Great Offshore on high-growth course

Increasing Oil Prices, Charter Rates Will Help Co Grow 40%

THE Great Offshore scrip has been falling consistently and grossly underperforming the BSE Sensex due to the tepid financial performance in the last four quarters.
However, with over 90% of its assets deployed on medium- to longterm projects, the scrip is finding favour with institutional investors.
With oil prices inching up and oil companies renewing their exploration efforts, Great Offshore is likely to see a lot of investor activity.
Demerged from GE Shipping in 2006, Great Offshore was acquired by Bharati Shipyard in a tussle with ABG Shipyard that lasted over six months from mid-2009 to early 2010. The company today owns 47 marine assets — three drilling rigs, 28 offshore support vessels, 12 harbour tugs, three construction barges and a floating dry-dock vessel. All these assets are chartered out to oil companies for carrying out offshore exploration and production work.
The company is set to acquire two more vessels — one jack-up rig and one multi-support vessel — for $245 million by mid-2011.
Great Offshore’s results for the trailing four quarters have been lacklustre mainly due to dry-docking and refurbishment expenditure on its rigs Kedarnath and Amarnath. The profit during this period slipped 3.7% while the revenues were down 5.5% against the yearago period.
In spite of the weak financial numbers so far, the company seems to have caught the fancy of institutional investors. The shareholding of institutional investors, which stood at 6.5% at the end of December 2009, has grown steadily to 15.4% by the end of September 2010.
The company operates in a capitalintensive industry and has a debt-equityratioof2.2witharound8%average cost of debt. However, it enjoys strong operating cashflows, which will enable it to service its debts comfortably.
Starting December 2010, Kedarnath drilling rig has commenced work on a five-year ONGC contract worth $125 million. This contract alone is expected to add 10% to the company’s revenues on a full-year basis. While the Amarnath rig gets refurbished, the other rig Badrinath will undergo refurbishment in the first half of 2011. Thus, mid-2011 onwards the company will have all its four rigs running simultaneously, provided they all get deployed at the earliest. Assuming comparable charter rates for all the four drilling rigs, they can generate . 375 crore revenues and . 190 crore of operating profits annually from FY12 onwards. This will mean a 40% growth compared with the FY10 numbers.
World over the charter rates of drilling rigs have once again started moving up after crashing in 2008 and staying low through 2009-2010. This trend is expected to strengthen the offshore support industry’s outlook in months to come.

Indian Equity Market: Ready for the next ride?

In 2010, equities gained their lost ground. In the New Year, the bulls will gun for new heights. Though concerns are mounting over rising food inflation and widening trade deficit, opportunities are also galore. ET Intelligence Group does the crystal ball gazing

THE Indian equity markets fared better than most other emerging markets in 2010. And the New Year ushers the markets to next peaks, the levels that so far looked elusive. The momentum could be strong enough for this to happen given the increased consumerism, burgeoning rural demand, focus on infrastructure and rising exports. But the journey is muddled with concerns over unabated inflation, trade imbalances and delayed recovery in some of the developed countries.
What investors would be eager to know is whether India’s growth story would continue in the New Year and which way the markets would swing. ET Intelligence Group discussed some of the issues with experts from the banking, finance and markets who closely follow the macroeconomic developments.
The objective was to find out factors that are crucial for the next big leap in the New Year; to explore the opportunities and to figure out what can potentially go wrong. To make it simpler, we divided the factors into concerns and opportunities. But first, a heartening revelation — most of the experts feel that some of the concerns that the nation is grappling with today are tomorrow’s opportunities in disguise. For instance, the consensus was that the administrative slack that was exposed through incidents of poor decision-making by those who handle public posts would give way to cleaner and transparent administration. Also, a few experts drew attention to some of the current opportunities that may become concerns if not attended to in time. Take for example, India’s booming international trade. The speed at which India’s exports grew in the period that followed the financial meltdown in the West is stunning. But, this may encounter headwinds if European and US economies suffer a further delay in all-round recovery.
Read on to know more about what can impede the growth of our economy and the markets in the New Year and what can offer a fresh impetus.

OPPORTUNITIES
Reducing Gap Between Rural And Urban Economies
Rural India will be the next big destination for consumerism to grow with more and more companies focusing on rural population. Experts feel that higher rural participation will fuel the next phase of growth in consumer spending. This is visible from the faster pace at which telecom and two-wheeler companies have expanded their markets in remote regions.
The rural theme also keeps Indian economy insulated from the global economic hiccups. “Rural penetration would fuel growth for telcos, auto players, FMCG and financial services firms,” says Samiran Chakraborty, who heads the research operations of Standard Chartered Bank India.

Cleaner And Efficient Administration
This is undoubtedly the most important factor that is likely to sweep the power corridors of the country. The recent scams have raised questions about the political and bureaucratic ethos of the country. Observers, however, think that it may not slow down the foreign capital flow. They think it instead will help making the system efficient and transparent. “A greater efficiency means sectors, such as infrastructure, might receive the required attention and project work may pick up,” says Abheek Barua, chief economist of HDFC Bank.

Firm Growth Momentum
The Indian economy is expected to grow at 8.5-9% in this fiscal. Enhanced rural income, higher industrial growth and a good capital expenditure cycle have been the leading contributors to this growth in demand. Also, half of the 1.2-billion population is less than 25 years old. Such a young pool of workforce is necessary for the future growth.

Steps Towards Reducing Energy Deficit
Despite its status as the second-fastest growing economy in the world, India suffers from energy shortage. Take for instance the coal shortage, India’s coal production in FY10 lagged the target production by nearly a half. This may change over the next decade with the government’s focus on developing natural resources. Further, commissioning of UMPPs in the coming years would help the cause.

CONCERNS
Inflation And Interest Rates
As the manufacturing capacities increase, demand for raw materials rises. Also, higher disposable income fuels demand for consumer goods. These factors have stoked inflation in the past few quarters. What makes the situation worse is that experts are finding it complex to determine the exact factors of inflation, especially in agriculture. “Dynamics of food prices is difficult to understand. Prices went up despite higher agro production,” says StanChart’s Mr Chakraborty. Inflation may remain firm. Goldman Sachs research estimates FY12 inflation at 6%, higher than the government’s comfort zone of 5-5.5%. GOLDMAN Sachs research estimates FY12 inflation at 6%, higher than the government’s comfort zone of 5-5.5%. To contain it, the central bank may have to tweak interest rates upwards. Rupa Rege Nitsure, chief economist at Bank of Baroda, says that higher inflation will stay for a while. “And as long as it is out of the comfortable range, we might see upward pressure on interest rates,” she adds.

Slack In The Non-Infra, Non-Durable Segments
Higher inflation and interest rates have started impacting growth. StanChart’s Mr Chakraborty draws attention to the sluggish trend in demand for non-infrastructure capital spending and for consumer nondurables. “In the 12 months to September, consumer durables rose 30% but non-durables grew a tad 3.5%. This is because the prices of non-durables have shot up whereas those for durables have not increased as much,” he says. Non-infra capital spend has also been lower. A report by Standard Chartered Bank highlights that most of the 87 projects approved by banks in the June 2010 quarter were in the infrastructure segment. Most of the infrastructure growth is due to the government focus to expand roads and develop water sources. But the private capital expenditure has remained muted. The momentum in these two categories will be necessary for the sustainable growth from hereon.

Burgeoning Current Account Deficit
India’s current account deficit has widened from 1% of GDP in FY05 to an estimated 3% for FY11. This is expected to rise to 4.3% by FY12 according to the estimates of Goldman Sachs. A major concern, says the research house, of the deficit is funded by short-term inflows. Rising oil prices could also be another concern since India imports nearly 70% of total crude oil requirement. A higher oil import bill would expand the trade deficit. The fiscal deficit could also expand since the impact of higher oil prices cannot be fully transferred to consumers due to the government subsidies.

