Interview- Rashtriya Chemicals & Fertilisers Planting Dreams

Recent changes in the policy for fertilisers are welcome, but some concerns remain

How has the domestic fertiliser industry shaped up over the past few decades?
The fertiliser industry has always been a strategically important industry for India due to its role in ensuring India’s food security. Ever since the pre-independence era, the government has had an interventionist policy with the aim of keeping the industry under its control. Even after liberalisation in 1991, fertiliser remained the only sector which bypassed reforms. As input prices shot up and the government didn’t hike fertiliser prices, the subsidy burden became manifold. But rather than tackling the problem in a straight-forward manner, policy makers started squeezing the industry in a bid to control their subsidy bill and kept fertiliser prices unchanged. As a result, the investment and capacity addition in this industry came to a standstill. The domestic fertiliser industry has not added any fresh capacity since 1999.
The past one year has been extraordinary, as the prices of fertilisers and their inputs shot up abnormally. As a result, the subsidy bill, which used to stay at Rs 10,000-20,000 crore annually, jumped up to Rs 50,000 crore in FY08 and this year, it is expected to cross the Rs 100,000-crore mark. At present, in phosphatic and potassic fertilisers, 80% of realisation comes from government subsidy. In the case of urea, it is 55%. This is unprecedented with no parallel in history. Just three years ago, only 20% of the fertiliser industry’s revenues used to come from subsidies and 80% from the market.

Fertiliser and input prices have crashed since the government changed its policies for fertiliser subsidy. What does this mean for the industry? When the government realised that its fertiliser pricing policy had made the sector unattractive for investors, it made some policy changes, hoping to attract investments in the fertiliser sector. For the first time, there was a departure from the cost-plus method, linking the subsidy payments to benchmark import parity prices. Earlier, there used to be two subsidies— one for domestically-produced fertilisers and another for imported fertilisers. But now, there is just one subsidy linked to the import parity prices. These is an important departure from the earlier policies, which is a good sign. However, there are certain concerns, particularly due to the recent crash in prices in the international market. Now there is a need to fine-tune the cap and floor prices to make it relevant in the current scenario.

Over the next five years where will RCF’s growth come from? What can retail shareholders expect from the company?
We have lined up several new capacity additions over the next five years that will add to revenues. Two of our plants were shut down in Trombay — a 300,000-tpa urea plant due to lack of gas, and a 350,000-tpa complex fertiliser plant due to an accident. Both these plants will be up and running by mid-’09. A further 2.5 lakh-tonne capacity will come on stream from the debottlenecking of the Thal plant and around 2.5 lakh tonnes of DAP capacity will come up in Rajasthan. Similarly, some of these large capital projects will capitalise in five years’ time, which includes expansion of more than one million tonne at Thal, revival of the Barauni unit, coal gassification and some joint venture projects. We may not have resources for all these large projects, but whatever materialises first, we will proceed with that. Profitability is limited in the fertiliser sector. We have been distributing nearly 40% of our profits by way of dividends. However, due to our huge equity base, that doesn’t result in an attractive dividend yield. We can’t raise the payout because we need some profits to plough back into the company. We are investing in our plants and good projects to create long-term value for our shareholders.

Increasing natural gas availability is expected to benefit the fertiliser industry. What is the ground reality?
At the moment, the requirement of natural gas-based fertiliser plants is 42 million metric standard cubic metres per day (mmscmd), against the supply of 28 mmscmd. Then the revamp, conversion of naphtha-based plants to gas, debottlenecking, brownfield expansion and so on will bring up more demand. At the same time, the availability of natural gas is expected to grow by 15 mmscmd by mid-’09, as Reliance Industries’ KG basin fields start production. So, as per the government’s current stand of giving first priority to the fertiliser industry, this will be entirely consumed by the industry against the existing shortfall. It will bring down the government’s subsidy burden, while the industry will benefit from higher volumes.

