ONGC: Fundamentally strong, but subsidy load weighs heavy

ONGC’s profit for June 2010 quarter plummeted more than expected as the subsidy burden surged. The company’s future prospects appear healthy, however, the government’s ever-changing subsidy-sharing policy poses the key risk.

Till June 2010 quarter, the upstream oil companies were required to contribute towards the under-recoveries only on autofuels. However, with the government decontrolling petrol prices and raising diesel prices in June, the subsidy sharing formula is set to change going forward. Given that the oil industry’s under-recoveries for FY11 will be higher than in FY10 in spite of the recent price increases, ONGC’s subsidy, which stood at 11,555 crore in FY10, is unlikely to ease.

In the June 2010 quarter, the oil industry’s under-recoveries rose to 20,000 crore, increasing the share of upstream companies to 6,667 crore. With over 80% of this shared by ONGC, it had to shell out 5,515 crore as discounts — highest in past seven consecutive quarters and 12-times the year-ago number. This amounted to nearly $33 per barrel of discount, pulling lower the company’s net realisation to $48.04, which stood at $58.25 in June 2009 quarter.

The subsidy burden was so heavy that the benefits of decontrolled gas prices failed to make a mark. The administered pricing mechanism was dismantled in April on the 48.5 mmscmd gas sold from nominated fields, which is expected to add 3,500 crore to its bottomline on an annualised basis. Although the company made nearly 850 crore higher profits on this count its net profit fell 24%, which shows the severity of these subsidies. Even the ONGC management couldn’t help call the subsidy burden ‘excessive’.

The 7% appreciation in rupee against the year-ago period played another trick on the company’s financial numbers as it bills its customers in rupees. The net realisation on crude oil, which appeared only 17.5% lower on y-o-y basis in dollar terms, was actually 22.6% down in rupee terms. In other words, every barrel of oil sold during the quarter fetched 22.6% lower price to the oil major compared to the June 2009 quarter. While the company’s oil production stagnated, it basically was the higher revenues in its gas business that enabled ONGC to restrict fall in net sales to mere 8.1%.

The company continues to remain fundamentally strong, with its production likely to increase gradually over next few years. Its attempts at diversifying the revenue base will also start giving results as its two petrochemical complexes and a power plant come up over next 18-20 months. However, the subsidy uncertainties continue to make it a doubtful investment candidate for retail investors.

REFINING INDUSTRY: Downturn may continue for a couple of quarters

THE June quarter results of three standalone petroleum refiners reflect the challenges faced by the industry globally. The scenario remains dull and is not likely to improve anytime soon, since incremental demand takes time to absorb the large surplus capacity. The cyclical downturn in the industry should continue at least for another couple of quarters before investors can hope to see a revival. Mangalore Refinery, Chennai Petroleum and Essar Oil reported heavy erosions in profitability for the quarter ended June 2010, with only MRPL managing to stay in the black even after a rise in sales. As the global inventory of oil products continued to swell, the rise in product prices was not as strong as the growth in crude oil prices. This resulted in the gross refining margins (GRMs) — the difference between the cost of a barrel of crude oil and sale proceeds of products from it — falling substantially from their year-ago levels.

All the three refiners also suffered foreign exchange losses. In the year-ago period, they had registered foreign exchange gains that had boosted their performances.

These companies attempted to make up for lower margins with higher volumes. Essar Oil operated its refinery at 105% of its capacity processing — 33% higher volumes compared to the year-ago period. Similarly, MRPL operated at the 130% utilisation level, which increased its throughput by 2%. Chennai Petroleum, however, reported a 13% lower output at 2.3 million tonne for the June quarter.

But this has not deterred them from continuing with their expansion plans. Essar Oil, which aims to increase capacity by 25% within a year, got a booster with its parent’s listing on the London Stock Exchange. The listing has enabled it to infuse over $633 million into the company. With sales from its Raniganj CBM block set to commence by December 2010, it opens up a steady revenue stream for the cash strapped major. MRPL is also continuing with its project to expand capacity and set up a polypropylene unit by end-2011.

Unless there is a significant unplanned refinery shutdown, product supply and inventories are expected to remain in abundance during the upcoming summer driving season in the US. Considering the refinery capacity additions during the remainder of 2010 and 2011, spare capacity is expected to remain relatively high in the short term. These factors are expected to keep the GRMs under check.

RELIANCE INDUSTRIES: Strong YoY growth may taper off after base effect play

THE financial performance of Reliance Industries was more or less in line with street expectations as the company reported another billion dollar show in profits during a quarter.

