Indian Oil & BPCL: Under-recoveries seen a big drag on oilcos’numbers

UPSTREAM discounts and the government’s promise for aid enabled India’s top two oil marketing companies — Indian Oil and BPCL — to post profits for the December 2009 quarter. But they fell short of their year-ago numbers. With the players losing control over their profitability, the future does not hold much promise either. Both the companies are expected to report significant fall in their March 2010 quarter profits against the year-ago period. Although the duo had several things going right in the December 2009 quarter such as forex gains, higher other income, reduction in staff costs and interest burden, their profits were lower compared to the year-ago period. This was mainly due to substantially lower upstream and government support, which reduced 30% and 53%, respectively, on a year-on-year basis. Another reason for Indian Oil’s profit fall was Rs 1,723-crore loss booked on sale of oil bonds. The oil marketing companies were fully compensated during FY09 for their under-recoveries. However, in FY10, the burden of a third of under-recoveries remains on the OMCs. Indian Oil, the industry leader, has absorbed net under-realisation of Rs 7,936 crore for the first three quarters of FY2010 — higher than Rs 7,539 crore suffered in corresponding period of last year. In physical terms, both the companies posted excellent performance with rising refinery throughput and domestic as well as export sales. However, due to artificially low prices and higher sales meant higher losses. Their refining operations, too, made a fewer profits due to global weakness in refining margins. Indian Oil shares have stagnated for over a month and closed at Rs 301.3 on Friday, before the results were announced. The scrip is now trading at a price-to-earnings ratio (P/E) of 6.5. The BPCL scrip has lost over 14.4% in the past one month to Rs 541.6 and is commanding a P/E of 4.4. The Kirit Parikh committee is long overdue to come up with its recommendations for the oil sector. Unless some pricing reforms are introduced, the oil marketing companies will continue to incur heavy under-recoveries in the coming quarters and will remain totally dependent on the government support for survival. As a result, the companies don’t appear attractive for investment despite the low P/E valuations.

HPCL: Tough refining biz, limited govt aid may dent Q4 profit

GOVERNMENT’s support, a jump in other income and a reduced interest burden helped Hindustan Petroleum (HPCL) post a tiny profit for the December 2009 quarter. Economic difficulties eroded margins in its refining business, while its marketing operations continued to incur losses.
The government’s promised aid of Rs 1,899 crore for the nine months ended December 2009 was entirely booked as revenues in the December quarter. Still the company’s operating profit was 33% lower compared with the year-ago period.
Other income saw a three-fold rise to Rs 225 crore due to a jump in interest on oil bonds. The company is currently carrying nearly Rs 9,600 crore worth of oil bonds, which is substantially higher against the year-ago period. A 72% fall in interest burden to Rs 220 crore also helped. As a result, the company posted a tiny profit at the pretax and post-tax level compared with losses in the yearago period.
For the second quarter in a row, the company reported lower refinery throughput, although the company’s sales continued to swell. Higher sales helped the company increase its trading activities. In fact, during the December 2009 quarter, nearly 44% of HPCL’s sales came
from products sourced from other refiners, and just 56% from its own refineries.
In a weak market, its shares ended 2% lower at Rs 344.25 on BSE before the results were announced. This is just around 2.1 times its per share earnings for the past 12 months and 1.1 times its book value for FY09. Such low valuations are a result of the company’s inability to control its profitability.
The outlook for the March 2010 quarter is not encouraging, given the weakness in the refining sector and limited support by the government for marketing losses. HPCL had posted a net profit of Rs 5,104 crore for the March 2009 quarter, and is expected record a significant fall in March 2010. Unless some oil sector reforms are implemented, no clarity can emerge on the company’s future prospects.

Gail: Stuck in the Pipeline

ALTHOUGH Gail India continues to remain a fundamentally strong company, its rich valuations are now indicating a limited upside in the short term. The company is entering a heavy investment phase in its core business to quadruple its gross block in five years. At the same time, the subsidies and E&P (exploration and production) expenditure have raised uncertainties over its earnings. Fresh investments should be avoided at the current valuation.