European Sovereign Debt Crisis
A lot of attention is paid to the debt crisis in peripheral Euro zone and its potential negative impact on the global economy. For India, the direct impact could be marginal. This is because Indian exporters have a limited exposure to many of the countries in this region, such as Greece, Ireland, Portugal and Spain. These countries together accounted for just over 1.5% of India’s total exports of $ 178 billion in FY10. However, recurrence of crisis in this region may affect sentiments in the short term. The trend in the growth and that in the market would depend upon how these myriad factors take shape during 2011. Analysts feel that markets would remain rather muted at least until March 2011. “While upward movement looks limited for the markets, the downward pressure would be little since insurance companies tend to invest during this period,” says Vikas Khemani, institutional equities head, Edelweiss Capital.
At the current levels of over 20,000, the Sensex companies together trade at 20 times their trailing 12-month consolidated earnings. Analysts have reduced the growth forecast for the next fiscal to 15-18% from 20% after considering the macroeconomic factors. According to the revised estimates, the forward P/E of the Sensex is just over 17. This is much lower than the P/E of more than 23 two years ago when the index was at similar levels, which means the current valuations are not stretched. Experts feel that a chunk of the second US fiscal stimulus of around $600 million may find its way to the emerging equities. If that happens, investors need to keep a close eye on whether higher liquidity makes valuations unreasonable.

THE BACKBENCHERS

THE YEAR 2010 was the year of bigbang recovery for India Inc. Most companies in the big league were back on track after suffering from the financial meltdown. Though it was an all-round revival in demand spanning across sectors, there were a few laggards. These companies failed to show an improvement over their previous year’s performance for reasons including supply glut, stiff competition, entry of new players and rising input costs. ET Intelligence Group’s Jwalit Vyas and Ramkrishna Kashelkar tell you more about some of these laggards and what you can expect from them in the New Year

Reliance Capital
RELIANCE CAPITAL HAS suffered from reduction in its brokerage revenue due to a shift in the trading pattern from share delivery to derivatives. A delivery-based model earns better margins. Its general insurance business has also not been able to scale up. The only segment in which the company reported growth was consumer financing. The company is planning to set up its investment-banking arm, which is likely to take months to have a meaningful impact on the revenues. In spite of its weak financial performance and tepid stock market performance in the past one year, the company’s stock trades at a price to earnings multiple (P/E) above 50, which is very high compared to its peers.

Petronet LNG
INDIA’S LARGEST LNG IMPORTER Petronet LNG successfully carried out its expansion plan to double the capacity at its Dahej terminal in mid FY10. Still its earnings growth has remained negative for the past 12 months. The company’s inability to scale up volumes due to pipeline constraints has been the main reason behind this. Increased interest and depreciation burden on completion of capex has been the other important reason. In the 12 months ended September 2010, the company’s revenue fell 8.4% as against 55% jump in its interest and depreciation costs. The company’s problems are expected to solve as Gail expands its key Dahej-Vijaipur pipeline to transport more gas. Stagnating production at RIL’s KG basin fields also bodes well for the company. Its buoyant stock market performance captures these positives.

Suzlon Energy
LOWER DEMAND FROM BOTH THE US and European markets has affected Suzlon’s wind power business. Clients deferring deliveries resulted in losses in spite of a strong order book position of 1,550 mw as on October 2010, out of which 55% includes international orders. However, the Indian operations contributed almost three-fourths to its sales in the first half of FY11. During the beginning of FY11, Suzlon had 700 mw of international orders, out of which has managed to execute only 20% in the first half. With no clarity on the renewal of tax credits for alternative energy in the US, order flow is expected to slow down drastically. Higher raw material costs are also eating out its profits. To add to this, the company has huge debt of around Rs 1,200 crore. This means that the company will have to bear high interest burden too. The outlook therefore looks uncertain.

ACC Cement
ACC, LIKE OTHER CEMENT players, is grappling with sluggish demand conditions at a time when the industry’s capacity is set to grow rapidly. In addition, the sector is facing a rising cost structure, with higher fuel and freight costs. Weak demand conditions resulted in a drop in ACC’s realisations from selling every tonne of cement in both the June and September 2010 quarter year-on-year. The operating environment for the cement sector remains difficult, with cost pressures not showing any signs of easing. And while cement prices have shown an uptick post-monsoon, there is an uncertainty over their sustainability, particularly in the absence of any fresh government-funded infrastructure project announcement.

GE Shipping
SHIPPING COMPANIES INCLUDING GE Shipping are facing a difficult operating environment for nearly 18 months now. That is because of a sluggish demand from Western countries in the key tanker segment, which is the transporting crude oil and allied products. The companies are yet to see any recovery in demand for vessels from the key consumers in the US and Europe, despite the quantitative easing programmes put in place by several governments. GE Shipping trades at 8.6 times its consolidated profits for trailing four quarters. However, investors could well avoid the broader shipping sector, until there is further clarity.

Reliance Communications
STEEPER COMPETITION AND FALLING per user revenue have crippled the performance of Reliance Communications (RCOM). Its poor show is visible in an 11% fall in revenue and a 20% drop in operating profit in the 12 months ended September 2010. The company is saddled with a debt of over Rs 37,000 crore. Its recent low-cost fundraising to replace one-fourth of this amount is unlikely to bring any sizeable gains. Unlike its bigger peer Bharti Airtel, which has expanded into other geographies, RCOM is dependent on the Indian market. This single dependence is likely to keep its growth prospects muted given the fast saturating domestic market and low tariffs. Also, the 3G services launch will take at least four quarters to add to the bottomline. Due to these factors, RCOM is expected to report depressed numbers in the near term.

Punj Lloyd
THE LEADING INFRASTRUCTURE AND construction company Punj Lloyd has been under pressure in 2010 due to recurring problems on project execution. With its projects getting delayed it had to pay damages to its customers. The scenario is changing slowly. After posting a consolidated loss of Rs 300 crore in March 2010 quarter, the company curtailed its losses in June quarter to be followed up by a profit in the September quarter. The company’s subsidiaries, which were suffering losses, appear to have turned profitable in the September quarter. The company continues to add orders to its kitty. It has an order book of Rs 25,470 crore as of November 2010, which is 2.6 times its revenue for the 12 months ended September 2010 on consolidated basis. However, nearly 40% of its unexecuted orders are from Libya and there is some uncertainty on their timely execution. For the 12 months ending September 2010, the company had a net loss. It is currently trading at a price-to-book-value (P/BV) of 1.15 times, which is substantially low.

Methodology
We gathered trailing 12-month growth to September 2010 in revenue and operating profit for the companies that are part of the BSE 200 index. The index encompasses majority of the frequently-traded big and medium-sized companies. We then selected those companies which reported falling topline when compared with their performance in the 12 months to September 2009. After arranging such companies in the ascending order, we opted for those companies that reported a similar fall in their operating profits.

Interview- Petronet LNG: The Game Changer

THE new man at the helm of Petronet LNG wants to be a catalyst for change of the company, which is eager to grow beyond being just a toll regassifier. AK Balyan, managing director and chief executive officer, Petronet LNG, shared his views on how the company could transform itself over the next five to six years in an interview with ET Intelligence Group’s Ramkrishna Kashelkar. Excerpts.