RIL’s net profit for the quarter to June was 4,851 crore on net sales of 58,228 crore. The scrip, which ended flat at 1,053 on Tuesday before the results were announced, still trades above a price-to-earnings multiple (P/E) of 20, only marginally lower than the P/E of BSE Sensex. It, however, remains to be seen how the company maintains the momentum in the next couple of quarters, given the lack of excitement in the global business environment. RIL put to rest analysts’ worries of a sequential slowdown in its earnings. In all its business segments, the profit margins registered an improvement — albeit marginal — compared to the March 2010 quarter.

Against the year-ago period, the margin erosion was evident in the June ’10 quarter numbers. However, what the company lost out on margins, it made up with higher volumes. Its refining business posted a 4% profit margin against 5.3% in the year-ago period.

However, the segmental revenues more than doubled, lifting the earnings before interest and tax (EBIT) by 57%. Similarly, a 150% spurt in revenues from the oil & gas segment led to a 91% jump in its EBIT to 1,921 crore.

The petrochemicals segment, however, registered a 3% fall in EBIT as margins weakened by 320 bps despite a 19% sales growth. Growing production from the Middle East based on natural gas feedstock could put pressure on RIL’s margins in this business.

The main business of petroleum refining, too, is facing headwinds as the weakness in the global economy suppresses demand. Refineries across the globe are working at 80%-85% capacity utilisation levels to match demand. Against this backdrop, the freeing up of petrol prices locally bodes well for RIL, which is operating its refineries at more than 100% of their rated capacities.

As the two main businesses face margin challenges, a further scaling up of its oil & gas business will play a critical role in maintaining RIL’s growth momentum in the next couple of quarters. During the past two quarters, natural gas production from its KG basin fields has been stuck at 60 mmscmd while oil production was gradually raised to 30,000 barrels daily. In view of the limited ability of this business to scale up further in the near term, RIL is likely to post similar numbers in the next few quarters. They could translate in healthy YoY growth initially, but will taper off as the base effect comes into play.

Reliance Industries (RIL): RIL likely to post the best net growth in past 10 quarters

Volumes To Drive Bulk Of Co’s Profits, Tight Margins To Affect Refining Biz

THE country’s largest company by market capitalisation Reliance Industries (RIL) is expected to repeat its March 2010 quarter performance when it publishes its June 2010 quarter numbers on Tuesday. The numbers will, however, look fabulous against the lacklustre June 2009 numbers with the y-o-y net profit growth pegged between 29% and 34% by various brokerages. If the analyst expectations come true, RIL’s net profit growth will be the best in the past 10 quarters.

A bulk of the expected profit growth will be driven by volumes and margins are expected to remain under pressure for RIL. The company’s refining business, which contributed nearly 70% to its revenues and 30% to FY10 profits, is expected to suffer from the weakness in the gross refining margins (GRMs).

“The Singapore GRMs have averaged lower this quarter at $3.7 per barrel against $4.9 per barrel in Q4FY10. The refinery utilisations rates have improved in this quarter leading to a q-o-q drop in the Singapore complex GRMs,” noted Elara Securities. Even the most lenient predictions peg RIL’s June quarter GRM at $8 per barrel — only marginally better than $7.5 of the year ago period.

The petrochemicals business, representing less than one-fourth of the company’s revenues last year, is also expected to face margin pressure. “The prices of key polymer products witnessed a decline in the range of 3-4% on a sequential basis as compared to the 1.3% sequential decline recorded in the naptha prices,” mentioned Sharekhan’s results preview note.

The higher decline in the petroleum product prices compared to the drop in the raw material prices is expected to pull down the petrochemical margins. Considering the increased supply from petrochemical capacity additions in the Middle East and China, the margins are likely to remain under pressure.

The main booster to the company’s profits will come from E&P business, as the KG basin continues to produce at nearly 60 MMSCMD of natural gas and 30,000 barrels per day of oil. Despite predicting a strong double-digit profit growth, not all brokerages are positive on the company’s performance, going forward. “Our near-term view on the refining and petrochemical cycle is bearish and we believe this could adversely impact margins of RIL and other refiners,” mentioned Motilal Oswal’s results preview note.

The cyclical weakness in the global refining and petrochemicals industries had so far not touched RIL’s numbers due to its expanded capacities. The scaling up of its gas production also supported the bottomline as the times tunred difficult. However, going forward, the base effect will come into play and a pressure on margins could dampen its profit growth.