Is diversifying away from fertilisers a viable option for RCF?
As our core area has strategic importance for the country, we will have to continue with that. But at the same time, we are investing in the chemicals sector. We recently ramped up all our chemical plants. We will be adding an argon plant at Thal this year and are revamping methanol and nitric acid plants. RCF became the first company to introduce Rapidwall load-bearing panels made from gypsum, which is a substitute for bricks in building houses. The commercial production is expected to start by January ’09. We have set up a joint venture with Fertilisers and Chemicals Travancore (FACT) for the gypsum project. We are also planning to foray into wind power. However, since fertiliser projects are highly capital-intensive — for example one ammonia-urea plant will cost Rs 4,500 crore — they will get a larger share in our capital expenditure plans.

The government is also trying to revive some old fertiliser plants, which were earlier shut down. How far is this feasible technologically?
When you talk of revival of old plants, it is not really a revival. It is basically setting up a new plant at the same location. So, the only thing from the old plant that will be put to use is the land and supporting infrastructure. The existing machinery, if any, will have to be replaced with totally new equipment. As such, the capital expenditure will be huge. At the moment, the government is reviving one plant at Barauni through the public sector, for which, a special purpose vehicle has been set up between RCF, National Fertilisers and Kribhco. The economics of these plants will greatly depend on the availability and price of natural gas.

(For the complete text of the interview, log on to www.etintelligence.com)

Aries Agro: Reaping The Gains

THE expansion project of Aries Agro, the Mumbai-based manufacturer of micro-nutrients for agriculture, continues to be on track as it inaugurated its seventh plant at Lucknow recently. Earlier this year, the company had inaugurated one plant at Hyderabad and another at Ahmedabad. This took its production capacity to 84,600 tpa compared to 21,600 tpa at the time of its IPO in December ’07. But the company is deferring its eighth plant in Panvel to March ’09, as it has sufficient capacity for this year and it also wants to benefit from falling lease rentals. The company has launched 40 vans for mobile marketing, which will be scaled up to 100 by the end of December. Golden Harvest, the company’s 75% subsidiary in the UAE, has also commissioned production since November '08.
The company typically derives 45% of its annual revenues in the first half of the financial year and 55% in the second half. Taking into account its revenue of Rs 54 crore in the first half, the company appears well-poised to achieve its target of Rs 125 crore in FY09. It plans to sell over 45,000 tonnes of products in FY09, compared to 24,600 tonnes in FY08. Aries Agro’s profit in the first half of FY09 was adversely affected due to a rise in raw material expenses. Input costs jumped 44% even though the company scaled down staff and other manufacturing costs. However, the company implemented a price hike in mid-October, which should help it to improve its margins. The company imports a major chunk of its raw materials. But it had stocked on inventories heavily in June and July. So, it no longer needs to import any raw materials this fiscal, which will safeguard it from the rupee’s fall versus the dollar. Most of the company’s products are slow-starters, as establishing concept and gaining farmers’ acceptance takes time. In view of its additional capacities, aggressive marketing strategies and unique position in the domestic market, the company appears to be an attractive pick for long-term investors.

Bold. But Beautiful?

Quite a few companies are commanding triple-digit P/Es even in these turbulent times. Are they really worth it? Ramkrishna Kashelkar explores

