Stepping On The Gas

Even as fortunes of the petroleum industry remain clouded, natural gas is entering a golden phase

IF YOU consider the Sensex’s roller-coaster ride during 2008 as dramatic, then reversal in the fortunes of energy companies was nothing less than unprecedented. The spurt in energy prices in the first half of the year turned into a disaster in the second half, as crude oil lost nearly three-fourths of its value. In the process, crude once again became a commodity from being one of the hottest asset classes in ’07 and early ’08. The booming refining industry also came to a sudden halt as gross refining margins (GRMs) shrank after the Beijing Olympics in September ’07. Refining margins in the US Gulf — which were ruling above $15 per barrel in September ’08 — crashed subsequently and turned negative by the first week of November ’08. The price reversal in crude also had a dramatic effect on the domestic petroleum industry, which is dominated by state-run oil companies. These companies continue to suffer due to the government’s control on retail fuel prices, even as private refiners mint money, with their GRMs touching historic highs. PSU Navratna companies, which were once cash-rich, are likely to end the year with net losses. These companies, which paid over Rs 3,400 crore as dividends in FY07, had to cut that figure down to a mere Rs 900 crore in FY08. And 2009 could well be the first dividend-less year for them. However, the domestic natural gas industry tells a different story. India’s long-standing gap between demand and supply may narrow, as gas supplies begin from reserves of RIL, GSPC and ONGC on the east coast.

FUTURE OUTLOOK:
2008 is set to emerge as the first after 1983 to witness a fall in consumption of crude oil. Average global consumption is likely to remain at 85.8 million barrels per day (mbpd) compared to 86.1 mbpd in ’07. In the near term, crude prices are likely to stay at the current low levels. But towards the end of ’09, they should move above $60 per barrel. Until that revival, profitability of ONGC and Cairn India will remain under pressure. The fortunes of the refining industry continue to remain clouded in the short and medium term, which will affect Essar Oil, Reliance Petroleum, MRPL and CPCL. While existing refineries are running on low capacities, several new ones will be completed in ’09. So, we may see closure of old and simple refineries.
However, India’s natural gas industry is entering a golden phase with the availability of natural gas expected to double in two years. This will help gas transportation companies like Gail, Gujarat Gas, GSPL and Indraprastha Gas, as well as ancillary industries such as CNG cylinder manufacturers. This section of the industry will witness healthy profit growth in the near term.

Interview-GMR Infra’s group: Still Going Strong

Despite the credit crunch & high interest rates, GMR Infra’s group CFO A Subbarao believes now is the best time to invest in infrastructure

Being an infrastructure player, are you not feeling the pinch of the credit crisis and rising interest rates?
The majority of our projects are no longer in the investment phase and are nearing their revenue-generation phase, and this is helping us. For example, in the roads sector, out of the four ongoing projects, one has already been commissioned and the other three will be commissioned over the next three months. The pending capex on these projects is just Rs 300 crore by February ’09. In the power sector, all our three projects with 800 mw installed capacity are currently in operation.
There are several new power projects in the pipeline, but most of them are only in the preliminary development phase, where we are seeking land clearance, environmental clearance, fuel security etc. Only two projects — the 300-mw hydel plant at Badrinath and 1,050-mw coal-based project in Orissa — are nearing financial closure, where the total capex required will be Rs 6,000 crore.
In the case of airports, the Hyderabad airport is already operational and we won’t incur any more significant capex on it in the near future, as we still have spare capacity. At Delhi airport, we have already achieved financial closure with Rs 5,000 crore of debt. Both the airports are now generating strong cash flows. Thus, most of our projects are well-funded and the revenue streams have started.

But wouldn’t high interest costs affect the viability of your existing or new projects?
Not really. For all our projects in the construction phase, we borrow at fixed rates, which will be reset only after 3-5 years. So currently, the average cost of debt comes to only 9.6% for the group. For our new projects, we will have to borrow at some 300 bps higher, but now we will go for floating rates. Again, that will not significantly affect our return on investment. For example, for our 1,050-mw Orissa power plant, we need to borrow Rs 3,500 crore. The debt will be drawn gradually over the three years of project execution, so the average debt comes to around Rs 1,750 crore. Hence, with 300 bps higher interest, our project cost will go up by Rs 150 crore, which is just 3.3% of the total project cost of Rs 4,500 crore. Another important factor that many people are ignoring is that although interest costs are going up, the cost of construction is coming down sharply. Prices of cement and steel, or margins of EPC contractors are all very low, which can save 20-25% of the project costs. This will far outweigh the loss on account of higher interest. Again, interest costs are cyclical; they will decline soon. In fact, I think this is the best time to start new projects to create a low-cost infrastructure for the future.