It is hardly six months since you took over at Petronet. What was the first major task you took up after joining?
The first major exercise we took up at Petronet after I joined was conducting a SWOT (strengths, weaknesses, opportunities and threats) analysis involving all our employees. It sort of provoked each employee to analyse how far we have been able to achieve our objectives, where we are today and where do they see Petronet in the next five years. Based on inputs from this brainstorming and collective thinking, we tried to come out with a new vision for the company and a strategy on how we should really go about to meet this. What has emerged is that PLL should not remain just a tolling company to import and regassify LNG. It should venture in some areas on its own, where we have strengths or can draw on our promoters’ strengths and grow. To achieve our vision and to position the company in a new business environment, we are now trying to work out the specific strategic goals we should set ourselves that can collectively help us meet our goal.

How do you plan to implement Petronet’s new strategy while addressing the domestic demand

supply gap in natural gas?
We can capture the opportunity that exists within the country by bringing in more gas. Natural gas is a unique business, where if you increase supply, demand would grow. Since there are huge volumes required in the country, we are aiming at doubling our volumes in the next five to six years.
Besides, we are looking at the possibility of entering into direct marketing of natural gas in areas where there are no pipelines. During the past three years, we have gained a lot of experience in transporting LNG through tankers. We are trying to create small hubs with appropriate storage capacity, which we can supply through tankers. We now supply LNG up to 500 km distance from Dahej to different industrial areas. And this is growing fast. So this will be an entry into direct marketing rather than staying just a tolling regassifier. In future, these small hubs could grow in nearby areas through small pipelines and even CNG stations could be set up. This kind of opportunity can be extended to various parts of the country. LNG can also be used directly in automobiles and other industrial uses. Since LNG is not stored under very high pressure, unlike CNG, it is safer to use and investments are not very high. You can actually carry much larger quantities of gas with LNG, which means less frequent refuelling.

Petronet has also talked about entering into power generation. What are your plans on this front?
LNG and power generation businesses actually go hand-in-hand. Being an LNG importer, we have some natural positives in the power generation. Firstly, we don’t have to pay any transportation charges or VAT, unlike other players, for the gas used in generating power. Since LNG is imported at sub-zero temperatures, we also have the benefit of cold energy, which adds 8-10% efficiency to power generation. Considering all these, we can be a very competitive power producer in spite of the imported fuel. At Dahej, we have acquired 50 acres of land near our terminal and a detailed feasibility study is underway. We have also applied for environmental clearances and will be going for final approval from the board soon.
We are aiming for 1,200 megawatt in phases with a total capex of close to Rs 4,000 crore. The entire capacity is expected to come up within 36 months from the zero date. When fully commissioned, it will consume over 1.2 million tonne of LNG annually.
Sourcing the gas for the power venture would not be an issue. Dahej terminal has been enhanced to 10 mtpa with only 7.5 mtpa firm supply. So we have 2.5 mtpa extra capacity. We are actively discussing with suppliers for filling this gap and I hope in the next couple of months, we will be able to tie up something for this.

What is the progress on your Kochi terminal?
The 2.5-mt Kochi LNG terminal is progressing fast and is already 60-65% complete. We are aiming for mechanical completion by the end of FY12. With prospects of gas becoming available in that area for the first time, a lot of new industrial activity has begun. Gail and us have done a lot of market study and the detailed analysis has justified doubling the terminal capacity to 5 mtpa. Our board has also approved this.
These exciting opportunities make us confident that we need to double our volumes over the next five to six years.

The domestic supply of natural gas is growing, which is cheaper to imported LNG. How do you view this scenario?
Natural gas pricing is a big issue in our country. We are perhaps the only country in the world, where a number of different prices are in vogue. This is not really a good situation for the country. We should have a narrow range in prices and marginal differences could be allowed based on transportation. This is the situation in most countries.
I am happy that the government is actively considering a ‘price pooling mechanism’ to address this issue. For a country of our size, affordability of energy source is an important thing. From consumer’s aspect also, it is a good thinking to keep uniform approach to the gas prices.
At the same time, I feel it is being practised to a certain extent. The government’s decision to allocate only 60% gas requirement of a power plant from domestic sources and making them source the rest on their own is a different way of averaging out the natural gas prices. However, a more structured way should be set up. If that happens, the differential between the cost of domestic and imported gas would come down. How will you be funding your projects? Would you need any equity partner for the power venture?
We are in a capital-intensive industry and need a chunk of investment to get going. So it is natural for us to leverage our balance sheet. We are maintaining the debt-equity ratio at around 1.3. The three major projects in front of us today are the Kochi terminal, then its expansion and the 1200 mw power plant.
We are also setting up a new jetty at Dahej, which will allow us to bring in bigger vessels lowering the turnaround time and improving operational efficiencies. This would also give us flexibility to operate at much higher capacity than the nameplate 10 mtpa.
We are enhancing our throughput. Our regassification charges are revised 5% up every year. So with higher charges, volumes, marketing of spot cargoes, I think we can meet our capex requirements for the Kochi terminal and its expansion. For the power project, we will need financing, but not in the form of equity.

It was reported sometime ago that pipeline constraint is putting a cap on your capacities. How is the scenario now?
Yes, the pipeline capacity remains a constraint. The first phase of expansion of DVPL is on track to finish in 2010, which will ease pressure for us. Another year or so down the line, the full expansion would commission when we will find a lot of improvement for PLNG. We have been operating our plant at an average 7.5 mtpa. When PMT fields were down for a month or so and demand was high, we have operated even at 12 mtpa capacity. But for a sustainable ramp up, the pipeline constraint needs to be removed.
The country needs a much wider network of pipelines. This will be very good for gas suppliers. At Kochi also, Gail is working very fast to lay the pipelines connecting major customers before our plant comes up.

Rising crude prices may play spoilsport on Dalal Street

Experts Warn ‘Costly’ Crude May Hit Cos’ Margins & Cause Macro Problems

ASK fund managers what their biggest near-term macroeconomic concern is, and most likely rising crude oil price will top the list. Brokers and money managers caution that a further rise in crude oil prices can trigger a downturn in share prices. Apart from hurting corporate profit margins through higher raw material and transportation prices, high oil prices will widen the country’s fiscal deficit, causing other macro-economic problems in its wake.
But the stock market appears to be indifferent to the problem for now, as seen from the steadily rising Sensex which closed above the psycho-logical 20,000-mark for the first time in over a month.
Oil prices have recently broken out of the narrow range of $75-85 per barrel seen for over a year, and are now nudging $90 due to liquidity infusion from the US, higher demand and falling inventories.
“The latest round of quantitative easing has fuelled investments in commodities on hopes of a recovery in US and Europe,” says Vikram Kotak, chief investment officer, Birla Sun Life Insurance, adding, “If this liquidity and momentum drives crude above $100, there will be pressure on the country’s current account deficit and also on corporate earnings.”
Some companies will be able to absorb the increase in raw material prices and even pass it on to their customers. But there will be others, who will be unable to pass it on either due to competitive pressures or government rules.
For instance, oil marketing companies which sell diesel, LPG and kerosene at a discount to cost price, will suffer huge losses. Upstream companies such as ONGC and Oil India will also suffer as they too have to share a part of the deficit. ONGC chairman and managing director RS Sharma had recently said that oil prices higher than $70 per barrel would work against the company.
“Raw material costs sectors like paints, tyres, textiles with the rising crude oil prices will go up,” says Sarabjit Kaur Nangra, VP-Research, Angel Broking.
“Many companies are expected to pass on the cost to the end user. While some may do it immediately others may be able to do it only with a lag effect,” she said.
The Empowered Group of Ministers (EGoM) headed by finance minister will meet shortly to review diesel prices. However, Ms Nangra feels that the government is unlikely to raise diesel prices “in the near future, especially given the persistent inflationary pressures”.
In addition to state-owned oil marketers, airline companies will feel the pinch of high fuel prices, as aviation turbine fuel accounts for 35-40% of expenses. ATF prices have risen 12-13% since October to around $765/ kilo litre.
However, the current quarter numbers of airline companies will not reflect the strain as passenger traffic was robust because of the holiday season. But a high oil price is good news for unregulated oil producers such as Cairn, Reliance Industries and Selan Exploration. Similarly, it could lead to increased exploration activity, benefiting companies like Great Off-shore, Aban Offshore and Shiv Vani Oil.