EQUITY MARKETS across the globe, including India, have gone into a tailspin following the subprime implosion in the US. The plunge in the Indian stock market has been more or less in line with what is happening everywhere.
Although the earnings of Indian companies haven’t taken a major hit, their valuations have crashed. So, a leading company like Reliance Industries (RIL), which commanded a price-toearnings (P/E) multiple above 30 in January, is now being valued at just nine times its earnings, despite a steady rise in its profits over the past four quarters.
The P/E multiple is the most widely tracked indicator, reflecting how much premium an investor attaches to a company’s trailing earnings or net profits. It also captures the expectations of investors about the company’s future growth. Hence, it is but natural that the P/E multiples of most companies have crashed in the current uncertain times.
But surprisingly, quite a few companies are still commanding triple-digit P/Es. Though a number of BSE ‘A’ group companies too figure in this list, one wonders if these are instances of high investor confidence or just speculative interest.
MMTC — a public sector company where the government holds 99.33% of its 5 crore equity shares — has a public shareholding of less than 11,000 equity shares, or 0.02% of the total. For the past one year, the average daily volume in this scrip has been just 541. It is this illiquidity which has enabled the stock to soar beyond what its current fundamentals support. Reliance Natural Resources (RNRL) and Adlabs Films are two companies from the Anil Dhirubhai Ambani group which figure in the list of richly-valued companies.
RNRL is fighting a court case over the supply of natural gas from RIL and only a win there will help it generate substantial revenues and profits. But excluding this, its existing business model cannot justify the current valuations.
Adlabs Films had posted healthy profits in FY08, but its numbers in the first half of FY09 are significantly lower due to the amalgamation of its radio business. Although its current market price is just 1.25 times its book value, the return on capital employed (RoCE) has steeply fallen over the past four years and is a major cause for concern for the company.
Essar Oil commissioned commercial production at its 10.5 million tonne per annum (mtpa) refinery only in May ’08. Hence, its earnings for the trailing 12 months appear low, bloating up its P/E multiple. The company has posted a net profit of Rs 56 crore in the first half of FY09.
The economics of the global refining industry have worsened significantly of late and even if the company is able to repeat this performance in the second half, its current market price will be 90 times its full-year earnings.
Ispat Industries is highly leveraged, with its debt component being 4.5 times its equity. The company posted a minuscule profit in FY08 after a gap of two years. With interest costs soaring in the September ’08 quarter, it again reported a loss. Despite all these factors, the company continues to be one of the favourites among derivatives traders, which has helped the stock remain at high levels.
There are quite a few companies with net losses in the trailing 12 months which are trading at high prices. Most of them are assetrich companies with high brand value. Since these assets have a certain replacement cost, their market capitalisation is not likely to fall below a certain level, even in difficult times. Some of them are even making healthy cash profits, but high depreciation is pushing them in the red. These include companies such as the three oil marketing companies IndianOil, HPCL and BPCL, Aditya Birla Nuvo, Tata Teleservices Maharashtra and GTL Infra.
Jet Airways, which was cash positive in FY08 despite a net loss, incurred heavy cash losses in the quarter ended September ’08 due to high fuel and operating costs and a weak economic environment. A downturn in textiles and real estate industries hit Bombay Dyeing, which posted losses in three of the four preceding quarters.
Dozens of companies are trading above P/E of 100 — or even 1,000 in some cases — among the smaller ones. But they continue to remain much more obscure compared to the larger ‘A’ group companies. Even among these ‘A’ group companies, we find little justification for such high valuations in most cases.
However, in some cases, the asset-rich nature of business, positive cash flows and high brand value support the valuations of these companies. Investors should exercise caution while picking up such scrips.

India Inc’s Q2 results confirm investors’ worst fears that the pain will continue in the months to come.

ANOTHER QUARTER has gone by and the results have hardly surprised anyone, least of all the stock market. The slowdown in India Inc’s profit growth, which had become visible after the first quarter (Q1) of ’07, continues unabated as we near the end of calendar year ’08. And there’s little hope that the tide will change in the near future. The globe’s worst financial crisis has pushed the world’s largest economies into recession with countries like the UK and US witnessing contraction of their economies. Consumer spending in the world’s largest economy — the US — has fallen sharply as a number of large retailers posted double-digit fall in sales during October ’08. Globally, a number of companies are cutting down operations and laying off employees. The unemployment rate has already reached a 14-year high of 6.5% in the US, which is likely to worsen. To ease the credit crunch, central banks across the world are resorting to interest rate cuts, besides injecting cash into the system. However, these attempts have hardly yielded positive results so far.

EXPANSION BINGE:
India Inc is not likely to escape the mayhem unscathed. Encouraged by the strong economic growth of the past five years, cheap and abundant credit, coupled with prevailing bullish sentiment, India Inc (here we are referring to non-financial companies) embarked upon perhaps the biggest-ever spend on capital expenditure (capex) in the country’s history. Companies across sectors either went for aggressive capex or acquired companies, especially outside India, to achieve a global scale and footprint. This spending binge was initially financed by strong internal accruals, but as their ambitions rose, most companies resorted to debt financing, including external commercial borrowings (ECBs). The chicken has now come home to roost and India’s profitability is now being hit by debt servicing and other recurring costs related to capex. Besides, companies with high level of outstanding ECBs are being haunted by mark-to-market losses on their dollar- or euro-denominated debt.
The difficulties have been further compounded by the economic slowdown and falling demand for goods and services across sectors. If two years ago, demand was ahead of supply, now companies are facing over-capacity across-the-board. This has adversely affected operating margins.
Even as their internal cash generation is on a downward spiral, companies are being forced to increase cash outlays in the form of interest payments and purchase of capital goods. For instance, during the past two years, leading companies such as Reliance Industries (RIL), Tata Steel, Tata Motors, Hindalco Industries, DLF, Suzlon Energy and Larsen & Toubro (L&T) had higher cash outflows on account of investment activity, compared to the cash they generated from operations. When a company has higher capex than its operating cash flow, it needs to either borrow or dip into its reserves or cut dividends. And in the current scenario, where interest rates have risen and access to credit is restricted, a high dependency on financial institutions adds to the risk. Again, the economic downturn may affect the existing cash flow of such companies, further adding to the woes.

