morgan Stanley expects Aban’s Q1 profits to triple, while Citi’s projection is a modest 57% growth and Religare’s just 35%. Other companies in this space, such as Garware Offshore and Great Offshore, too are expected to do well.

Gas Transportation
The results of most of the gas transporters are unlikely to be exciting. India’s largest gas transporter GAIL will continue to reel under the pressure of subsidies. “While higher gas transmission volumes will allow GAIL to offset the impact of the gas price increase (which impact petchem and LPG margins), leading to a 25% Y-o-Y rise in core EBITDA, subsidy sharing is expected to double during the June 2008 quarter to Rs 550 crore. This will restrict net profit growth to a modest 2% Y-o-Y,” mentions CLSA’s report. Smaller players such as Gujarat Gas, Indraprastha Gas and Petronet LNG are likely to report profit growth of around 10%. Gujarat State Petronet could turn out to be an outperformer in this league.

Interview-Petronet LNG: All Ready To Roll

Petronet LNG hopes to ride the expected boom in LNG capacity in India. CFO A Sengupta elaborates

Tell us about the current global LNG scenario. What kind of changes do you see in the way business is shaping up over a period of time?
LNG is nothing but natural gas. Just for transportation purpose, we need to liquefy it. Natural gas demand is increasing throughout the world, thanks to two reasons. Firstly, it is very clean fuel and secondly, wherever it is used, the efficiency improves. Today, there are three distinct LNG markets in the world. Asia Pacific includes Japan, Korea, Taiwan, China and India. Then there are the European and the US markets.
Over the next 10 years, while the global LNG supply will double, we believe both Europe and the US will get flooded by piped natural gas. Europe already has pipelines supplying gas from Russia, while another one is being built from Algeria in North Africa to Italy. Similarly, Nigeria is likely to get connected with Europe soon. Across the Pacific, the US is witnessing growing natural gas supplies from Canada.
These pipeline projects will stagnate the LNG demand in these regions over a period of time. As a result, the Asia Pacific region will emerge as the major demand hub for LNG. Even logistically, this region is placed favourably with regard to the two major LNG producing hubs — Middle East and Australia. Over the next 10 years, Australia is likely to emerge a major LNG supplier with a liquefaction capacity of around 50 million tonnes.

Gas availability in India is likely to go up substantially in the next few months. In such a scenario, will there be sufficient demand for costly LNG?
It is true that the availability of gas will go up in future. However, the main question is: by when and how much. If the availability increases by say, 120 million standard cubic metres per day (mmscmd) of gas within the next one year, then, yes, we will have a lot of competition. However, if it goes up in phases over a period of 2-3 years, the likely growth in demand will be higher.
Our estimates, as well as the government’s data, show that by ’12, the domestic demand for natural gas will be 283 mmscmd and domestic supply will be 180 mmscmd. Hence, imported gas will have to fill up the gap, which is huge. Again, if there is any problem in the short term, it will only affect the spot cargos, because our longterm contracts have back-to-back long-term sell arrangements.

You are doubling your current LNG capacity to 10 million tonnes by next year. What is your strategy to ensure sustained capacity utilisation?
The expansion of our Dahej terminal will be completed by the end of ’09. We already have a 7.5-mtpa contract with RasGas, of which, 2.5 mtpa will start flowing in when the expansion is over. We have also approached various other suppliers for middle-term contracts and we are hopeful of securing some of them. Otherwise, the spot cargo potential is always there. Hence, I don’t think Dahej will remain under-utilised at all. For long-term contracts, we will import only if we have back-to-back sell agreements, as the exposures are very high. However, in future, we will not book our entire capacity with long-term contracts, which takes away flexibility from the business. When the volumes are very high, any downstream disturbance may have high repercussions, as all our contracts are take-or-pay contracts.

When will the RasGas contract come up for price revision? Considering the current high energy prices, what will be the likely impact?
It’s due on January 1, ’09. However, it’s not price revision. The formula remains the same for 25 years, which is linked to Japanese Crude Cocktail (JCC). It’s just that for the first five years, the reference JCC price was fixed at a certain level, which will go out from ’09 and the formula will be followed. However, there is a cap and a floor price, so it will remain within that. Similarly, the five-year average JCC price is taken for reference. Hence, the current spurt in energy prices won’t have any immediate impact on the LNG contract prices. At the same time, thanks to the back-to-back selling arrangements, we won’t see any change in volumes.

What is the current status of your Kochi LNG project? Have you tied up for the LNG supply? What kind of return on capital do you expect from it?
We have already started awarding contracts for the 5-mtpa Kochi LNG terminal, which is scheduled to come up by end of ’11. We have split up the entire project into three distinct parts, viz, storage tanks, marine work and vapourisors. Since the storage tanks are highly specialised equipment, we have already placed orders for the same. For the other two facilities, we will award contracts through a global bidding process by the end of the current year.

We’ve Got The Power FOR THE LNG supply to Kochi, we have had long negotiations with Exxon Mobil for its share from the Gorgon LNG project in Australia and have submitted our final price quote. We are highly hopeful of securing the contract. There are two aspects to return on capital. Firstly, the capital cost will be higher, at around $650 million, for the Kochi terminal, compared to around $400 million for the first phase of Dahej. Secondly, our earnings will depend on the volumes we handle or capacity utilisation, since it is just the regasification margins that we earn. However, Kochi and the nearby areas lack pipeline connectivity and hence, our LNG won’t have much competition, thus enabling us to utilise full capacity. All in all, we may not be able to sustain the current RoCE of above 25%, but it will remain healthy.

What kind of synergies do you expect from your latest venture in power generation?
We are proposing to set up a 1,200-mw power plant in Dahej near our LNG terminal at a capital cost of Rs 3,500 crore. We have inherent strategic advantages for entering the power generation business, thanks to the availability of ‘cold energy.’ We will be setting up three 350-mw turbines totalling 1,050 mw, but our output will be 1,200 mw. LNG is transported and stored at temperature as low as minus 160 degree Celsius. Hence, when it gets regasified, it brings down the temperature of water to zero. This water is then used for cooling in turbines improving their efficiency. Besides the savings of 12.5% value-added tax (VAT) on fuel, this will ensure that our power will be the cheapest among all gas-based projects in India. We are currently waiting for the state government to allocate us land to set up the power plant.

Currently your debt-equity ratio is above 1. How do you plan to finance new projects, including the Kochi terminal and the proposed power plant?
For us, the acceptable level of debt-equity ratio is 2.3, so we have huge borrowing capacity. At present, we can borrow around Rs 2,200 crore, while internal accruals will contribute another Rs 500 crore every year. Hence, financing the new projects will not be much of a problem for us.