What future plans do you have for the Hyderabad and Delhi airports?
Since we have taken both these airports and adjoining land on a 60-year lease, we are working on significant long-term plans. We plan to develop these airports as regional hubs and international transit points. The available land — nearly 6,500 acres in Hyderabad and around 250 acres in Delhi — will be used to develop aero-related businesses, which will help in attracting more traffic. In the immediate future, we plan to set up a maintenance, repair and overhaul (MRO) business at Hyderabad airport with around Rs 200 crore investment by March ’10. We have tied up with Malaysian Airways as the technical support partner, and we are looking for a domestic airline as the anchor customer to join as a partner. This will be the first MRO service in India and considering that today, nearly 500 aircraft in India visit overseas destinations for these services, we expect to do well. On the rest of the land in Hyderabad, we plan to develop an international city with all facilities such as hospitals, hotels, office complexes, etc. We are currently going slow on this due to the economic slowdown.

What is the revenue generation capacity of your airports?
If we look globally, airports such as Singapore or Hong Kong earn $17-18 per passenger, which can be as high as $50 per passenger in Europe, taking both aero and non-aero revenues together. So, we have set $20 per passenger as a target for generating revenues from our airport business. The user development fee (UDF) is a special and temporary charge and is not considered for this purpose. We are assured of 17% return on investment for the Hyderabad airport, and 11.33% in the case of Delhi airport, considering only the aero revenues. Non-aero revenues such as retail, commercial, advertising, parking and cargo — which comprise over 60% of an airport’s total revenues — are not part of these calculations. Only in the case of Delhi airport, which is a brownfield project, 30% of the non-aero revenues are added to the aero revenues for this purpose.

Which of your verticals will drive the future growth of GMR group?
Our power business will continue to drive future growth. This business will perform very well over the next three quarters, with all our 800-mw capacity running continuously, which can generate Rs 2,000 crore in revenue annually.
Further, the European company, InterGen, in which we picked up a 50% stake earlier this year, has a 8,000-mw running capacity with projects of 4,000 mw in the pipeline. We are not consolidating these revenues right now, as the investment is held through convertible debentures. Once we convert these bonds into equity shares, we will be able to consolidate the revenues. That will boost the power segment’s revenues substantially. Besides, the 1,050-mw Orissa power plant is scheduled to be commissioned in March ’10. We also want to add another coal-based 1,000-1,500 mw power plant, probably on the west coast of India, by mid-’11, for which we are trying to acquire stake in some coal mines in Indonesia.

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

NITIN Fire Protection Industries: All Fired Up

NITIN Fire Protection Industries has emerged as a beneficiary of the increased awareness among Indian corporates about protection from fire, following the recent terrorist attacks in Mumbai. The company has recently bagged several contracts from various banks and hotels for fire alarms and fire fighting systems, and has an order book of Rs 70 crore under this business segment. Going forward, its order book is likely to grow further. The company’s seamless cylinder business is also doing well and currently has pending orders worth around Rs 30 crore. For FY09, the company is expected to produce around 140,000 CNG cylinders at its plant in Vizag SEZ, against the installed capacity of 500,000 units, to generate revenues of around Rs 80 crore. This includes its CNG cascade business, which is also generating high demand from companies setting up CNG stations across the country. Considering that the number of cities with CNG networks is rapidly increasing in India, over the next couple of years, the demand growth for cylinders is likely to remain strong.
In the first half of FY09, the company’s net profit surged by 115% to Rs 19.5 crore, while its revenue doubled to Rs 124 crore. The company’s OPM rose by 200 bps to 20.6% in H1 FY09, which is likely to continue in the second half as well. At the current price of Rs 239, the scrip is trading at a P/E of 10.1 based on its consolidated net profit for trailing 12 months.