BUSINESS:

Gail operates India’s largest natural gas pipeline network with a current length of 7,200 km and a transmission capacity of 150 million metric standard cubic metres per day (MMSCMD). It also produces over 1.3 million tonnes of liquid hydrocarbons including LPG and 4.1 lakh tonnes of polyethylene per annum.
In a bid to secure its raw materials, the company has also invested in 30 exploration blocks including operatorship in two. The company is investing in the entire value chain of the natural gas business and owns promoter’s stakes in Petronet LNG and seven city gas distribution companies including Indraprastha Gas. The company has also floated a subsidiary, Gail Gas, for CNG stations along highways. Its 70% subsidiary, Brahmaputra Cracker, recently obtained financial closure for its 280,000-tpa polymer unit in Assam with an investment of Rs 5,460 crore.
The Petroleum and Natural Gas Regulatory Board (PNGRB), constituted in October ‘07, has laid out rules for determining tariffs for existing and new pipelines with effect from November ‘08. When the change takes place, Gail will have to account for its impact on profits with retrospective effect.

FUTURE PLANS:

The company is expanding its pipeline network substantially to add another 6,600 km of pipelines within the next three years. In addition, it is investing in its E&P blocks besides investing in its joint venture projects such as Brahmaputra Cracker and ONGC Petro Additions. The projected capital expenditure for the next five years is Rs 49,155 crore - almost thrice its current gross block.
In the near term, the rising production from Reliance Industries’ KG basin fields will bring in additional transmission revenues for the company, while any E&P success could add to future growth visibility. But rest of its projects will take long to generate returns.

FINANCIALS:

Over the last three years, the company has spent an average of Rs 270 crore annually on the E&P business towards survey and dry well expenditure. So far, in the first nine months of FY10, it has written off Rs 108 crore. As a result, the company is likely to write-off another Rs 150 crore in the March ‘10 quarter. The company has been cash rich with over Rs 3,000 crore of annual operating cash flows. However, its ambitious investment plans for the next five years will necessitate it to raise debt of Rs 28,700 crore in the next five years. Since FY04, Gail is sharing subsidy on LPG and has so far contributed Rs 8,200 crore on a cumulative basis. Subsidy sharing has always remained the most influential factor for Gail’s profits and which will remain equally uncertain in future as in the past. A reduction in subsidy burden was the key driver of Gail’s good performance in the December ‘09 quarter. Over the last five years, the company’s net sales have grown at a cumulative annual growth rate (CAGR) of 15% and net profit at a CAGR of 10%. In the nine months ended December ‘09, the company’s profits are only marginally higher than that of the year-ago period.

VALUATIONS:

At the current market price, the scrip is trading at a price-to-earnings multiple (P/E) of 17.7. This is comparable with its smaller peers such as Gujarat Gas, Gujarat State Petronet and Indraprastha Gas. Based on the estimated earnings for FY11, the scrip is trading at a P/E of 14.1. Considering the uncertainties attached to the earnings, this valuation is not attractive for fresh exposure in the scrip.

Reliance Industries: Better than Expected

THE refining business of Reliance Industries (RIL) took a third position in the pecking order for the first time in the company’s history, when profits from both petrochemicals and oil & gas businesses exceeded the refining profit. Incidentally, RIL’s both the refineries, which represent the world’s largest single-location petroleum refining complex with 1.44 million barrels per day, operated significantly above their rated capacities during the quarter.
Overall, the numbers are in line with market estimates, with the rising profit from the oil & gas segment offsetting the falling profit of the refining business. Globally, the refining business was severally under pressure in the December quarter with significantly lower margins due to high product inventories. RIL’s gross refining margin at $5.9 per barrel, although lower compared to $6 of September ‘09 and $10 of December 2008, was substantially better compared to the regional benchmarks.
During the quarter, the company ramped up its KG basin gas production to 60 MMSCMD and is ready to take it to the first plateau of 80 MMSCMD on signing offtake contracts. The first three quarters of FY10 have turned out extremely well for the company on all operational parameters with production of refineries, petrochemicals and oil & gas growing consistently. The cyclical downturn in the petroleum refining has been made up by higher volumes and the oil & gas business. The RIL scrip gained nearly 3% immediately after the results were announced to reach an intra-day high of Rs 1,070 on BSE, but closed slightly lower at Rs 1,050.70. For the trailing 12-month period, the company now has per-share earnings of Rs 46, which result in a P/E multiple of 22.8.
The benchmark gross refining margin has revived in January 2010 and is expected to improve further with global economic growth. This could bring about a major revival in the company’s refining profits in the coming quarters. Growing gas production will also augment revenues. At the same time, the large cash pile through sale of treasury shares could be an indicator of a likely acquisition in the near term. Although growth prospects are high, the current rich valuations appear to factor in most of it.