OIL MARKETING COS: Dependence on Centre to stunt growth

THE investor frenzy engulfing the three oil marketing companies (OMCs) as the government announced partial price decontrol in the last week of June is likely to prove short-lived as two of the three oil majors posted heavy losses for June quarter.

After spurting between 18% and 35% within a week of the announcement, the three scrips have already started losing steam and have lost between 5% and 8% from their peak. The losses for the June quarter that HPCL and Indian Oil announced after markets closed on Friday, although not entirely unexpected, could dampen the investor confidence further.

Crude oil prices averaged around $78 per barrel during the quarter, which was third-highest than the yearago period. While the retail fuel prices remained controlled for the entire quarter, higher oil prices necessitated a higher support from the government to OMCs. Although the upstream oil PSUs upped their support nearly 12 times that in the June 2009 quarter, the government failed to make good its part of the losses. As a result, the two oilcos ended up absorbing a humungous amount of 10,300 crore towards under-recoveries on selling oil products below their costs during the quarter. Their combined accounting loss stood at 5,273 crore for the June quarter against a net profit of 6,059 crore year ago

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For Indian Oil, its diversification strategy to reduce dependence on oil retailing failed to pay any dividends as the petrochemicals business too posted losses. With the global refining industry weakening, IOCL’s gross refining margin slumped to $3 per barrel from $7.36 year ago. Its interest costs zoomed up 71% to 571.2 crore while it booked a forex loss of 467.5 crore against a gain of 652.8 crore in the corresponding quarter of last year. HPCL reported a 20% drop in refinery throughout the quarter as its Mumbai refinery underwent a planned shutdown. Its GRMs weakened to $3.7 per barrel from $5.7. The company, however, reduced its interest burden by 27% to 197 crore for the quarter, thanks to lower interest rates and better treasury management.

As it increasingly becomes clear that the three OMCs would continue to depend on the government and upstream support for their profitability despite the price revisions in this month, the companies risk further erosion in their market capitalisation. Their high dependence on the state support means they continue to lack any control over their own profitability besides permanent liquidity problems. Commissioning of BPCL’s Bina refinery — and its much-talked about IPO — and HPCL’s Bathinda refinery over the next 12 months should keep investors slightly more positive on these companies. However, rather than fundamentals, their valuations will be driven more by news flow.

Living on the edge

The current stock rally reminds us of the euphoria at the end of 2007 when the Sensex had outperformed its global peers.With clouds looming large over the world’s leading economies, retail investors must not forget the lessons learnt from the last crash, says ET Intelligence Group’s Ramkrishna Kashelkar

IT’S NOT EASY BEING AN EQUITY investor in the current macroeconomic environment as the markets try to balance the domestic growth story with global uncertainties. This has translated into volatile markets and insipid performance by frontline stocks across sectors. Corporate results in the past few quarters have been encouraging, monsoon rains are likely to be normal, the Indian economy is growing briskly, FII flows have been good and the Indian stock markets continue to outperform world’s major indices by a comfortable margin. Everything appears perfect for the beginning of another bull-run on Dalal Street. But then, it was no different in the last quarter of 2007 and what followed it is part of folklore now. Will it be different this time?

Not really! The storm clouds have already started gathering over the world economy and the risk of a small jolt snowballing into a full-fledged crash continues to grow. All the leading global economies from the US, Europe and Japan to China are facing their own brands of troubles. As we learnt it the hard way in 2008, it doesn’t take long for economic troubles to seize financial markets. This is why, it is the right time for Indian investors to hedge their bets and protect their portfolios — just as Noah built his Ark when it was still sunny — that can see them through even if a storm were to strike a few months down the line.

In the past three years, the world has witnessed the cycle of over-optimism followed by over-pessimism that reached its trough in March 2009. The global economy as well as the markets have come a long way since then, however, as it often happens, the recovery in the equity markets has been disproportionate to rebound in the real economy.
As investors wake up to the longforgotten fears of a double-dip recession in the US, the Indian markets curiously find themselves in a situation quite similar to that of the last quarter of 2007, when the investment euphoria was at its peak globally. Although it is still early to predict exactly, there are enough indications that
prompt retail investors to be careful going forward.

How the current situation resembles the last quarter of 2007?
Currently, India’s BSE Sensex — the oldest benchmark index — is trading above a price-to-earnings multiple (P/E) of 21 consistently almost for a year. The last time it had traded so strongly and so consistently was in the 12-month period trailing September 2007. And just when a number of market players started getting worried about valuations, an investor frenzy — led by the conspicuous theory of decoupling — drove stock prices even
higher. Four months later, when the meltdown struck, the Sensex was trading above a P/E of 27. In absolute valuation terms, the current market situation is similar to what we witnessed in September 2007 — and it is more than interesting that the decoupling theory is again gaining currency.