TATA CHEMICALS: UK buy eases raw materials uncertainty

THE proposed acquisition of British Salt will fill a key strategic gap for Tata Chemicals. Brunner Mond, Tata Chemicals’ wholly-owned subsidiary in the UK, has signed an agreement to acquire British Salt for £93 million (. 656 crore approximately).
Brunner Mond was at risk of being hit by spurt in raw material prices after its supply contract with Ineos ends in 2016. By acquiring British Salt, it will have a captive and consistent source of raw material salt at reasonable cost.
The acquisition price that Tata Chemicals has agreed to pay for the acquisition is nearly six times the operating profits (earnings before interest, tax, depreciation and amortisation, or EBITDA) of the company. For a commodity chemicals company, this valuation is not cheap. However, the possible strategic synergies for Brunner Mond justify the pricing. The uncertainty over raw material supply at reasonable cost is eliminated for Brunner Mond’s UK operations. As British Salt starts supplying salt in a few months’ time, Brunner Mond’s raw material bill is likely to fall. Lastly, as the acquired company mines underground salt from its fields, the cavities created can be used for storing natural gas. Within five years, the new owners expect to generate gas storage business worth £45 million.
The acquisition will be funded through debt raised on the books of Brunner Mond and British Salt. British Salt’s is a high-margin business, with 45% to 50% operating profit margins and high cash generation, which will ensure easy debt servicing. Since the acquired company is profit-making, the acquisition will add to the EPS from the first year itself.
In this acquisition, Tata Chemicals has not repeated the mistake made while buying General Chemicals in the US in 2008. The pension fund liabilities in British Salt show a small surplus and there won’t be any incremental liability on this count on Tata Chemicals in future. In the case of General Chemicals, the incremental pension fund liabilities had put pressure on the company’s overall earnings for FY09 and FY10.
Tata Chemicals is back on a strong growth path after a couple of years of stagnation. Its acquisition of Rallis and foray into customised fertilisers are aimed at supplying a whole gamut of products to domestic farmers. While all these measures add to the corporate profitability, a mega-booster will come if it is able to double its urea capacity. The project continues to await firm gas allocations from the government.

Clariant Chemicals: Clariant seen on a sound footing

Co Offers A Healthy Dividend Yield

SPECIALTY chemical manufacturer Clariant Chemicals may have lost heavily as the markets tumbled during the past few weeks, but investors need not fret as the company is likely to outperform the market due to its strong business position and sound financials.
The company’s profits more than doubled in 2008 and grew by over 60% in 2009. In 2010, the growth seems to have almost stagnated. Till September 2010, the company had posted a modest 13% profit growth on a 9% growth in revenues. As a result, its operating profit margin has come under pressure. However, it has already paid a . 10 per share interim dividend in 2010 so far and is well placed to at least match its last year’s dividend of . 25 per share.
Clariant Chemicals, a 63.4% subsidiary of German specialty chemicals major, is India’s leader in colorants, dyestuff and specialty chemicals catering to industries such as textiles, leather, paper, plastics, and paints, among others.
During the past couple of years, the company shed its non-core businesses and monetised excess assets. It disposed of its flexible laminating adhesives business in 2009 and sold its diketene and intermediate business in early 2010. These two businesses contributed . 85.7 crore to its revenues in 2009 and fetched the company a profit of . 8.9 crore on sale.
In August, the company approved the sale of its land at Balkum, Thane, for . 240 crore. The sale is likely to be completed in a few months. The funds will enable the company to meet its own internal requirement
for expansions, besides raising its dividend payout.
Clariant has maintained an excellent dividend payment record. It has paid dividends for 15 consecutive years. Even though the scrip has gained over 60% in the past one year, the dividend yield works out to 3.7%.
Masterbatches, which used to be a small portion of the company’s overall business, has registered a strong growth over the past couple of years. To cater to the market potential of its product range, the company is expanding capacities and setting up a green field manufacturing facility in Ambernath. A healthy dividend yield and steady capital appreciation could be passé for investors of this company.

RALLIS INDIA New acquisition is in line with long-term plan Ramkrishna Kashelkar ET INTELLIGENCE GROUP RALLIS India’s acquisit

RALLIS India’s acquisition of a seeds company marks an important milestone in the long-term strategy of not just Rallis but also Tata Chemicals in catering to the needs of Indian farmers. This addition to the product portfolio will bring significant synergies for the group, which already has an extensive distribution network.

The acquisition is not likely to boost Rallis’ profits in the near-term; in fact, the acquired company, Metahelix Life Sciences, is just breaking even. The main benefit will be in the form of access to Metahelix’s elaborate set-up — three research facilities with systematic R&D programme and a team of 50 scientists, product-testing centres across the country, established products in rice, maize, millets and vegetable seeds and good germplasm, which is crucial to developing new seed varieties, besides a strong sales force. Metahelix is also the first Indian company to have a proprietary Bt cotton variety.

Rallis is paying about . 125 crore for a 59% stake , with the balance stake to be bought in phases by 2015. This will push back the impact of the acquisition on the balance sheet of Rallis, which is mainly paying from its existing cash reserves. The deal values Metahelix at about . 210 crore, nearly twice its expected revenue for FY11, according to the management.

In terms of future guidance, the Rallis management says the acquired business will generate cumulative revenue of . 1,000 crore over the next five years. This target translates into a cumulative annualised growth rate (CAGR) of 35% over the next five years, if the company ends FY11 with . 100 crore of revenues. How profitable the Metahelix operations will be over the next five years , however, remains to be seen. The seed industry leader, Advanta India, reported a measly 3.4% net profit margin on a consolidated basis for the 12-month period between October 2009 and September 2010. However, smaller players such as Kaveri Seed and Monsanto India enjoyed a net profit margin of 16-17% for the same period.

The future growth of Rallis India will get a boost from the new agrochemicals plant at Dahej being set up with an investment of . 150 crore. The company is expecting cumulative revenues of . 500 crore from it over first three years of operations. With Tata Chemicals launching a crop and soil specific customised fertiliser, Paras Farmoola, just a few weeks ago, the two large corporates now have a presence in the entire value chain of farm inputs. Their ability to offer a comprehensive solution will provide them with a competitive advantage.

Oil India: Aiming For A Big Leap

FROM being a small company confined to the distant north east for decades, Oil India has come a long way. The company’s chairman and managing director NM Borah says that the company’s future growth will hinge on a clear strategy and a policy and procedural framework. In an interview with ETIG’s Ramkrishna Kashelkar, Mr Borah spoke about the future of the company and and the steps taken by him to enable the state owned firm to take the next big leap. Excerpts:

How has Oil India grown in the past few years?
In the past 25-30 years, the company has primarily been producing three million tonne (MT) of crude oil per year. To grow after such a long stagnation, the first challenge was to make our own people to believe we could go higher. After much effort in the past 4-5 years, we could increase the production. At present, we are producing 3.7 MT of crude oil and now aiming for 4 MT. In fact, the September quarter production of 0.93 MT was the highest ever for the company and I am confident that we are in a position to achieve 3-5% annual growth in the coming years.
In the natural gas business, we have a lot of potential to grow. Within the past 3-4 years, the production has grown over 50% to about 6.8 million cubic metres per day. It can be expanded further also. There are not many small-scale gas-consuming industries in our vicinity, which is why we are dependent on a handful of large customers. It has happened a few times in the past that we had to cut production as customers did not lift the promised quantities of natural gas. We were predominantly a northeastern company for decades. Thanks to the new exploring licensing policy (Nelp), we became a pan-India company and subsequent policy liberalisation enabled us to expand overseas. Today more than 80% of our total acreage is either overseas or obtained under Nelp.
The expansion drive seems to have slowed down in the past one year after your IPO.
In the past one year or so, we have deliberately slowed acquisitions. This is not due to lack of opportunities or we don’t have money. As a matter of fact, there have been plenty of both. But this is a question of strategy. Thanks to our expansion of the past few years, we have enough exploration work on our platter, which is a lengthy and risky process. As part of our newly formed strategy, we decided to consolidate our existing portfolio and not to look for adding new exploration prospects overseas. On the contrary, we would like to look for discovered or producing assets. Arising out of this strategic thinking, we joined the Carabobo project in Venezuela, which is a substantially large heavy oil field. We are also actively looking for acquiring more such producing assets.