When Will The Tide Turn?

The Business Confidence Index has fallen to a five-year low of 119.9 as pessimism spreads in India Inc. However, governments across the world are taking extra efforts to combat the slowdown. It remains to be seen how these measures play out in the coming quarters

INDIA INC’s business confidence has ebbed further. This is reflected in the 66th round of the ET-NCAER Business Expectations Survey (BES) for the quarter ended September ’08. The Business Confidence Index (BCI) has dipped to a five-year low of 119.9, as companies’ expectations have worsened on all the four parameters, viz overall economic conditions, financial position, investment climate and capacity utilisation levels. The index stood at 154 in January ’08, but has consistently deteriorated since then.

Although all these four criteria — which carry equal weightage in the BCI — suffered, unlike in the previous round of the survey, the dip in confidence in the current round has not been uniform across regions, sectors or size of companies. With the passage of three months since the previous round of the survey, many respondents seem to have given in to the barrage of negative news. In fact, several groups, which had remained bullish earlier, have now turned bearish. At the same time, those respondents who had posted the largest fall in confidence in the previous round have mostly remained unchanged.

ALL’S NOT LOST
The services industry has seen a healthy revival in sentiment to emerge as the sector which is most hopeful about the overall economic conditions. In the previous round, this sector was the most pessimistic about overall economic conditions. The intermediates sector is the least affected, as it remains the most optimistic about the current investment climate. Nevertheless, the sector has witnessed a fall in respondents who expect a growth in production and sales over the next six months. However, the capital goods industry, which had seen the maximum decline in confidence level in the previous round, has turned out to be the biggest loser in the September ’08 quarter as well.
There has been a marked increase in the number of respondents expecting a growth in sales over the next two quarters. Despite this fact, the services industry remains the most pessimistic about the investment climate and financial position over the next six months. With the increased optimism about higher production and sales, the expectations on the profits front over the next six months have also increased. However, there has been a fall in the number of respondents expecting profit growth in excess of 10%. WEST, SOUTH KEEP THE FAITH
In terms of regional comparison, the West and South have witnessed a surprising improvement in business confidence across all criteria. The southern region has emerged as the most optimistic, but the western region, which was the most pessimistic in the previous round, continues to languish at the bottom, despite its improvement in confidence. The North has witnessed weakness on all counts, with a particularly steep fall in outlook on the current investment climate.

SIZE MATTERS
Surprisingly, the smallest of companies in the group have joined the largest ones to register an improvement in confidence.
Companies with turnover of less than Rs 1 crore, as well as those with turnover exceeding Rs 500 crore, are more optimistic about the economic conditions, investment climate and capacity utilisation, but they don’t feel that their financial positions will improve.

PUBLIC VS PRIVATE
Public sector enterprises, which were buoyant in the previous round of the survey, also seem to have succumbed to the pessimism. This is reflected in a fall in their business confidence. The BCI for public sector companies has fallen to 120.7 in the September ’08 quarter from 149 in the June ’08 quarter, and the sector is now most pessimistic about the current investment climate and financial expectations.
The listed companies in the private sector, which figured at the bottom in terms of business confidence in the previous round, continue to maintain their position, with little change.

PRICE WATCH
Given the current economic downturn, there has been a decline in the number of respondents reporting a rise in raw material costs. The percentage of respondents which witnessed a hike in raw material prices during the preceding three months fell to 67.5% in the September ’08 quarter from 75% in the June ’08 quarter. Similarly, only 62% of the respondents now expect a price increase over the next six months compared with 70.4% earlier.
As a result of the worsening outlook, the labour market is also expected to remain subdued. Respondents reporting a wage hike or an increase in number of workers have come down sharply.
Still, there has been an increase in the percentage of respondents expecting a wage increase over the next six months.

KEEPING FINGERS CROSSED
As the recession has spread to major global economies, India Inc seems to be uncertain about its immediate economic future.
This is mainly due to a decline in those sections which had not fallen steeply earlier. However, several sectors of the industry hope to post healthy growth over the next six months. Governments across the world are taking extra efforts to combat the slowdown and have introduced several measures to this effect.
The results of these efforts will become visible gradually over the next 6-9 months. Till then, India Inc needs to wait and watch how these measures will affect its confidence in the coming quarters.