In view of the better economic growth prospects, the BSE Sensex has outperformed the US market’s benchmark index, the Dow Jones Industrial Average (DJIA), for the past several years. Accordingly, the Sensex has rightly enjoyed a premium valuation. However, the current level of premium — the difference between the P/E of Sensex and P/E of DJIA — has gone up so much that once again one is reminded of the last quarter of 2007. At present the Sensex is trading with a P/E above 21.5, as compared to 14.1 for the DJIA, or a difference of 7.4 points. In the past 10 years, it was only in the October 2007 to January 2008 period that the Sensex commanded such high premium over the DJIA.
Strong FII flows had been a key characteristic of the period prior to December 2007. In the 18-month period leading to the peak of December 2007, FIIs had poured in almost Rs 100,000 crore in the Indian markets. In the past 18 months, since the bottom of March 2009, the net FII inflows were in excess of Rs 130,000 crore. Increasing FII investments in the Indian debt — both corporate as well as sovereign — have emerged as another important trend this time.
And this time round, the markets have been bloated with huge amounts of speculative money floating around driven by globally low interest rates and accommodating monetary policy by the world’s key central banks. The substantial outperformance of risky small-caps over sturdy large-caps during this period could be taken as an indicator of this speculative investment trend. In the past one-and-a-half years, the Sensex has almost doubled, however, the BSE Small Cap Index has more than tripled. In comparison, a similar period leading to the peak of December 2007 was marked with more sober growth — Sensex doubled while BSE Small Cap Index had gained 125%.
During that period, the rupee had appreciated nearly 15% to a high of 39.4 against the US dollar. Although in the current rally, the rupee has not reached those high levels seen in December 2007, it has appreciated consistently by over 8.5% from the trough of March 2009. It is mainly the economic turmoil in Europe, which is driving investors in search of a safe haven from the US dollar, preventing the rupee to appreciate further.

GLOBAL ECONOMIC TROUBLES
The stock markets tanked globally in May as the Greek sovereign debt problems brought back the memories of the sub-prime crisis of 2008. But the impact proved short-lived with the markets soaring up again in the past few weeks. This appears to be the initial phase of over optimism, which is disregarding the inherent troubles of the world’s leading economies.

Turbulent Times Ahead
After a relatively strong initial recovery, the growth rates of most developed economies are already slowing, despite the immense previous stimulus. In the past three months, more or less universally in the developed world, there has been a disturbing slackening in the rate of economic recovery. As a result, stock markets in the developed countries have grossly underperformed those in the developing ones — notably India’s.
The developed countries such as the US, the UK and other European countries find themselves in a dilemma. At one end, the high level of personal and sovereign indebtedness is risking a debt-servicing problem. At the other end, an attempt to control the debt levels runs the risk of affecting the consumption demand and grounding the already fragile economic recovery.
Amid this, the weak economic activity in these countries is leading to lower government revenues due to their higher dependence on real estate taxes and capital gains, which have been dampened due to falling asset prices. However, their commitments — particularly salary and pension — are hard to cut. As a result, sovereign debt has reached alarming highs. Besides, these economies are facing prospects of under-funded retirement benefits and healthcare costs as the numbers of beneficiaries grow faster than workers due to an ageing population.
In the long run, these high debt levels will have to be curtailed to a more sustainable level, which will indeed be a long and painful process. The famous economist Nouriel Roubini recently mentioned that the advanced economies will “at best have a protracted period of anaemic, below trend growth” as deleveraging by households, financial institutions and governments starts to impact consumption and investments. The process has barely begun.