What are the kind of assets that you are seeking to acquire?
This is also a question of long-term strategy, which took a lot of time for us to formulate.
But the time was worth spending because now we have developed not only the structured logic to decide on acquisition matters, but also the entire background policy framework.
The process has also identified more criteria for our prospects. In terms of oil or gas, we are comfortable with both. We have a lot of expertise in onshore, but we won’t mind offshore as we are building our capabilities there. In terms of size, we will be comfortable with asset with production potential of 10,000-20,000 barrels per day, which will be around 0.5-1 MTPA. However, we could look at smaller projects as well to gain an entry point in a particular geography. In terms of specific geographies, we would primarily wish to expand in those areas, where we are already operating. Apart from that, we have identified certain regions of South East Asia, Australia, Latin America and Canada as areas of our interest. We are also considering acquiring a company with niche technical expertise to fill up certain technology gaps within Oil India.
To spot the opportunities that match our appetite from the numerous proposals we get, we have created a parameter checklist. Only when a proposal meets this parameter, we take it up for further study. We also have identified a few financial institutions to facilitate in getting such proposals and have also laid out a transparent procedure to decide their fees etc. With this entire set up ready, we are very comfortable in going ahead with our acquisition strategy. In the calendar year 2011, we plan to make minimum two such acquisitions.

What will be your strategy for diversification?
While we would like to stick to our core competence in E&P and long distance oil & gas pipelines, we have a strategy for ‘selective diversification’. However, these diversifications will be related to the petroleum value chain such as refinery or petrochemicals. Apart from the a 26% stake in Numaligarh refinery, Oil India has also bought 10% in the Brahmaputra Cracker & Petrochemicals, which is scheduled to go on stream in 2013. Similarly, the company has tied up with BPCL, Gail and ONGC apart from Indian Oil to participate in bidding for the city gas distribution business. We also have a 45,000 TPA plant to produce LPG, which we sell to Indian Oil. An earlier idea of petro-product retailing was dropped due to under-recoveries.
In gas transportation, we can extend our upcoming Duliajan-Numaligarh pipeline to Guwahati and further to Barauni as we already have the right-of-way, thanks to our existing pipeline. We have also done survey on market potential and anchor customers on this route. We are also looking for certain opportunities in Bangladesh in pipeline business. In non-conventional energy, we are readying ourselves for the bidding rounds for shale gas that the government is planning for.

These are all strategies for the long-term growth that you have outlined. What will drive the company’s earnings in the near term?
Today, 100% of our oil and 95% of gas comes from the northeast. While the exploration and development work progress in our other fields, our majority production in the next few years will continue to flow from the northeast fields. And we feel that a lot more can be done to increase production — induction of better technology to arrest decline in old fields and improving operational efficiency to reduce the time in bringing new discoveries to production. In the next 1-2 years, we would aim to increase our oil production to 4 MTPA level.
Our natural gas volumes would grow once the pipeline supplying 1 mmscmd to Numaligarh refinery commences operations in February 2011. Oil India also holds 23% in the pipeline with Assam Gas Company and Numaligarh Refinery holding the rest. The next big jump in gas volumes would come in 2013, when the Brahmaputra Cracker project commences operations. We will be the largest gas supplier at 1.35 mmscmd to the project.
In other exploration blocks through Nelp, we have two highly prospective onshore blocks — one in KG basin and another in Mizoram. We are trying to bring them to drilling phase as fast as possible.

You spoke about shale gas. Has Oil India done any work on this front ?
Our geological perception is that the northeast in general is a rich source of shale gas, although it is not possible to give a definite figure. The problem we are facing today is too much of data. In over 50 years of operations in the north east, we have gathered a lot of geological data. When we were drilling for our target reservoirs, the wells have passed through the shale ranges at different depths. However, the data was generated without any specific perspective on shale gas.
Compiling all this data, processing it and taking a fresh look at it from the shale gas perspective is a time-consuming process. We have set up a small team within the company for this purpose. Within the next 4-6 months, we will be in a position to complete the study to find the resource potential. And once we have this information, we can tie-up with someone, who has actual shale gas drilling experience to help us identify the best locations to drill. Secondly, we would also like to go to acquire a shale gas asset overseas to gain hands-on experience. Since it will be a producing asset, the cost will be high. Hence, we have taken steps for a strategic tie-up with suitable domestic partners.

REFINING : Q3 to ride high, but margins likely to soften

THE last couple of months have been good for the refining industry globally, with margins improving due a spike in demand amid stagnant supply. This may boost the industry’s December quarter numbers. However, the buoyancy appears temporary.
During the September quarter and so far in the December quarter, demand for oil rose in the 34 economically advanced countries that are part of the Organisation of Economic Cooperation and Development (OECD). On the other hand, the global refinery throughput actually came down due to maintenance shutdowns, production cuts induced by low margins, and the industrial unrest in France. A strike in the Fos and Lavera oil terminals in France for most of October forced the temporary shutdown of more than 1 million barrel per day (mbpd) of refining capacity. This reduced the OECD refinery throughputs from 37 mbpd
in September to 34.6 mbpd in October. The global refining throughput fell by 2.3 mbpd in this period. These problems had resulted in supply stagnation in Europe, and as a result refiners all across the world witnessed improvement in their margins.
“In October, due to the tight situation of products in Europe, gasoline and distillate stocks dropped, causing a recovery of the gasoline crack in the US, which, in combination with stronger distillate demand on both sides of the Atlantic, allowed the US to protect its refining margins,” an OPEC report said. Cracks represent individual product’s profitability over the crude oil, while the gross refining margins (GRMs) represent the differential between the cost of a barrel of crude oil and revenues from sale of all petroleum products produced from it.
In its December 2010 report on the Indian oil sector, Edelweiss said there was a sustained improvement in the refining margins of domestic firms in November.
These higher GRMs are likely to witness pressure in the coming months as the fundamental demand-supply imbalance will prevail. The outlook on global oil demand recovery in 2011 remains mixed with the large economies of US, Europe and Japan stagnating. Also, an estimated 6 mbpd refining capacity will be added steadily through 2015. In a webcast with investors earlier this week, the refinery head of petroleum major LyondellBasell, Kevin Brown, said that the refining margins are likely to remain flat “over next several years”. This may not be strictly true for Indian refiners, but investors should be wary of the global economic recovery in the coming quarters before investing in this industry.