ONGC: Waiting for Gas Price Revision

INDIA’S leading oil and gas producer Oil & Natural Gas Corporation (ONGC) stumped the markets with results substantially below expectations. A jump in exploration costs which proved to be unsuccessful and absence of other income led to ONGC reporting a profit of Rs 3,054 crore — well below market estimates which had pegged it at close to Rs 4, 800 crore.
ONGC’s subsidy burden was lower by 28.6% against the year ago period at Rs 3,497 crore, which helped boost net realisation to $57.7 per barrel as against $34 in the year-ago period. It were these positives that had prompted analysts to project a much higher profit number.
Although the lower subsidy burden and higher net realisations were in line with market expectations, ONGC’s writing-off Rs 2,480 crore of unsuccessful exploration expenditures was unexpected, which added 63% to its depreciation burden. It wrote off nearly Rs 660 crore on two dry wells drilled in the Konkan-Kerala offshore, around Rs 500 crore towards dry wells in KG basin and close to Rs 250 crore towards dry wells in Mumbai High. ONGC annually drills around 150-160 wells every year and writes off the expenditure if they turn out to be ‘dry’ or without any hydrocarbons.
Similarly, ONGC’s other income turned negative during the quarter from Rs 1,037 crore in the December 2008 quarter. The company converted its loan to wholly-owned subsidiary ONGC Videsh (OVL) to an interest-free loan and wrote back Rs 460 crore received as interest in first half of FY10. Reduction in overall interest rates to 6% from 11% also brought down ONGC’s other income. Going forward, the company has agreed to extend loans up to Rs 5,000 crore to its other subsidiary MRPL at discounted rates.
The scrip dipped 2% to Rs 1,140 on Thursday before the results were announced. Adjusting for the December 2009 profit numbers, ONGC’s current market price is 16 times its earnings for trailing 12 months.
Going forward, the main positive trigger for ONGC remains the revision in gas prices. ONGC is losing over Rs 2,000 crore annually on the sale of natural gas under administered prices, which could be recouped if the price increase takes place. Considering that the ONGC stock has underperformed the benchmark Sensex over the past six months, the current valuation appears fair and reasonable. Superior March 2010 quarter numbers could help the scrip gain some traction.