THE KEY CHANGES HAPPENING
The global economics are undergoing a paradigm shift. The way investors view the world is undergoing a change, which will continue well into the future and nobody knows exactly how things would stand a few months from today.
US treasuries and US dollars — considered as one of the safest places to park investments — could be in for a role reversal, if one looks at the country’s burgeoning debt burden. Noted economist and investor, Mark Faber, recently compared the US government’s current situation to a giant ponzi scheme, meaning the government will have to borrow increasingly more to meet the interest obligations, which would ultimately shake the confidence that investors keep in this asset class. While the reality may not turn out to be as grim as Faber has predicted, the US is indeed facing a problem the magnitude of which is unheard of.
Just last week, the US Federal Reserve’s chairman Ben Bernanke warned the US Congress against withdrawal of fiscal stimulus to bridge the budget deficit, insisting it was too risky for the recession-threatened US economy. The latest set of economic data from the world’s biggest economy showed an increase in weekly unemployment claims, a drop in home sales and easing of economic activity.
At the same time, the equities, government bonds and currencies of the Asian countries are fast becoming “hedges against the global risks”, something unimaginable in the past. By now, Asia has become the world’s great hope for growth and this perception is, unsurprisingly, reflected in the equity market valuations.
One major part of this Asian growth story — the Chinese economy — is also cooling off. Its government’s efforts to curb overheating and contain the asset bubble are likely to result in the country’s economic growth slowing to a range of 8-8.5% in 2010 from 11+% earlier. At the same time, experts believe China is set to enter the phase where incremental demand for labour will exceed incremental supply. Such a scenario will basically end the era of low-cost labour enjoyed by the country. Such a transition would surely have far reaching effects on the country’s economy in the years to come.
Conclusion: The wisdom that emerged after the large stock market shock of 2007-08 is that the decoupling only referred to the economic growth of various regions and that the financial markets the world over didn’t really decouple. This is also applicable to the current scenario. Although India’s economic growth should remain above 8-8.5% in the next couple of years regardless of the global economic slowdown and it remains an attractive destination for foreign investors, the same may not apply to Dalal Street.
High valuations have increased the risk of an abrupt shock if any of the fears related to double-dip recession or European debt crisis become a reality. And the current indications are that the likelihood of these fears turning true — at least partially — is growing with every passing day.
Several market gyrations have made it clear that it is the liquidity and investor confidence that drive the stock market performance — the economic growth plays only a supporting role. Needless to mention, both these factors are extremely finicky and can change tracks fast.
It is, therefore, imperative that domestic investors keep a strict eye on global happenings and not get swayed by momentum when taking any longterm decision. Recommendation: The rangebound market offers retail investors an opportunity to churn portfolios and make them less risky. A global economic slowdown can greatly hurt commodity businesses and high-beta stocks while in the current scenario, where most advanced countries would rather depreciate their currencies, owning export-dependent companies may not be wise. In fact, despite the Shanghai Composite’s underperformance since August 2009, most of the companies focusing on China’s domestic economy have done well.
An investor can avoid taking longterm bets for the time being and book profits on every market spurt. Investors should simultaneously also increase the proportion of less risky, most stable, India-centric companies that have history of generating strong cash flows and generous dividend payouts.

Huge under-recoveries may dent oil cos’ margins

ONGC, Oil India Profit To Take A Hit, But Cairn, RIL May Put Up Strong Show

ALTHOUGH the first quarter of FY11 was marked by a number of positive developments for the Indian petroleum industry, their impact on the first quarter numbers will be muted. Higher levels of under-recoveries are expected to impact the industry performance down in this quarter. However, the sector offers several investment opportunities, and investors need to wait for dips to invest.
The profits of state-run oil producers are expected to remain under pressure in the June 2010 quarter. Of the estimated Rs 18,000 crore of under-recoveries for the quarter, ONGC’s share is expected at Rs 5,100 crore — several times larger than the Rs 429 crore it had to bear in the June 2009 quarter. With the net realised oil price poised to fall below last year’s and stagnating production, ONGC’s standalone profits could fall on a y-o-y basis. Various brokerages have estimated a fall of close to 28-30% in ONGC’s profits for the June quarter. Apart from a higher subsidy burden, Oil India’s profits will also take a hit from the 100-day shutdown of Numaligarh refinery, which is its key customer. Oil India’s production had to be curtailed during the quarter, resulting in a millionbarrel production loss.
E&P player Cairn India is, however, set to post a huge jump in profits as it commissioned its pipeline and increased the production level. “Having its Rajasthan output ramped up to 60,000 bpd, we expect Cairn to report a strong quarter with an average production at 45-50 kbpd in June 2010 quarter, up from 17.5 kbpd in March ’10 quarter,” says Alok Deshpande of Elara Securities. Cairn is expected to post a net profit of over Rs 400 crore.
RIL’s profits are expected to be far stronger than the year-ago numbers aided by higher gas volumes and doubled refinery volumes, as the petrochemicals segment starts witnessing margin pressure. Sharekhan’s results’ preview note mentioned a higher fall in petrochemical prices compared to its raw material naphtha, which would result in a margin pressure. Most analysts have pegged RIL’s profit growth at 24-30%. The other refinery companies are expected to take a hit due to weak refining margins. “With the increase in refinery utilisation rates, gasoline and naphtha cracks came under pressure, bringing June ’10 quarter’s gross refining margins below $4/bbl,” noted the results’ preview report of Motilal Oswal. This is expected to weigh heavily on the numbers announced by Chennai Petroleum, Essar Oil and Mangalore Refinery.
Although the government decided to revise petroproduct prices upwards, the announcement came at the fag end of the quarter. As a result, the downstream marketing companies will face the brunt of under-recoveries estimated at close to Rs 18,000 crore for the quarter. Of this a burden of close to Rs 2,500-3,000 crore is set to fall on three oil marketing companies — Indian Oil, BPCL and HPCL. The net profit of all these companies could be lower by 60-70% when they announce their quarterly numbers later this month.
While its subsidy burden is sure to rise, the largest gas transporter Gail is set to benefit from the revision in the APM gas prices, which now leaves it in a position to book marketing margins. At the same time, higher gas output from KG basin as well as higher volumes from Petronet LNG’s expanded capacities will result in a jump in the volumes transported during the quarter. Analysts are expecting the company’s profits to jump 20-40% against the year-ago period.
The overall subsidy burden for FY11 is likely to be substantially lower than estimated at the beginning of the year. This will enable public sector oil companies to report better numbers in the coming nine months.
With oil prices expected to remain rangebound, the performance of E&P companies will remain stable. Cairn India should show continuous profit growth till mid-FY12, when its production from the Rajasthan fields plateau. RIL’s numbers will have little upside surprises in the next couple of quarters, although it will continue to report profit growth. Gail’s profitability is likely to remain higher in the coming quarters as the increase in its pipeline capacity translates into higher revenues. Investors must watch stock movements closely to identify good buying opportunities in each of these stocks for long-term gains.