CRUDE OIL: Energy agency warns of a price bubble

AFTER staying range-bound for over a year, global crude oil prices appear to have broken a key resistance level and headed northwards. Several factors are at play. Among the key factors that have boosted oil prices is a sustained increase in demand, especially from the OECD countries, during the last few months. Global oil demand in the September 2010 quarter was higher by 3.1 mbpd y-o-y, continuing the acceleration since the beginning of 2010 — 2 mbpd y-o-y growth in the March 2010 quarter and 2.8 mbpd growth in the June 2010 quarter. On a sequential basis, the demand in the third quarter at 87.5 mbpd was nearly 1.5 mbpd more than in the second quarter of 2010. This made the International Energy Agency (IEA) revise upwards its earlier demand growth estimates for 2010 by 0.2 mbpd. The latest estimates peg the world’s oil demand to average 87.3 mbpd in 2010 — 2.3 mbpd or 2.8% higher against 2009. OPEC countries increased production, but non-OPEC countries registered a sequential fall in output during the September quarter. This resulted in a reduction in oil inventories the world over. In the US, for which weekly inventory numbers are available, oil stocks have fallen by 37.5 million barrels from the beginning of September till end-November. In Europe, the inventories fell substantially in September and continue to remain below the year-ago level in spite of a marginal growth in October.

Traders remain bullish on crude oil, since the US dollar is likely to remain weak thanks to ‘quantitative easing’. The revised demand forecasts by institutions such as IEA as well as OPEC mean that the signals appear to be more bullish than bearish.
These developments do not bode well for India, whose oil import bill and budget deficit will swell if oil prices continue to rise. Similarly, under-recoveries for state-run oil companies will start moving up. According to a research report by brokerage firm Edelweiss, under-recoveries on the sale of diesel averaged . 3.3 per litre in November 2010 from . 2.3 in October. “Based on crude and product prices as on November 30, 2010, gasoline and diesel under-recoveries are at . 1.3 per litre and . 4.9 per litre, respectively,” says the report.
Rising oil prices would spell bad news also for economies struggling to recover after the economic turmoil during the last few years. The IEA has warned of a renewed price bubble, built from a perception that there could be tightening in the oil markets in the near term. “This points to the possibility of weaker 2011 GDP growth, and, thus, the oil demand,” the report says. If that is the case, high oil prices may not be sustained in 2011.

Jindal Drilling & Industries (JDIL): Debt-free, cash-rich JDIL looks attractive

Co Insulated From Rig Charter Rate Fluctuation

THE shares of Jindal Drilling & Industries (JDIL) have underperformed the markets almost throughout the past one year, losing 10% while Sensex gained 15%. However, it had more to do with the company’s internal instability rather than its financial performance. The company’s board recently removed its managing director unceremoniously “having concluded that they have lost confidence in him” to be re-placed by one of the promoters. It has also put its earlier restructuring ideas on the backburner.
Jindal Drilling (JDIL) is in the business of hiring jack-up drilling rigs and deploying them on ONGC contracts, besides offering support services such as mud-logging and directional drilling. These two support services represent around 10% of the company’s total revenue.
For the first half of FY11, the company reported a 34% profit growth to . 49.9 crore, although revenues dipped 21.5% Y-o-Y to . 526.3 crore. This was mainly on account of a substantial cut in its single
largest cost item of drilling operation charges. In effect, the company is now paying around 80% of revenues as charter hire charges to rig owners – down from 87% last year. The numbers were slightly affected due to dry-docking of one of the rigs between the contract renewal phase.
The company currently has five jack-up drilling rigs on hire — three from Noble and one each from two joint ventures, Discovery Drilling and Virtue Drilling, where the company owns 49% stake. All these rigs are working with ONGC on long-term charters of three or five years and the next renewal is due only in October 2011.
The company’s share in these two JVs resulted in a net profit of . 91.5 crore during FY10 — more than its standalone profit of . 84 crore. However, the return on capital is substantially higher in the standalone business.
Despite being in the offshore drilling services business, the company is virtually insulated from the fluctuations in the rig charter rates. This is mainly because it doesn’t own any rig on its own and earns its income as a differential between what it gets from ONGC and what it pays to the rig owner. Typically, both these contracts are back-to-back, with 80% of revenues being paid to the rig owner.
Being asset-light, the company has emerged a debt-free and cash-rich company with strong operating cashflows. Its joint venture companies, which had raised loans to buy rigs, are also repaying their loans rapidly. During FY10 alone, the outstanding loan in JVs fell by . 235 crore or 30%.
While focusing on repayment of debts in the JVs, the company is also looking to charter few more rigs for the Indian market. JDIL is currently trading at 12.1 times its standalone earnings for trailing 12 months. Considering the profits on a consolidated basis, the valuation would appear even more attractive.

Debt-free, cash-rich JDIL looks attractive

Co Insulated From Rig Charter Rate Fluctuation

THE shares of Jindal Drilling & Industries (JDIL) have underperformed the markets almost throughout the past one year, losing 10% while Sensex gained 15%. However, it had more to do with the company’s internal instability rather than its financial performance. The company’s board recently removed its managing director unceremoniously “having concluded that they have lost confidence in him” to be re-placed by one of the promoters. It has also put its earlier restructuring ideas on the backburner.
Jindal Drilling (JDIL) is in the business of hiring jack-up drilling rigs and deploying them on ONGC contracts, besides offering support services such as mud-logging and directional drilling. These two support services represent around 10% of the company’s total revenue.
For the first half of FY11, the company reported a 34% profit growth to . 49.9 crore, although revenues dipped 21.5% Y-o-Y to . 526.3 crore. This was mainly on account of a substantial cut in its single
largest cost item of drilling operation charges. In effect, the
company is now paying around
80% of revenues as charter hire
charges to rig owners – down
from 87% last year.
The numbers were slightly
affected due to dry-docking of one of the rigs between the contract renewal phase.
The company currently has five jack-up drilling rigs on hire — three from Noble and one each from two joint ventures, Discovery Drilling and Virtue Drilling, where the company owns 49% stake. All these rigs are working with ONGC on long-term charters of three or five years and the next renewal is due only in October 2011.
The company’s share in these two JVs resulted in a net profit of . 91.5 crore during FY10 — more than its standalone profit of . 84 crore. However, the return on capital is substantially higher in the standalone business.
Despite being in the offshore drilling services business, the company is virtually insulated from the fluctuations in the rig charter rates. This is mainly because it doesn’t own any rig on its own and earns its income as a differential between what it gets from ONGC and what it pays to the rig owner. Typically, both these contracts are back-to-back, with 80% of revenues being paid to the rig owner.
Being asset-light, the company has emerged a debt-free and cash-rich company with strong operating cashflows. Its joint venture companies, which had raised loans to buy rigs, are also repaying their loans rapidly. During FY10 alone, the outstanding loan in JVs fell by . 235 crore or 30%.
While focusing on repayment of debts in the JVs, the company is also looking to charter few more rigs for the Indian market. JDIL is currently trading at 12.1 times its standalone earnings for trailing 12 months. Considering the profits on a consolidated basis, the valuation would appear even more attractive.

