Merger times

THE long pending merger between India’s largest oil marketing company Indian Oil (IOC) and its Assam based subsidiary Bongaigaon Refinery and Petrochemicals (BRPL) consummated on 25 March ‘09 after the Ministry of Corporate Affairs, which oversees the mergers between public sector companies, tendered its consent. Both the boards had approved the merger in November ‘06, which was followed subsequently by approvals from shareholders as well as other regulatory authorities.
The record date for the share swap is yet to be announced. The shareholders and creditors of both the companies had long ago conceded their approval for the merger with a swap ratio of 4:37 (four shares of IOC for every 37 shares of BRPL).
Prior to the merger Indian Oil held 74.5% stake in BRPL, which is IOC’s second largest subsidiary in terms of net sales. As a result, IOC will have to issue 55.1 lakh equity shares for the outstanding BRPL shares, which amounts to equity dilution of less than 0.5%. In the trailing 12-month period, both the companies have incurred net losses and hence if we compare the FY08 net profit numbers, the merger is slightly EPS accretive for IOC investors.
Indian Oil’s petroleum refining capacity, which already stands at 44 million tonnes per annum (mtpa), will now stand 4.5% higher at 46 mtpa. BRPL’s rated capacity is 2.35 mtpa, however, it is operating below 85% utilisation due to lack of availability of crude oil.
BRPL had set up facilities to produce petrochemicals such as di-methyl terephthalate (DMT) and polyester staple fibre (PSF) between 1985-88. However, these facilities were closed in November 2005 due to lack of commercial viability. The refinery itself suffers from lack of sufficient crude oil supply due to dwindling crude production in the north eastern region. However, the refinery being located in north east enjoys 50% excise duty waiver. IOC already has another refinery in this region at Digboi. Through this merger, IOC will also save on sales tax, which it had to pay earlier on marketing of BRPL’s refined products.

GOLDEN HARVEST

In a bear phase the dividends could and should be a compelling reason of buying. The current low stock prices mean market is full of these low hanging fruits offering juicy dividend yields

AS a Spanish proverb puts it, “Habits are at first cobwebs, then cables”. We have been so used to seeing the share prices go up month after month between 2003 and 2008 that investing for capital appreciation has become a habit. Even after a long year of turmoil, most investors are asking the question, “ye kitna upar jayega?” before buying shares. Investors are still not prepared to accept the reality that the bull-run is long behind us and the market is staring at a drought of good news to take it forward. This new reality requires the investors to revisit their investment rationale.
The days of momentum buying (buy high and sell higher without looking at the company’s finances) are over. Nor is it possible to double or triple your capital in ultra short time anymore. The froth is out and the investment world is back to its normal trajectory. Does this mean the end of the road for equities? Not really.

It just means that investors will now have to change their perception about equities. While equities were traditionally bought for capital returns, they could become excellent sources of steady income during bear phases. The lower stock price translates into higher dividend per share, thereby pushing up the dividend yield to attractive levels.

Right now, the market is full of low-hanging fruits where the posttax yields are almost double those in fixed income instruments. ET Intelligence Group makes your task easier by doing the necessary legwork. We must add that this does not amount to ‘buy’ recommendation for any of the stocks listed in the table. The investors are advised to do their homework before taking the plunge.

Rationale behind dividend approach
The new financial year is just a week away. The beginning of the new fiscal will usher in the annual dividend season. Beginning from the middle of April, companies that follow the April-March financial year (and bulk of them do that) will start announcing the annual goodies to the shareholders. It makes sense to focus on dividends which are also incidentally tax-free in the hands of the investor. In fact, a dividend yield of 6.5% is equivalent to 10% interest earned over a period of one year, which is a taxable income.

Another important aspect of dividends is that they are more stable than corporate profitability. Most companies raise their dividend payout ratios during times of low profitability instead of cutting the dividends in tune with a decline in profitability.

In fact, in the Western countries, a large section of people invest solely for dividends. And a cut in dividends is considered as a fundamental degradation of a company’s financials. For example, General Electric lost more than 30% of its value immediately after it announced a reduction in dividend and the shares of Citigroup dipped below $1 after it cancelled its annual dividends.