SUPREME INDUSTRIES: Weak Q1 nos, but stock seen fairly valued

SHARES of plastic products maker, Supreme Industries, fell close to 10% intra-day after the company reported a 13% drop in profit in the June quarter. The scrip, which had risen to a high of Rs 619, slipped to a low of Rs 569 only to recover marginally and close at Rs 579.3 — 1.7% below its previous close. However, investors need not panic as the operational performance of the company continues to improve and at the same time has increased its dividends.
The June 2010 quarter results appear weak in comparison to the year-ago numbers, mainly due to the high base effect. In the June 2009 quarter, the company had nearly tripled profits to Rs 60 crore because of substantial inventory gains.
The company didn’t report any sales from its commercial complex at Andheri, valued at around Rs 450 crore. Out of the total area which can be sold, aggregating 2.5 lakh sq. ft., the company plans to keep 20,000 sq. ft. for itself and to sell the remaining portion by December 2010. So far, it has sold one office block and negotiations
for a few more are at an advanced stage.
In its traditional business of plastic products, the company reported a 12% volume growth in the yearended June 2010. The growth couldn’t be higher because of the delay in its Rs 130-crore capex programme, of which Rs 49 crore will be spent by October 2010. Supreme Industries has already planned the next phase of capex investing at Rs 180 crore in FY11, to enhance capacities across all its product lines and increase the share of value-added products. The company is aiming for a 20% volume growth in its sales for FY11.
The sale proceeds from the commercial complex will not only enable the company to fund this ambitious expansion programme but also to reduce its debt burden. The company curtailed its interest cost by 39% to Rs 33 crore by reducing debt as well as bringing down the average cost of borrowing. This could go down even further, if the property sale plans proceed as envisaged.
The company is, however, rewarding its shareholders with handsome dividends and not hoarding cash for the sake of expansion plans. It raised its dividend for FY10 to Rs 18 per share from Rs 12 last year. At the same time, it is planning to sub-divide its shares of Rs 10 face value into shares of Rs 2 face value. Considering the average daily volumes of 14,000 shares in the last one month, this will greatly increase liquidity and could attract more institutional investors. Institutional investors now hold less than 1% of the company’s paid-up equity.
Supreme Industries is now valued 10.2 times its net profit for the year ended June 2010, which can be considered fair for its existing business. However, considering the revenues from the property business, its expansion plans and improving dividends, the scrip remains attractive for retail shareholders.