OIL INDUSTRY: Range-bound price play puts pressure on nos

THE September quarter numbers of the domestic oil industry were good considering the hefty compensation the three oil marketing companies (OMCs) received from the government for under-recoveries. Upstream PSUs performed well, with the only exception being ONGC, while the numbers of private-sector players were healthy in line with market expectations. The three OMCs — Indian Oil, BPCL and HPCL — were during the quarter promised nearly . 13,000 crore as compensation towards under-recoveries in the first two quarters. Indian Oil Corporation, the biggest of them all, posted a net profit of . 5,294 crore, while BPCL and HPCL posted profits of about . 2,100 crore each. All these companies had posted heavy losses in the June 2010 quarter due to a lack of governmental support.
In the upstream sector, the largest oil producing company, ONGC, couldn’t meet market expectations as it posted a muted 6% profit growth at . 5,389 crore in spite of a highly favourable market environment. The company enjoyed higher oil production, higher gas prices and higher realisations compared with the year-ago period. However, a . 2,441 crore write-off towards unsuccessful exploration efforts and rupee appreciation weighed on its profit growth.
On the other hand, Oil India, although quite smaller to ONGC, surprised the markets with its best-ever quarterly profit of . 916 crore. The company’s oil production grew 3% y-o-y, with 11% higher realisation, while profits from the natural gas segment jumped six-fold thanks mainly to decontrolled gas prices.
Amongst the private players, Reliance Industries posted healthy numbers. Its integrated business model enabled it to make up for the margin pressure on petrochemicals and oil & gas from the higher margins in the refining business. Better refining margins enabled Essar Oil to report a tiny profit of . 130 crore for the quarter as against net loss a year ago and also in the preceding quarters. In the case of state-owned standalone refiners such as MRPL and CPCL, operating results were weaker y-o-y.
Going forward, oil prices are expected to remain range-bound, while refining margins are likely to stagnate. This may put some pressure on the earnings growth of the companies, particularly if the rupee appreciates further from the current level. The upstream PSUs will be able to expand earnings by growing production and higher gas prices. However, the OMCs will continue to depend on government’s support to sustain. The deregulation of diesel prices, as was done with petrol prices in June this year, will act as a key trigger for the companies’ earnings growth.

JAIN IRRIGATION: Co has to strike a balance between growth and debt

THE results of Jain Irrigation System (JISL) for the September 2010 quarter cheered investor sentiments on Monday as the scrip gained nearly 3% in an otherwise weak market. The company reported a 46% jump in its net profit for the quarter, traditionally its leanest. The stock is trading at more than 34 times its earnings for the past 12 months.
The company had reported losses in its subsidiaries for FY10, which had dampened the scrip’s performance over the past couple of months. The June quarter numbers, although operationally strong, was weak due to to forex losses. Against this background, the September quarter’s performance provided a muchneeded boost to investor sentiments.
Out of JISL’s outstanding loans of 1,941 crore, loans worth 750 crore are in foreign currencies. With currency rates fluctuating, the company has to book a mark-to-market loss or profit on these liabilities, which are notional in nature. These numbers influence the company’s quarterly earnings to a great extent. For example, in the June quarter, it booked a forex loss of 20 crore, which resulted in a drop in net profit drop when compared with the year-ago level. On the contrary, the strong net profit growth in the September quarter was helped by a 21.6 crore forex gain due to the rupee’s appreciation.
Discounting the effect of forex fluctuations, the company’s June quarter results were actually better than the September quarter’s. The company’s operating profit had grown by 31% in the June quarter; in the September quarter it grew by just 15% y-o-y. Nevertheless, the net profit at 62 crore made the September 2010 quarter the second-best quarter historically for the company after the March 2010 quarter, when it had posted a net profit of 117 crore.
The company’s agri-input business continued to do well with a 24% growth in sales and 45% growth in preinterest-and-tax profits during the September quarter. It was mainly a volume-led growth particularly in the micro-irrigation business, which contributes almost half of the company’s total turnover. As against this, the industrial inputs division registered a dip due to discontinuation of the polycarbonate sheet business last year.
The company plans to achieve over 25% growth at the topline level in FY11. Considering that the company is likely to generate two-thirds of its business in the second half of the year, it is expected to meet the target. The company is also spending nearly 400 crore in FY11 to expand its micro-irrigation capacities. As it continues to grow, managing its debts and the borrowing levels would remain the key challenge before it.

Acting In Sync

With the market poised to touch a new high, the performance of India Inc’s subsidiaries is more in alignment with their parent firms. ET Intelligence Group’s Ramkrishna Kashelkar guides you on how to evaluate the performance of corporate subsidiaries


DEAR Sir, the EPS given in your story at 13.9 appears to be incorrect. The actual data is 5.9. If this is wrong, then your recommendation is totally false. Please check the same and answer my mail,” wrote one of our readers in response to a stock idea story in Investor’s Guide recently. We were startled. We double-checked the numbers again. The mistake was at the reader’s end. The financial numbers referred to in the article mentioned by the reader were on a consolidated basis. What he was referring to was standalone numbers.
The incident, besides reconfirming our belief that readers of Investor’s Guide analyse every statement, every number that we put out, revealed an important fact. In the complex world of companies financials and their valuations, investors often feel confused about standalone and consolidated numbers. ET Intelligence Group attempts not just to demystify these terms, but also illustrates how these concepts can be used in investment decisions.

REALITY CHECK
Standalone financial numbers indicate the financial performance of a company as a single entity, while consolidated numbers comprise the numbers of its subsidiaries. These subsidiaries could be either acquired or floated and could be wholly or partially owned. It also takes into account performance of associate companies - firms in which the parent company’s control is less than 50%.
Since consolidated financial statements present an aggregated look at the financial position of a parent and its subsidiaries, they enable one to gauge the overall health of an entire group of companies as opposed to one company’s standalone position. Naturally, while calculating price-toearnings (P/E) ratio or evaluating a company, one must always look at consolidated results after deducting minority interest and not standalone results.
Why is it important to consider consolidated results? The main reason is that a company can have a significant chunk of its earnings or liabilities hidden in a subsidiary. For example, in case of Cairn India, the consolidated net profit in FY10 stood at 1,050 crore, while on standalone basis, there was a loss of 69 crore. This happened mainly because it had most of its producing assets under subsidiaries. The company has recently taken steps to merge a few of its subsidiaries with itself, thereby rectifying this aberration to a certain extent.
There will be several such examples. In the case of leading companies such as Sterlite Industries, United Phosphorous, Jindal Steel, Hindalco, Tata Power or Grasim Industries, subsidiaries contribute substantially to their total kitty. It will be erroneous to calculate their P/E ratio or per share earnings using standalone numbers.
However, if you are an investor who gives more emphasis on the track record of dividend payment or bonus issues when investing in stocks, you need to focus on standalone numbers. This is because the annual dividends or issue of bonus shares come from the earnings of the standalone entity, and not consolidated.

RETURN TO PROFITS
The performance of India Inc’s subsidiaries has started improving, of late, which till a year ago, proved to be a burden. Indian companies’ overseas acquisition drive over the past few years had created a number of subsidiaries which underperformed in 2008 and 2009 as the going got tough due to a slowdown. However, we see a turnaround in FY10 and beyond.
In the sample of BSE 500 companies, we found 217 companies providing annual consolidated and standalone numbers for the past five consecutive years. These companies were showing consolidated performance slightly ahead of their standalone numbers in FY07 and FY08. The scene changed in FY09 with consolidated numbers falling more than the standalone ones.
In FY10, the group’s aggregate consolidated profits grew 23% y-o-y as against 19.7% growth at the standalone level indicating a revival. This revival in subsidiaries was accompanied by an improvement in the operating profit margins, with stagnated interest cost.
Two companies, NDTV and 3i Infotech, reported net losses on standalone basis, while profits from subsidiaries helped them post positive numbers. In the case of Suzlon, the profits in subsidiaries were not sufficient to make up for the loss on a standalone basis. As many as 74 companies, or a third of our sample size, still had a net loss in subsidiaries during FY10 - the largest being that of Tata Steel. Its subsidiaries, which include European steelmaker Corus, incurred a loss of 7,056 crore in FY10 as against the company’s standalone profit of 5,046 crore.