THE QUARTER GONE BY:
The September ’08 quarter was a reflection of these trends as India Inc’s profit growth came to a halt. The net profit reported by 1,214 listed companies grew by just 3% on a year-on-year (y-o-y) basis — the slowest profit growth in the past 10 quarters. We excluded banking and finance companies from our calculations due to the different revenue recognition practices they follow, as well as four public sector oil majors — IndianOil, Bharat Petroleum (BPCL), Hindustan Petroleum (HPCL) and ONGC — whose profits depend on government-determined subsidies and their large size can influence the aggregate numbers. A fall in the operating margin of the sample, which came down to a 20-quarter low of 15.6%, was not totally unexpected due to high inflationary pressures. When inflation soars, raw material costs and sales revenues move up in tandem; then the same operating profit, when calculated as a percentage to net sales, results in a lower operating margin. In fact, to remove this inflationary effect and to make historical data comparable, we have calculated various cost components as a percentage of operating profit, rather than net sales, in the adjacent chart.
Other income, which was fuelling India Inc’s profit growth towards the end of ’07, has failed to prop up profits in the September ’08 quarter. As a result, the y-o-y growth in PBDIT slipped to 10% from 16% in the June ’08 quarter and around 25% in FY08.

HURTING INTEREST:
A spurt in global interest rates was one of the major outcomes of the unprecedented global credit crisis. At the same time, the rupee lost heavily due to an exodus of foreign investments. Both these factors increased the interest burden for domestic companies, which rose a whopping 86% y-o-y. The interest costs alone took away over 16% of India Inc’s operating profits in Q2 FY09, which was substantially higher than 10% in FY08. Besides a rise in interest costs, an increase in the proportion of depreciation in operating profits indicate that various projects, launched earlier, have commenced operations in the quarter. The resultant pre-tax profit grew just 1.4%. However, a fall in the effective rate of tax propped up the net profit growth to 3% y-o-y. The effective rate of tax dipped to a two-year low of 22.8%.

NOT JUST LOSERS:
Industries such as cement, automobiles, consumer durables, pharmaceuticals and chemicals had a particularly bad quarter. Telecom, hospitality, healthcare and logistics sectors, which were doing well in the past couple of quarters despite the slowdown, have also taken a hit in the current quarter.

No Silver Lining
DESPITE THE odds, a few industries have done better than the others. These include the information technology (IT) sector, where a number of mid-sized companies recorded a healthy profit growth, thanks to a weaker rupee.
The sugar industry gained from higher sugar prices, while changes in the government’s subsidy norms helped fertiliser companies. Even the metals industry posted a double-digit profit growth, as the recent crash in prices had a limited impact in the September ’08 quarter. Healthy profit growth of biggies such as GE Shipping, Shipping Corporation of India (SCI) and Container Corporation (Concor) helped the logistics sector to report double-digit growth.
The profit growth of the FMCG sector, although in single-digit, was better than that in the preceding quarter. Although these industries did well during the September ’08 quarter, the likelihood of a continued outperformance is limited.