SINTEX: Co can count on cash balance, order book

THE market was not happy with the 29% net profit growth for the June 2010 quarter reported by Sintex Industries, which saw the scrip end 0.2% lower on Monday, when the BSE’s benchmark index Sensex gained 0.6%. The company’s consolidated net sales were 37.5% higher against the year-ago period at Rs 910.6 crore with a net profit at Rs 79.1 crore.
Although the company improved its operating profit margin by 190 basis points to 15.1%, its net profit margin weakened by 50 basis points to 8.7%. Three major factors — a sharp fall in other income, a spurt in interest cost and higher tax burden — pulled the bottomline growth lower. The company’s consolidated numbers received a booster with subsidiaries doing well during the quarter. The net profit of the subsidiaries jumped 67.7% to Rs 20.7 crore while the standalone profit of the parent company was up only 20.5%. Again on the standalone basis, the textile business that had been performing below par in the past, came up strongly to post a 68% jump in pre-interest-and-tax earnings to Rs 11.4 crore. The segment profit reached a double-digit number, after being in low single digit for four straight quarters. In the company’s largest segment of plastic goods, the proportion of building materials increased as the sales of this sub-segment jumped nearly 80% YoY against around 10% growth in moulded products.
With these results, the company’s profit for the trailing 12 months stands at Rs 321 crore, discounting the current market capitalisation at 13.7 times. The company has been carrying over Rs 1,000-crore cash balance in the hope of an acquisition while it is carrying an order book worth Rs 2,300 crore in monolithics business to be executed over the next 22 months. These factors can drive the company’s growth in the coming quarters. However, another round of economic slowdown in the European or US economies could stifle the improving performance of its subsidiaries.

Oil India:Reaching Boiling Point

Oil India’s heavy capex plan, gas deregulation and expanding portfolio of E&P blocks make the stock an attractive bet for long-term investors

ALTHOUGH Oil India’s results for the June 2010 quarter will appear subdued, longterm investors betting on India’s oil sector should buy into the stock on dips. The company is set to double its gross block in the next couple of years and to invest in several projects also.

BUSINESS: Oil India is the country’s third-largest oil producer at 70,000 barrels per day and 6.6 million cubic meters per day of natural gas. Oil India, in which the government holds a 78.4% stake, recently achieved a ‘Navratna PSU’ status.
The company holds stakes in 65 domestic oil blocks and 9 overseas blocks. It has historically operated out of north eastern states of India and its production predominantly comes from onshore blocks. The company’s proven reserves (1P) are estimated at 521 million barrels of oil equivalent or 12 years of current production level. The proven and probable (2P) reserves are estimated to last over 22 years at the current level of production.
The company also owns and operates 1,157 km-long crude oil pipeline with an annual capacity to transport 6 million tonne that transports its crude oil to refineries. Similarly, it also operates 660 km 1.72 mtpa pipeline for petroleum products. Besides, it holds minority stakes in two other pipelines — 741 km pipeline in Sudan and 192 km Duliajan-Numaligarh pipeline. The company also holds a 26% stake in Numaligarh Refinery. Being an upstream oil producer, the company had been forced to share a part of the underrecoveries of the downstream oil marketing companies. In the past 6 years, the company has shared over Rs 10,500 crore, or 9%, of the total under-recoveries borne by the upstream companies.

GROWTH DRIVERS: The recent deregulation of administered gas prices has immensely benefited the company, which has indicated a net benefit to the tune of Rs 350 crore on an annualised basis. This will immediately improve the company’s net profit for FY10 by more than 13%.
Despite being in production for more than a century, the Assam Arakan basin is relatively underexplored with DGH estimating discovered hydrocarbons so far at around 27% of the total prognosticated resources. Induction of world-class technology to increase reserves and production from existing acreages is one of the key strategies adopted by the company.
For the next two years, the company has lined up an ambitious capex programme to invest nearly Rs 8,500 crore, which will more than double its gross block. While nearly 60% of the capex will be incurred on exploration and development activities, more than one-fourth of the kitty will be spent on merger and acquisition activities. The management has indicated their preference to go for small and medium-sized companies in E&P space producing around 10,000-20,000 bpd.
The company is also investing in creating evacuation and storage infrastructure that can support higher natural gas production. Its pipeline to carry natural gas to Numaligarh refinery is set to complete by July-end. The gas-based Brahmaputra Cracker and Polymers project is expected to come up by 2012 that will almost double Oil India’s current gas output. It has also tied up with other oil companies to lay city gas distribution projects. The company has picked up a 3.5% stake in Venezuela’s Carabobo project, which will translate in 14,000 bpd production once the project reaches its plateau at 400,000 bpd over the next few years.