Will the dividends really come this year?
The number of dividend-paying companies in India and the total quantum of dividends would, no doubt, reduce this year compared to FY08. However, if we look back in history, a number of companies had a consistent dividend-paying record over the past 10-15 years regardless of the ups and downs in the business cycle. We also need to appreciate the fact that even the promoters of these companies depend on dividends as a source of their income.

We at ETIG sifted through heaps of data to identify companies that are most likely to maintain their dividend pay-outs. We only chose companies that never missed a dividend pay-out in the past 10 years, have healthy operating cash-flows, comfortable debt-to-equity ratio and haven’t performed too badly in the first 9 months of the year. We excluded companies in the automobile, auto ancillary and real estate space. Our list also excludes newly listed companies. Enjoying ample legroom
A case explained: Let’s take the case of Tata Steel. Its profitability has been hit by the crash in steel prices. Being a commodity business, the steel industry is cyclical and has undergone several ups and downs in the past. However, if we look at the history of the past 15 years, the company has never missed a single dividend. Even when its PAT fell by more than 60% y-o-y in 2002, it cut its annual dividend by just 20% to Rs 4 per share.

The worst of estimates predict a mere 25% decline in Tata Steel’s profits in FY09. Even if the company just maintains last year’s payout ratio, it would still pay Rs 12.5 per share as dividend. This is a 7.1% yield on the scrip’s prevailing market price.

Companies such as MM Forgings, Deepak Fertilisers, Graphite India, Tamilnadu Newsprint and Balmer Lawrie have actually seen a rise in profits in the first 9 months of FY09 over the past year. So they just need to maintain their dividend at the past year’s levels to make the cut. Most of the companies in our list paid out a very small portion of their last year’s profits as dividends. This provides them ample leg room to fiddle with pay-out ratio and thereby maintain dividend stability.

If we broaden our search to companies paying dividends since FY 2000 — to include companies listed in 1999 or 2000 — more interesting names would crop up. The readers can log on to www.etintelligence.com website for the detailed list.

At the end, we must mention that the payment of dividend is at discretion of the company management and shareholders should not treat it as their right. Nevertheless, in the current market scenario, dividend payout could and should be a compelling reason for buying shares, rather than being disappointed at the stagnant stock prices.

The International Energy Agency (IEA): Bullish Sentiment

The International Energy Agency (IEA) further cut its global petroleum demand forecast for 2009 to 84.4 million barrels per day (mbpd) - 1.5% or 1.3 mbpd lower compared to 2008 - in its latest monthly report published on 13 March 2009. According to the energy policy advisor representing 28 countries, the world was consuming 86 million barrels of crude oil every day in 2007, which fell to 85.7 mbpd in 2008.
The major highlight of the report is the visible reduction in the global supply of crude oil down 1 mbpd from January 2009 to 83.9 mbpd in February 2009. The crude oil production of 12 members of the Organisation Of Petroleum Exporting Countries (OPEC) stood at 28 mbpd in February indicating nearly 80% compliance by the member countries with the agreed production quotas. Since September 2008, OPEC has cut the production of crude oil by 4.2 mbpd and now the current production level is 1.6 mbpd below what IEA estimates OPEC to produce on an average in 2009. OPEC itself in its latest monthly report has estimated a need to produce an average 29.1 mbpd of oil in 2009.The high compliance level of OPEC spreads bullish sentiments in the crude oil market, particularly when the OPEC is set to meet on Sunday, 15 March 2009 to take stock of the situation and discuss the production strategy. The speculation about another production cut propelled crude oil prices 11.7% in the last couple of trading sessions to $47.3 per barrel - a level last seen in the first week of January 2009. Considering OPEC’s present production level, it now has a spare capacity of around 4.5 mbpd, substantially higher than the average of 1.5 mbpd during 2004 to 2008. This cushion along with the weakening demand for petroleum products is likely to keep the crude oil prices soft in near future. If OPEC goes ahead with another round of production cuts on 15 March, we may see a short rally in crude oil prices.