WRITING ON THE WALL
Going by the quarterly numbers, one can find the companies where the performance of subsidiaries has started improving, of late. For example, Tata Steel’s losses from subsidiaries turned into profit since the March 2010 quarter. Its results for the September 2010 quarter, which will be announced later this month, will be substantially superior on a y-o-y basis, considering the 3,610 crore of loss its subsidiaries had booked last September.
The problem is that several companies do not publish their consolidated numbers on a quarterly basis. For example, India’s leading electrical equipment manufacturer, Havell’s India, announced a turnaround of its important subsidiary, Sylvania Europe, in the September quarter, which was in the red earlier. The company’s press release mentioned that for the quarter, a consolidated loss of 14 crore last year turned into a net profit of 71 crore. However, the company had stopped publishing quarterly consolidated numbers after FY09. Together They Unlock Value
IN OUR sample size, quarterly consolidated numbers are available for nearly 150 companies. Tata Motors is a leading example of how a turnaround in subsidiaries is boosting its earnings. The turnaround of Jaguar Land Rover (JLR), over the past couple of quarters, has led to the subsidiaries contributing nearly 80% of its quarterly profit. Similar is the case with Dr Reddy’s Lab. After posting an operating loss in the December 2009 quarter, it has reported a gradual improvement at the operating level in the subsequent quarters. In the September 2010 quarter, it reported a healthy operating margin of 22.7%, thanks to improvement in its subsidiaries. Lupin, Mercator Lines, United Phosphorous are similar such examples of firms that have seen turnarounds in their subsidiaries in the past few quarters.

VALUE UNLOCKING
Sometimes subsidiaries are also like hidden gems as the value in them can be unlocked in due course and can give a booster to the parent company’s valuation. For example, a recent IPO of Orient Green Power (OGPL) might have lost money for its investors, but boosted the valuations of its parent Shriram EPC. The company’s market capitalisation gained 50% within a span of just two months on OGPL filing the draft prospectus in April 2010.
There are several other companies planning to unlock value in their subsidiaries at an opportune moment. The engineering behemoth L&T has long been planning to list its various subsidiaries, particularly the IT and finance ones, to unlock value. Other companies, such as Ballarpur Industries, GE Shipping and Glenmark, have plans for listing their subsidiaries.
This analysis takes us to a method of choosing the future winners. Companies - particularly those which publish consolidated numbers only once a year - are likely to be undervalued if fortunes of their subsidiaries have changed. Investors should, therefore, do well to know the businesses and geographies of the key subsidiaries of companies and track their performances consistently to make investment decisions. Remember that investors of Tata Steel, when it had posted its largest consolidated quarterly loss in the March 2009 quarter, would have tripled their money by today.

Exploring Growth Avenues

11th October 2010

Exploring Growth Avenues

From $6 billion in 2006 to $14 billion today, Cairn India’s valuation has gone up strongly. But the road had been full of hurdles. The company’s Executive Director & CFO Indrajit Banerjee talks about the company’s future growth plans and the challenges of the past in a telephonic interview with ETIG’s Ramkrishna Kashelkar. Excerpts:

What were the key challenges involved in executing the Rajasthan project?

Developing the Rajasthan field in the middle of desert was an enormous task. In 2007, it was one of largest onshore developments globally. And implementing it, while balancing out various uncertainties, was a huge challenge for the management. We had several key regulatory issues that lacked clarity. There was total uncertainty on evacuation of oil. On top of it, the project cost started soaring. Then there was the economic turmoil, credit crunch and crash in oil prices that created hurdles for fund raising. All this had to be considered while devising the best exploration and development methods. A lot of efforts went into tackling these issues. We spent a lot of time explaining the necessity to set up evacuation pipeline to the Gujarat coast and include its cost in field development plan to the government. With our JV partner ONGC firmly by our side, we managed to get the permission. We could have decided to wait for full clarity on all these issues before risking our capital. However, it was a conscious decision to go ahead. Importantly, we kept all our stakeholders informed of what we were doing. Finally, the efforts paid off.

How were your experiences in arrangement of funding?

The IPO had left us with cash of around $600 million, while there was $850 million debt facility contracted before the IPO. However, further funding became necessary as our project cost went up. Firstly, the global spurt in oil exploration increased the cost of commodities and oilfield services. And subsequently, the scope of the project increased to include the 690-km pre-heated pipeline to evacuate crude oil. By the time we felt the need for further funding, the world had entered the financial crunch and global banks were unwilling to lend. Indian banks, which were used to security-based lending, were not accustomed that time to fund the development of E&P assets. Even interest rates were going up. And this was the time our project was progressing at a ferocious speed and the pipeline had to be built up. The first thing we did was to relook at the financing options. In April 2008, we got an opportunity to raise $625 million by placing equity with a couple of long-term investors — a Singapore-based fund and Malaysia’s Petronas. This gave us a breather. At the same time, we optimized our capex plans to prioritise only that capex, which was absolutely essential to commence oil production. The priority was to aim for oil production at the earliest and meet our 2009 target. For example, rather than building all our processing trains simultaneously, we focused on building the first 30,000 bpd processing train, which was small but cheaper and quicker. We started selling oil since August 2009 by trucking even at high cost. This opened the tap of cashflows. By May 2010, when our pipeline partially commenced operations, we had sold nearly 6 million barrels of oil.

What hurdles did you face while raising debt from domestic banks?

It was a rare occasion of reserve based lending of such a large scale was being tied up. The main asset we have was oil in the ground. However, Indian banks then were not ready to accept that as security. We had to create a security, which was acceptable to them. Finally, a consortium of banks led by SBI took an extremely proactive view and accepted our participating interest in Rajasthan field as security. At that time, this was a novel thing in India. We raised 4,000 crore of debt from the consortium and another $750 million loan from Standard Chartered Bank in October 2009. We replaced earlier loan arrangement with this.

What has been Cairn’s capex on Rajasthan project so far? What is the planned capex for the next couple of years?

We have already spent nearly $3 billion on Rajasthan fields so far and plan to spend another $2 billion in 2010 and 2011 together. This will take care of our entire planned development work at the Rajasthan field to reach the plateau production level of 175,000 bpd. The capex, thereafter, will depend on lot many factors such as success of our EOR pilot, further exploratory successes and the government’s nods. Considering the growing cashflows from oil sales, we are well funded to see us through our current capex cycle. In fact, we may not need the entire $1.6-billion debt line arranged last October. These funding arrangements were done in times of uncertainty and with crude oil assumptions at much lower level than what they are now.

What are the challenges before the company in future? Where will the future growth come from?

Immediate challenges for us are reaching the plateau of 175,000 bpd production as early as possible. We are already at 125,000 bpd and Bhagyam and Aishwarya fields need to be operationalised. We have a vision to reach a production level of 240,000 bpd from the Rajasthan field. This will involve implementing enhanced oil recovery (EOR) techniques, exploiting oil reserves in the Barmer Hill formation and developing other smaller discoveries. We are taking all stakeholders with us to meet this vision.Similarly, we have all along maintained ourselves as low-cost efficient producer. At Ravva and Cambay offshore fields, the direct production cost is around $2-2.5 per barrel, which is comparable to most efficient producers in the world. For Rajasthan field also, we need to achieve this distinction. During the quarter ended June 2010, this stood around $4 against our desired target of $3.5. With the production increasing, the average cost should come down.Future growth of the company will come from our ability to make the most out of Rajasthan field, where further exploration work is continuing. Our other exploration blocks will also provide another growth avenue. For example, we had a discovery in our KG basin block recently. Exploratory drilling in other couple of blocks is set to begin soon.

How do you view the proposed change in the promoter group of the company?

As this was a decision at the shareowners’ level, Cairn India had no role to play in this deal whatsoever. However, we believe this is a positive development particularly for retail shareholders. Vedanta’s willingness to acquire Cairn India and the price they are paying for it, are actually a great endorsement to the quality of our assets, the management capabilities and future growth prospects. As for the management, we are as focused on the company’s growth and committed to value creation as we ever were.

ramkrishna.kashelkar@timesgroup.com