Tradeable bonds help fertiliser cos rock, stocks rise up to 24% in a week

SHARES of fertiliser companies are seeing renewed interest on bourses, following the government’s move to make recently-announced fertiliser bonds 2022 tradeable.
As part of the stimulus package announced for various industries, the Union government had announced 7% Government of India Special Bonds 2022, for the fertiliser companies. The special bonds are transferable and eligible for ready forward transactions (Repo), improving their market demand. Better liquidity means the companies will not have to sell the bonds at a steep discount as was the case earlier. Though the government has issued fertiliser bonds in the past, they did not have a repo status.
Over the past one week, shares of Tata Chemicals, Chambel Fertilizer and Chemicals, Gujarat Narmada Valley Fertilizer Company (GNFC), Nagarjuna Fertilziers (NFCL), Managalore Chemicals and Fetilziers, Rashtriya Chemicals and Fertilizers (RCF), Zuari Industries and Coromandel Fertilizers, to name a few, have risen around 24%. On Monday, frontline stocks in the sector were up between 3-7%.
“The move will improve liquidity in these (fertiliser) bonds and will help the industry sell them at par. This, in itself, is a major boost for the cashstrapped industry, which could not earlier liquidate them due to huge discounts of around 10% earlier,” said US Jha, CMD of Rashtriya Chemicals and Fertilisers (RCF).
Industry sources say the government has advised fertiliser companies to borrow under the collateralised borrowing and lending obligations (CBLO) scheme for the next couple of months till the effect of the recent rate cuts become visible. Once the interest rates ease, these companies will be able to offload their bonds at par value, without incurring any loss.
“The government has assured us that these bonds will be made eligible under CBLO and we are expecting a RBI notification soon,” a senior official with a leading fertiliser company said. Once eligible under CBLO, fertiliser companies will be able to raise cheaper loans by pledging these securities with banks. Fertiliser bonds are classified as eligible investments for provident funds, gratuity funds and superannuation funds, as per a ministry of finance order.
Similarly, investments in special bonds by insurance companies are eligible under classification of other approved securities, the notification added. With India’s agri production touching record highs, most fertiliser companies are in the midst of an expansion drive. State-run GNFC plans to infuse around Rs 3,000 crore in capacity expansion over the next three years.
Tata Chemicals has already spent Rs 350 crore on Babrala and Haldia expansion and debottlenecking and it may soon kick-start its debottlenecking plans which had been postponed due to the ongoing credit crunch. Tata Chem had earlier said it would debottleneck its 3,000-tonne per day Babrala plant to add 500 tonne per day of urea at Rs 200 crore. Urea maker Nagarjuna Fertilizers & Chemicals has also plans to set up overseas plants and foray into complex fertilisers.
Nagarjuna plans to set up an urea plant in Nigeria with a maximum capacity of two million tonnes, and is in talks to tie up gas supplies in the Middle East and other regions.

Agriculture sector: Riding The Boom

Given the slowdown in manufacturing and services segments, the agriculture sector is set to support India’s economic growth. But will this benefit cos which provide vital inputs to the agri sector?

COMPANIES PROVIDING inputs to agriculture and related activities are back in vogue, given the deceleration in manufacturing and services sectors. The major companies operating in this space have performed well on the bourses in FY09 so far, outperforming the BSE Sensex. ETIG brings you a first cut on this sector and various players therein.
Following the global economic crisis, a slowdown is visible in manufacturing as well as services sectors in India. Be it in textiles, steel, construction, automobiles, gems & jewellery or IT & IT-enabled services, finance, hospitality, travel & tourism — the news about lay-offs and slowdown are doing the rounds everywhere. Also, after growing steadily till September ’08, India’s merchandise exports dipped by a whopping 12% in October ’08. Against this backdrop, economists are looking at the agriculture sector to spring a surprise and support India’s economic growth in the second half of FY09. This is expected to benefit the companies which provide vital inputs to the agriculture sector. The agro sector needs a number of vital inputs for its survival and growth, which include fertilisers, micronutrients, pesticides and seeds. Though fertilisers play an important role in agriculture, the sector is highly regulated in India and thus, has limited ability to benefit from any growth in the agro sector. Hence, we are not considering this sector here.