Offshore support cos see drop in market value

Sector Loses One-Third Of Its Value Despite Good Q3 Numbers

IF YOU believe higher stock prices inevitably follow a robust profit growth, the fate of India’s offshore support services sector defies this conventional wisdom. The sector has lost nearly one-third of its market value since the beginning of 2009 despite companies in the sector tripling their combined net profit during the last quarter of 2008.
The contrast could get even more puzzling if we compare this with the benchmark Sensex, which has lost only 10.1% in 2009 despite a disappointing performance by much of India Inc in the same quarter — an ETIG analysis shows India Inc’s net profit tumbled by more than 48%.
Aban Offshore’s net profit jumped fourfold to Rs 256 crore in the December 2008 quarter, but failed to prevent its market capitalisation plunging 57.2% since the start of 2009 to Rs 1,194 crore. Similarly, Shiv-Vani Oil & Gas too posted a strong 43% growth in its bottomline during the period, but saw a 29.3% drop in its market value during the same period.
Some companies across the sector did well in the last quarter — Jindal Drilling almost tripled its net profit and Dolphin Offshore posted a five-fold jump in profit. However, only Seamec and Great Offshore saw their market value improve.
The reason for the particularly poor performance on bourses is the negative perception in the market about the outlook for this sector. With crude oil prices falling, some global petroleum majors have declared cuts in spending on exploration and production this year, which could severely impact these services.
The fact that many of these companies have borrowed funds and bloated their debt-to-equity ratio (DER) does not help them either.
Aban Offshore’s consolidated debt was 16 times its equity at the end of March 2008. For Dolphin Offshore, DER stood at 2.2. For Garware Offshore, it was 1.4 and 1.1 for Great Offshore and Shiv-Vani Oil. Seamec and Jindal Drilling were the only two companies in the group to have low DER. The industry is also a victim of simple demand-supply economics.
“With crude oil prices crashing, highcost exploration projects are no longer economical. Hence, the demand for rigs is slackening, while many new rigs are ready to join the global fleet,” says RK Mehrotra, executive chairman of Foresight Group, a $500-million UK-based offshore drilling firm. Big Indian exploration companies are yet to cut spending, providing the services sector some respite. But it may not be for long. “Charter rates of rigs in India have not fallen so far. Still in the next 6-12 months, rates are bound to soften,” says SN Ajmera, chief financial officer, Jindal Drilling.

Crude oil prices: On Slippery Ground

Slackening of global demand and rising inventories have brought down crude oil prices from all-time highs. Prices are less likely to bounce back from these levels, finds out Ramkrishna Kashelkar

THE crude oil prices, which shot up to $147 a barrel in mid-2008, have now fallen below $45 levels. The combination of slowing demand and high inventories means that the commodity has a limited upside available from the current levels. Crude oil is the world’s most actively traded commodity, and the light, sweet crude oil futures contracts traded on New York Mercantile Exchange (NYMEX) are the world’s largest-volume futures contracts traded on any single physical commodity. Crude oil is the single-largest source of energy for the entire world representing nearly 35% of the energy basket. In 2007 the world consumed 86 million barrels of crude oil every day (MBPD) - which is coming down.

THE SLOWING DEMAND:
The global economic slowdown has hit the demand for crude oil hard. The International Energy Agency has continuously revised downwards its monthly oil demand estimates for 2008 and 2009. In July 2008, when the agency for the first time published its official estimate on the global oil demand in 2009, it was 87.7 MBPD. This now stands slashed to just 84.7 MBPD and with further downside risk. This means that the global oil consumption in 2009 will be lower than 2008, which itself was lower than 2007. This is the first time in past 25 years that we will witness such demand contraction for two consecutive years.