Reliance Industries: Analysts Divided over RIL Q3 show

WITH the benchmark gross refining margins (GRMs) touching new lows and petrochemical margins under pressure, Reliance’s (RIL) results for the quarter to December will be watched with extra interest by investors and analysts.
Although the company posted lower profits on year-on-year (yo-y) basis during the past five quarters, its profit has grown sequentially between the December 2008 quarter and September 2009 quarter. Increasing natural gas production from the KG basin proved to be the main driver.
Although the stock has not gone anywhere in the past few months, investor interest in the scrip has perked up of late as indicated by the strong uptick in traded volumes and delivery.
Over the past 15 trading sessions, the average daily traded volumes have more than doubled compared to the average for December 2009, while the percentage of delivery has risen to 39.4% from 24.8%. In fact, the average delivery volumes during 2009 averaged at just around 18% of the total traded volumes.
The analyst community remains divided on whether RIL can post a fifth consecutive sequential profit growth for the December 2009 quarter by posting profits in excess of Rs 3,852 crore recorded in the September 2009 quarter.
Vinay Nair, research analyst with Khandwala Securities, expects the company to post slightly lower numbers compared to the September 2009 quarter. “The impact of lower GRMs at around $5.2 per barrel and weaker petrochem margins is expected to be offset by rising KG basin output, estimated to average at 46 million cubic meters per day (MMSCMD),” he mentioned.
Motilal Oswal’s estimates peg RIL’s profit at Rs 4,130 crore for the December 2009 quarter. IDFC SSKI expects the profit at Rs 3,971 crore, while Sharekhan has predicted a profit of Rs 4,011 crore.
The Street expects RIL’s refining margins to be between $5 and $6 per barrel, marginally weaker compared to the $6 it reported in the September 2009 quarter due to the global weakness in the refining industry.
The December 2009 quarter saw BP’s global indicator margins dip to the lowest in 15 years, while the refining margins calculated by International Energy Agency (IEA) were in negative for most locations across the world.
Against this backdrop, the results published so far by Indian companies have been encouraging and have sparked off some optimism in the analyst community. Deepak Pareek of Angel Broking said, “Going by the higher refining margins posted by MRPL or the improved petrochemical margins of Gail, we expect RIL to post slightly better results compared to our earlier estimate of Rs 3,749 crore. We remain bullish on the scrip considering its cash accumulation that indicates some buyout.”
RIL is currently reviewing a number of global opportunities for growth, one of them being a proposed acquisition of bankrupt Netherlands based Lyondell-Basell. RIL has raised Rs 9,330 crore through sale of treasury shares in the past four months and still has nearly 30.9 crore treasury shares valued at Rs 32,500 crore.

Gail India: Maturing Valuations

GAIL India’s scrip gained 3.1% to close at Rs 438.70 as it reported a better-than-expected result for the December 2009 quarter. The company more than tripled its profits for the quarter to Rs 860 crore while it transported an additional 29% natural gas at 109 million cubic meters a day.
Although Gail couldn’t post a major growth in volume terms or at the net sales level, the reduction in its subsidy burden to Rs 455 crore from Rs 905 crore boosted the margins.
This enabled its liquid hydrocarbons business to post a robust profit of Rs 125 crore as against a loss of Rs 250 crore in the December 2008 quarter.
The other important contributor to Gail’s higher profitability was reduced E&P expenditure. The company wrote off Rs 20.2 crore in December 2009 quarter towards dry well expenditure, much lower against Rs 109.4 in the year ago period.
Staff costs also reduced against the year ago period as Gail reversed some earlier staff cost provisions. At the same time its cost of traded goods came down 11% mainly due to the reduction in imported LNG rates. LNG cargoes were being imported at a rate above $10 per million British thermal units (mBTU) in the year ago period, which averaged around $7 per mBTU during December 2009 quarter.
Being cash-rich, Gail earns a sizeable other income every quarter. The December 2009 quarter saw its other income fall 45% y-o-y as interest rates dipped and it used a part of the funds in project execution.
At the current market price, Gail is now valued at 19.5 times its profits for the trailing 12 months. It is investing heavily to lay the national gas grid and is planning to add over 6,600 km of pipelines in the next three years. Considering the long gestation period for its pipelines, the current valuations appear fair for the company.