GROWTH DRIVERS FOR AGRICULTURE:
The purchasing power in rural India is likely to remain healthy, despite the global economic turmoil. The sector is now attracting direct and indirect investments from the private sector. The minimum support price for the kharif season has also been attractive. At the same time, the government’s loan waiver scheme earlier this year and its continuing expenditure on developing the rural economy will also provide a positive impetus to the domestic agriculture sector.

AGROCHEMICALS:
Agrochemicals have become an integral part of the development process of agriculture and their use is expected to increase manifold in India. There are two growth drivers in this business. The first one is increase in labour cost of farm labour and continuous decrease in the availability of farm labour. The second is increasing awareness among Indian farmers regarding usage of new products.
Due to availability of cheap technical manpower and lower cost of production, India has become a manufacturing hub of agrochemicals exporting to western countries. Nearly half of the pesticides manufactured in India are exported to various countries. United Phosphorus is India’s largest agrochemicals company, which has expanded into various countries through acquisitions in the past few years. Bayer CropScience is the market leader in the domestic pesticides market with well-established products. The company more than tripled its profits in the first half of FY09. Rallis has also performed well over the past four years after its turnaround and posted a higher operating profit in H1 FY09 than during entire FY08. It is one of the very few companies whose valuation in terms of P/E multiple has not suffered due to the current market turmoil.

SEEDS:
Many countries, including India, give greater priority to high agricultural productivity. This is possible only by increasing the genetic potential of seeds on a continuous basis to increase yields. As a result, expansion of the seeds industry has taken place along with growth in agricultural productivity.
Hybrid and genetically modified seeds are increasingly being used in India to improve agricultural yield. Advanta and Monsanto are the leading players in this business, although numerous other players also operate in this space. Monsanto has divested its sunflower seeds business and part of its herbicides business to focus only on hybrid corn seeds and glyphosate herbicide. On the other hand, Advanta is trying to emerge as a global player in the seeds business, following in the footsteps of its parent company, United Phosphorus.

GOOD H1 FY09:
The agro inputs industry had an exceptionally good first half as the demand for agrochemicals continued to rise even as prices continued to move up. Due to the sudden spurt in demand, there was a shortage of pesticides in several parts of the country. As a result, the industry enjoyed higher sales and margins.

ALL’S NOT WELL:
However, this industry has its own set of woes. When prices were increasing, the industry players built up raw material inventories — at times paying upfront for future deliveries. Now, with prices crashing steeply, these companies will take a hit on their margins. The 15% demand growth witnessed so far this year in domestic agrochemicals may not continue in future.
Even on the exports front, things may not work out well for the industry, despite a weak rupee. Due to the ongoing credit crisis, a number of overseas importers are unable to secure letters of credit required for importing materials, thereby resulting in a fall in demand for domestic manufacturers. As a result, companies may achieve their sales target in the second half based on healthy domestic demand, but their profit targets will take a hit.

Dig Deeper For More

The current market turmoil has pulled down the high valuations that E&P companies were enjoying just a few months ago. But their prospects seem promising due to strong order books