WHERE TO GO:
Although the Indian economy is less dependent on exports, it is linked to the global economy in more ways than one. The number of troubled industries is growing steadily from just textiles and real estate to airlines, brokerages, gems & jewellery and NBFCs, which have been in the news for cutting salaries or laying off employees. Other sectors such as hospitality, steel, cement, shipping and automobiles are also facing a slowdown.
Most of the companies in the above mentioned sectors have been expanding capacities over the past couple of years.
Although conditions are tough for everyone, there still remain a few industries where investors can expect some growth. The much-touted FMCG sector is one such investment avenue. The natural gas transmission industry is also likely to defy the difficulties and prosper, thanks to the rising availability of natural gas in India.
Similarly, companies offering services to onshore and offshore petroleum exploration activities are likely to grow, largely due to the existing long contracts they hold. Also, considering the power deficit in the country, turnkey contractors for power plants will continue to see healthy performance. Investing in stocks to earn dividends can also be a good approach, since a number of good companies are available at healthy dividend yields. However, a careful research of the companies is a must.

WHAT NEXT?
While India Inc’s profit growth has hit the bottom, the overall economic environment continues to deteriorate. For the time being, liquidity problems are being well-addressed, but the financial system globally is expected to suffer for some more time from the aftershocks of the subprime crisis.
At the same time, the options available with the Indian government to support economic growth appear limited, thanks to burgeoning trade and fiscal deficits. All this indicates prolonged pain in the months to come. If the current trend continues, India Inc can very well expect its December ’08 profits to slump below the December ’07 levels.

OMCs: Oil’s Well

DOMESTIC oil marketing companies (OMCs) — which together posted a net loss of over Rs 12,800 crore in the September ’08 quarter, despite almost equal amount of discounts from ONGC and over Rs 20,500 crore of oil bonds — are set to gain as crude prices have crashed. Crude prices on NYMEX fell to $61 per barrel by the second week of November — more than 58% lower than the high of $145 reached in July.
Prices have declined despite the 1.5 million barrels per day production cut implemented by Opec from November 1, as the economic downturn is reducing demand for transport fuels. Demand for gasoline in the US (the largest consumer of petroleum) has fallen so steeply, that refiners are now incurring losses on sale of gasoline. At the same time, China, which posted highest incremental growth in petroleum consumption last year, is also witnessing a slowdown in fuel demand.
In the September ’08 quarter, OMCs posted negative refining margins due to inventory losses, while the marketing operations continued to lose money. However, with crude prices stabilising around $60, the story will be different in the next quarter. The Indian basket of crude oil that represents a blend of Dubai/Oman and Brent crude in a 62:38 proportion, has fallen to the $56 level, at which, marketing of transport fuel has become profitable. With crude prices stabilising, OMCs’ refining operations will also turn positive. Given that government support and upstream discounts continue to take care of losses on LPG and kerosene, BPCL, HPCL and IOC can once again post healthy profits.

GREAT Offshore: Sailing In Choppy Seas

GREAT Offshore (GOL) recently completed the acquisition of 100% stake in two companies operating on India’s east coast — KEI RSOS Maritime and Rajamahendri Shipping & Oilfield Services — for Rs 160 crore. The company had announced this deal in early September. These companies are mainly into port management services, single-point mooring and offshore support.
This acquisition added 19 vessels (nine offshore support vessels and 10 harbour tugs) to GOL’s existing fleet of 41 vessels, with four more to join over the next six months. GOL itself has ordered a drilling rig and multi-support vessel to be delivered in March ’09 and September ’09, respectively, at a cost of $230 million. This acquisition is expected to add Rs 30-32 crore to GOL’s consolidated bottomline in FY10. Last year, GOL had raised around Rs 168 crore through foreign currency convertible bonds (FCCBs) and Rs 150 crore through preference shares, specifically for acquisition purposes. It was also planning to acquire a foreign company, but the deal did not fructify. The company recently spent Rs 55.2 crore on share buybacks at an average price of Rs 564. This reduced its share capital by around 2.6%, resulting in an increase in promoters' holding to 20.5%.
GOL’s results for the past couple of quarters have been dismal with a significant fall in profits, though it is the largest offshore support company in India in terms of fleet size. Over the past couple of years, the company has been trying to grow rapidly, which has resulted in cash outflow on investment activities, outstripping operating cash inflows. In view of the recent weakness in economic environment and the fall in crude oil prices, the company’s ability to secure high charter rates for its vessels remains crucial for future success. GOL faces the risk of a fall in charter rates in the offshore drilling industry by the time its two high-value vessels are delivered.