OPEC CUTTING SUPPLIES:
The Organization of Petroleum Exporting Countries (OPEC), which produces a little over one-third of world’s oil demand, had cut production by 2 MBPD in Nov 2008 and by another 2.2 MBPD starting Jan 2009. However, this didn’t help the crude oil prices as OPEC’s spare capacity rose to 5 MBPD, removing altogether any supply disruption figures. RISING INVENTORIES:
US commercial oil stocks surged a significant 27 million barrels in January to stand at 1,746 million barrels, which are now within a striking distance of the all-time high inventory levels seen in Oct 2006. The inventories in other developed countries such as Japan and the European countries, however, have been steadily coming down in the same period. It is not just the demand falling faster than supply that has resulted in higher inventories. The crude oil market has entered into a contango - a situation where the near term contracts trade at lower value compared to the longer term contracts - which has encouraged traders and producers to store excess crude in floating storage to profit from higher forward prices. By the end of January 2009, an estimated 75 million barrels of oil was stored in 35 very large crude carriers (VLCCs). These developments have lead to a historically unique problem. The US oil inventories at the key WTI delivery point of Cushing, Oklahoma, have shot up substantially. As a result, the crude oil storage at Cushing, which is a land-locked place, has reached 34.9 million barrels, approaching maximum operational capacity of 36 million barrels. This resulted in a distortion in the price of benchmark WTI, which has diverted from broader market fundamentals. West Texas Intermediate crude, the oil that the New York Mercantile Exchange uses as the underlying commodity for its crude futures, is trading at its largest discount ever to Brent crude, the European benchmark and as well as the OPEC crude basket, despite being superior in quality. This discrepancy between WTI and the international oil market could slowly disappear only after the oil demand rebounds and Cushing inventories start falling.

THE WILD CARDS:
Apart from the fundamental demand-supply factors, several other factors also influence the global crude oil prices. The sporadic upsurge in the geo-political tensions in the Middle East region- more prominently the Israel-Palestine unrest and Iran’s nuclear energy programme - can suddenly create supply concerns and boost the crude oil prices. On the other hand, the compliance of OPEC members with the quotas agreed upon by them has always remained questionable. Although the production discipline is being observed currently, any slippage would have a big negative impact on the markets. The weekly data on US petroleum inventories also drives the markets. The inventories, which rose in January, have fallen in the past two weeks providing support to the crude oil prices. The next OPEC meeting on March 15, 2009 will also have a bearing on the market. As crude oil supplies - including the spare capacity - remain strongly above the demand, the speculative interest in the commodity has vanished. At present, there are hardly any factors to help the commodity move up consistently. The recent fall in US inventories is a positive development but is mainly regarded as a temporary blip. Hence crude oil is expected to remain between $40 and $45 per barrel in the near term.

Merger between RIL and RPL:Oops… I did it again!

ET Intelligence Group’s Ramkrishna Kashelkar finds out how investors can benefit from the much talked about merger between RIL and RPL

THE boards of Reliance Industries (RIL) and Reliance Petroleum (RPL) will be meeting on March 2 to consider amalgamation of both the companies. This will be yet another instance when RIL, the biggest private refiner in the country, would merge its refining subsidiary with itself.
There are several alternatives of carrying out the merger, the clarity on which will emerge only later. If it’s an allcash deal, and RIL comes out with an open offer for RPL, it will have to pay out over Rs 10,000 crore for the outstanding RPL shares.
Alternatively, RIL could issue its shares in the exchange for RPL shares. The swap ratio could work out to somewhere between 1:15 and 1:17, based on the valuation methodology. Comparing the current market capitalisations, one RIL share is worth 16.6 RPL shares, whereas comparing the latest available balance sheet, the book value of one RIL share is 14.8 times that of RPL share.
At an assumed swap ratio of 1:15, RIL will have to issue 8.89 crore equity shares against the outstanding 133.3 crore RPL shares. As a result, RIL’s equity will rise to Rs 1,662.65 crore, which amounts to a dilution of just 5.6%.
The new refinery is expected to bring in additional revenues of Rs 100,000 crore and net profit of Rs 8,500 crore, annually, which is over half of RIL’s net profit for the 12 months ended December 2008. Hence, there is no doubt that the merger will be EPS accretive for RIL shareholders.
What RPL shareholders should do now is a key question. If they choose to convert their shareholding to RIL immediately, they will get a swap ratio of around 1:17. However, it is likely that the company will fix the swap ratio based on the book value at 1:15 or so. Hence, RPL shareholders should wait for more clarity on the swap ratio. However, if the equation between RIL and RPL shares moves above 1:15 in the stock market, they would do better by switching.