GLOBAL CRUDE prices have crashed over the past few months and so has the stock market. But irrespective of the prices, the search for ‘black gold’ continues unabated across the world. A number of countries are battling falling crude oil production, while in India, which imports over 70% of its requirement, energy security is at stake. Recently, the government awarded 44 oil blocks under the seventh round of the New Exploration Licensing Policy (NELP) and is preparing for the eighth round in early ’09. This indicates that the boom in the exploration and production (E&P) industry is unlikely to slacken in the current economic downturn.
The trend is already being reflected in the fattening order book positions of domestic companies operating in the E&P support industry, which are helping oil majors in their exploration efforts. A multiplicity of projects and paucity of equipment means that in several cases, these companies secured confirmed contracts for their equipment, even before their actual delivery. Aban Offshoreis India’s largest owner of offshore drilling rigs with a fleet of 20 drilling vessels and one floating production unit (FPU). Its results for the preceding four quarters indicate the upturn in its earnings, which is likely to continue in future. Drilling charter rates, which had reached unprecedented levels earlier, are now off their highs in global markets. But Aban Offshore already holds firm charter contracts worth over Rs 4,000 crore for the next 12 months, which is nearly three times its turnover in the past 12 months. Also, for half of its vessels, the charter rates are locked for more than 24 months, giving stability to its future revenue growth. Great Offshoreis India’s second-largest offshore support company, operating a fleet of 41 vessels, including offshore support vessels (OSVs), drilling rigs and a construction barge. The company posted uninspiring results in the preceding two quarters due to changes in accounting of gains and losses in foreign exchange (forex). The company entered into port management and other related services via acquisition of a couple of companies on India’s east coast, adding another 19 vessels to its fleet. It is adding more vessels and expanding into marine construction to boost growth. Jindal Drillingentered into joint ventures with Singapore-based Discovery Drilling and Virtue Drilling, respectively, both of which have secured firm contracts from ONGC for offshore drilling rigs under construction. Of these, Discovery Drilling’s rig has commenced its contract with ONGC for three years, while Virtue Drilling’s rig will be deployed from mid-December ’08 for five years. These contracts will add significant revenues to the company on a consolidated basis. Dolphin Offshoreoffers marine and subsea engineering services, mainly to ONGC in western offshore. After working for a long period as a sub-contractor on ONGC’s offshore EPC contracts, the company has recently become eligible to bid for them as the main contractor. The company sold off two of its old vessels and its office premises over the past 12 months, which has boosted its numbers. It carries an order book of Rs 400 crore to be executed by December ’09. Shiv-Vani Oilis India’s largest onshore exploration support company. Onshore exploration is more of a local industry unlike offshore exploration, which is an international industry. So, the company faces little competition in India, which is reflected in its order book of Rs 3,600 crore to be executed over the next three years. The company’s cumulative revenues for the past three years were less than Rs 1,000 crore. It already has 34 drilling rigs with six more on order. All these 40 equipment will be deployed by end-FY09. Seamec, the Mumbai-based owner of four multi-support vessels (MSVs), has put up a disappointing show over the past 12 months. The upgradation of the vessel it purchased was delayed by nearly a year, while another of its vessels remained out of waters due to an accident. To make matters worse, a couple of its clients filed for bankruptcy in the US, making dues irrecoverable. However, it seems to be back on track now, with all its four vessels deployed gainfully. As the company’s vessels are used in sub-sea engineering, repairs and maintenance, the crash in crude oil prices is unlikely to impact it.
The current weakness in the rupee is beneficial to all these companies, which are net earners of forex. However, the presence of foreign currency loans on their books means they will have to write off the losses due to forex fluctuations. A high debt-equity ratio can be a big concern for the companies operating in this industry. However, they have secured revenue sources with sufficiently high interest-coverage ratios. Also, one must take into account the current scenario, where debt is the only way of raising finances for these fast-growing companies. The current market turmoil has pulled down the high valuations these companies were enjoying just a few months ago, which offers a good entry point for long-term investors.

ALPHAGEO India: On Shaky Ground

ALPHAGEO India, one of the largest onshore seismic service providers in the private sector, recently obtained a Rs 43.7-crore contract from ONGC to provide seismic data in Nagaland over a period of one year. Considering the company’s FY08 net sales of Rs 82 crore, the current contract amounts to over half of its annual turnover.
Last year, the company obtained a 3D seismic data acquisition contract from Oil India in Assam and Arunachal Pradesh. However, one of the contracts had to be foreclosed due to operational constraints posed by socio-environmental problems. The company defaulted on the other contract, paying liquidated damages of Rs 2.6 crore. The company will complete these contracts during the current financial year. It has also obtained a contract from Naftogaz to gather 3D seismic data in the second half of FY09.
Since the company’s business is contract-based, there are significant fluctuations in its q-o-q earnings. During the first half of FY09, the company posted only 10% higher revenue at Rs 45 crore. Its net profit fell by 5% to Rs 8 crore due to a fall in operating margin and rise in depreciation.
The company’s operating margin has remained range-bound in the past between 46% and 50%. Its current market price of Rs 88.25 is below its book value and translates into a P/E of 3.7. Although the company operates in a rapidly growing industry with healthy order book position, its ability to complete contracts on time is not fully proven, making it unattractive for long-term investment.