MRPL: Weak global cues, shutdown may impact profits in Q4

MANGALORE Refinery and Petrochemicals’ (MRPL) December 2009 quarter results turned out to be better-than-expected. The company was expected to post profits over December 2008 quarter losses, but its performance over the September 2009 quarter is what has surprised the market, given the weak refining environment. MRPL reported a net profit of Rs 259.5 crore in December 2009 quarter compared to a loss of Rs 285 crore in December 2008 quarter.
Higher inventory gains, processing of low-cost Cairn crude oil and improved capacity utilisation proved to be the main factors contributing to higher gross refining margins (GRM), while forex gains added to the bottomline. With oil prices steadily moving up, MRPL made an inventory gain of $2.53 per barrel in December 2009 quarter, higher than in September 2009 quarter. The inventory valuations had crashed in December 2008 quarter along with oil prices leading to loss of $14.4 per barrel. The GRM for December 2009 at $4.51 per barrel was higher than $3.59 of September.
The company also processed Cairn’s Rajasthan crude oil for the first time during the quarter, which came in at a 10-15% discount to benchmark Brent prices. Although the share of Rajasthan crude was around 3% in the 3.4 million tonne of crude oil processed during the quarter, it helped boost margins.
In an otherwise weak economic environment, the company also raised its capacity utilisation to improve profits. As a result, the sales volumes during the quarter moved up 11.7% against the year ago period to 3.28 million tonne.
With the rupee appreciating during the quarter, MRPL booked a gain of Rs 153.1 crore as against a loss of Rs 78.8 crore in the corresponding quarter of last year.
In a weak market, the MRPL scrip shed 3.1% to Rs 86.25 before the results were announced. Factoring in for the December 2009 quarter earnings, the scrip is now trading at a price-to-earnings multiple of 10.3.
The persistent weakness in the global refinery industry and the company’s planned 35-day shutdown in the fourth quarter of FY10 will impact MRPL’s profits, going forward. As a result, the upside from current levels appear limited in the short run.

Oil majors may score well in Q3

But It Will Be A Tough Ride Ahead As Concerns Over Global Recovery Remain

SEVERAL Indian petroleum companies are expected to post healthy growth numbers when they publish their December 2009 quarter results in the next couple of weeks. On the face of it, the growth numbers for the December 2009 quarter may appear encouraging for investors, however, they must bear in mind that this growth is posted on a low base. Most companies had suffered heavily in the December 2008 quarter due to a crash in oil prices.

UPSTREAM
The profitability of ONGC will jump markedly in December 2009 quarter mainly as its subsidy burden declines. ONGC contributed Rs 4,899 crore as subsidy in December 2008 quarter and reported net realisations were just $25 per barrel of oil sold to oil marketing companies. In the current quarter, its subsidy burden is expected to decline to Rs 3,600 crore, which will improve its realisation above $55 per barrel. Brokerage estimates peg ONGC’s profit jump between 75% and 105% against the year ago period. Cairn will report its first production numbers from Rajasthan field during the third quarter. Cairn sold its first cargo of crude oil from Rajasthan fields in the first week of October 2009 and is estimated to have sold a total 1.25 million barrels of oil during the December 2009 quarter. However, with the start of commercial operations, interest and depreciation costs will dent its profitability. Brokerage estimates vary widely for the company, estimating a profit fall between 3% and 75% against the corresponding quarter last year.

MID-STREAM
The standalone refiners such as Mangalore Refinery and Chennai Petroleum will post modest profits in the December 2009 quarter compared to the net losses in the year ago period. However, the weaker industry outlook means their profits will be lower on a sequential basis compared to the September 2009 quarter. Private sector refiners RIL and Essar Oil too will face the pressure on their gross refining margins. However, RIL will post some profit growth, thanks to doubled volumes from additional refinery and increasing gas volumes from KG basin. According to various brokerages, RIL will post GRMs between $5 and $5.6 per barrel and profit for December quarter will be higher by 13-19% on a y-o-y basis.

DOWNSTREAM
The fate of public sector oil marketing companies (OMCs) — Indian Oil, BPCL and HPCL — will clearly depend on whether the government compensates them fully for their under-recoveries. These companies have not received any government support for the first half of FY10. Latest media reports suggest that the finance ministry is willing to make good only one-third of the estimated under-recoveries of these three oil majors for FY10 so far. This will leave the oil companies to absorb a large chunk of losses for the whole year.
The global business outlook for the petroleum industry is expected to remain subdued for the months to come. While the refining players will face margin pressure, the crude oil prices too run a downside risk if the built-in growth expectations don’t fructify.
For Indian players, the long overdue recommendations by the KG Parikh Committee remain the foremost positive factor. Any liberalisation in the industry could bring down the under-recovery problem for the PSU players, while the private players could find themselves on a level playing field in the retail business. Besides, the proposed gas price hike will bid well for ONGC while the success of LyondellBasell deal could bring in more positives for RIL.

RALLIS INDIA: Dahej unit to propel Rallis’ future earnings

TATA Group firm and agrochemicals manufacturer Rallis India came out with strong profit growth numbers, when it unveiled its results for the quarter to December 2009. The profit growth was on expected lines considering the improved industry outlook in India and the company’s initiatives at innovating, optimising costs and expanding capacities despite a sluggish exports market. The main feature of the results is the strong improvement in the company’s operating margins to 20.7% from 14% in the year ago period. This enabled the company to post a jump of nearly 50% at the PBDIT level notwithstanding a dip in net sales. Better product portfolio and working capital management helped the company in improving margins. The company’s interest cost remained insignificant, while depreciation charge slipped marginally. The resultant pre-tax profit was 57.8% higher against the December ‘08 quarter numbers. Taking into account the extraordinary items and tax, net profit rose 54.5% to Rs 24.1 crore. Rallis is investing Rs 150 crore in setting up a new plant in Dahej scheduled to be commissioned by July 2010. This plant with an annual capacity of 5,000 tonne is expected to generate cumulative revenues of over Rs 500 crore in its first three years of operations.
The company also continues to introduce new products at regular intervals and had launched Ergon, a product developed through in-house R&D. Recently, Rallis has become a subsidiary of Tata Chemicals, which bought out the stakes of other promoter group companies. Further 9.8 lakh shares were allotted to Tata Chemicals on a preferential basis during the quarter, taking the Tata Chemicals ownership in the company to 50.2%.
Coming as it is after a poor kharif season hit by erratic monsoon, the rabi season appears better compared with the yearago period, mainly due to higher cultivation acreage. Overall, the agrochemicals industry is going through an excellent phase at present, with farmers enjoying a better liquidity. The Rallis scrip, which has more than tripled from the year-ago level, gained 0.9% to close at Rs 1,061 on BSE before the results were announced. The current valuation at a price-toearnings multiple of 15.5 appears to have fairly discounted the December ‘09 quarter numbers. While the company is expected to post better numbers even for the March 2010 quarter, the improved domestic business outlook and its upcoming unit in Dahej will propel future earnings growth.

SINTEX: Acquisition Synergies Help Dec 09 Numbers

BETTER synergies generated after the acquisition of subsidiaries helped Sintex show a flat consolidated performance during the quarter to December ‘09, although on a standalone basis, its performance was weak.
The company’s profits for the quarter dipped 11.3% on a standalone basis to Rs 55.9 crore, but the consolidated numbers at Rs 72.8 crore were 1.5% higher compared with the year-ago period.
Sintex had acquired six companies over the past couple of years – two in the US, one in France and three in India. The overseas subsidiaries had been hit hard by the economic turmoil over the past 18 months, but have now started looking up. However, following the company’s failed attempt at acquiring Geiger Tech in Germany, which filed for bankruptcy, Sintex is likely to write off its initial investment of E7 million (approx Rs 46 crore) during the current financial year. For the December quarter, the company reported a 3.4% growth in consolidated net sales to Rs 848 crore. However, rising raw material costs impacted its operating margin leading to a situation where its PBDIT is now below the year ago level. The company shaved off close to one-thirds of its interest costs by replacing high cost loans, which helped its pre-tax profit inch up 3.5% to Rs 98.8 crore.
Its textiles business grossly underperformed during the quarter with a 6% dip in sales and 67% fall in profits. In comparison, the plastics segment performed well with a double-digit profit growth against the year-ago period.
Sintex Industries’ December 2009 quarter financial performance failed to impress investors, as its shares dipped 0.8% to close at Rs 269 on BSE. The scrip, which has underperformed the Sensex during the past year, is now being valued at 12 times its consolidated earnings for the past 12 months. The company reported improving capacity utilisation rates across businesses, which can help boost higher revenues, going forward. With over one-thirds of its annual profits typically generated in the last quarter, the March 2010 quarter numbers could be substantially better.
The company is also carrying a war chest of around Rs 1200 crore of cash, initially raised to fund an acquisition, which could add an unexpected boost to growth.