FINANCIALS: The company’s net sales have grown at a cumulative annualised growth rate of 16.7% during the past 10 years, while the net profit grew at 21.1%. The company has always been a cash-rich and debtfree. The Rs 2,800-crore IPO in August 2009 has given an additional booster to its cash on books, which has increased at a CAGR of 47.7% in the past 10 years to Rs 8,542.9 crore as on March 31, 2010.
The company has increased its oil production in the past 5 years at a CAGR of 2.8% and natural gas at 3.7%. Its reserves replacement ratio — addition to hydrocarbon reserves compared to its depletion due to production — has always remained above 1 in the past five years.
The company’s performance for the June 2010 quarter will be subdued against the previous year due to the extended shutdown of its largest customer, Numaligarh refinery, in April and May 2010. This resulted into a loss of sales to the tune of 1 million barrels of oil and 28 mmscm of natural gas.

VALUATION: Based on the profits for FY10, the company’s shares are currently trading at a price-to-earnings multiple (P/E) of 12.8 and the dividend yield works out to be 2.4%. Its immediate competitor ONGC is trading at a P/E of 14.3 with a dividend yield of 2.5%. Considering the scaling up opportunities available to it going forward, the company is likely to outperform in the longer run.

SHALE GAS : A home remedy for India’s gas problem

TAKING a cue from the US, India is seriously looking at the unconventional shale gas, which, if successful, could mean a substantial improvement in the country’s energy outlook within the next few years. The government is gearing up with policy guidelines for shale gas exploitation and auction shale gas blocks within the next two years, even as various E&P players are moving ahead with their pilot projects. ONGC has tied up with Schlumberger for a pilot project in Damodar valley at a capital cost of Rs 128 crore. Similarly, Oil India has initiated a project in Assam, while Reliance Industries is active in Cambay basin. However, the project timelines are not short. ONGC, which has been researching shale gas in India since 2006, is expected to spend the next two years gathering geological data in its Damodar valley field, followed by drilling and resource estimation by 2013. In 2014 the company will be able to assess the feasibility and consider production from this pilot project.
While state-owned players are trying to source shale gas technologies from foreign players, Reliance Industries has chosen to learn the trade by working on live projects. RIL has agreed to invest over $3.1 billion in two separate deals over the next four years to garner 3,08,000 acres of shale in the US.
Shale is a common rock found across the world and the petroleum explorers are well aware of hydrocarbon deposits trapped in it for a long time. But its exploitation was considered impossible due to the solid nature of shale that prevented hydrocarbons to flow up. With development of newer drilling techniques in the past few years, it has become possible to tap this energy reserve. The US is today witnessing excessive availability of natural gas, which is depressing its imports, increasing its inventories and pressurising prices.
A number of Indian sedimentary basins, including the hydrocarbon bearing ones — Cambay, Assam and Damodar — are bestowed with thick sequences of shale. Though not all shales are good candidates for shale gas exploration, substantial potential for gas from shale is expected from these basins. ONGC informed that parameters like productive shale volumes, gas content, thermal maturity, type and amount of organic matter, lithology & extent, mineralogy and saturation, need to be assessed before shale formation can be considered promising.
While learning the technology to exploit these shale gas reserves is a key hurdle, lack of transporting and storage infrastructure for natural gas and policy framework are other impediments. The entire shale gas exploitation process also carries a number of environmental risks which need to be addressed for sustainable growth.
Although it is too early, India’s ability to successfully exploit shale gas could go a long way in supporting its future growth. A home-grown remedy to domestic energy needs could indeed be the key in sustaining economic growth and strengthen India’s position in global economics.

REI Agro: Rei Agro may soon see a turnaround

Co’s Rs 1,245-Cr Rights Issue Will Lower Debt, Additional Capacity To Boost Efficiency

THE shares of India’s biggest basmati rice player REI Agro have heavily underperformed the market in the past one year, falling 26%, while the BSE Sensex gained 21%.
With its Rs 1,245-crore rights issue, it is expected to lower its debt burden and improve efficiencies with additional capacities. This can boost its profitability and mark a key turnaround in the performance of its shares.
The company ended FY10 with a debt burden, which was 4.45 times its equity and interest cost, which was more than twice its reported net profit. The debt-equity ratio is likely to fall to 1.5, post the rights issue while the saving on interest cost could be around Rs 85 crore annually.
At the same time, the company is planning to increase its rice-processing capacity by 60% in the coming months to replace the leased capacity it currently uses. This is expected to bring in additional gains in the form of improved operational efficiency.
Rei Agro reported a strong 51% growth in net sales to Rs 3,693.2 crore for the year ended March 2010, while the net profit jumped 158% to Rs 157.2 crore. The company has had an exciting growth record with a compounded annualised sales growth of 37.7% in the past 10 years, while its profits rose 46.1%.
However, the nature of the basmati rice industry meant that the high-speed growth needed a morethan-proportionate rise in inventories. The inventory of basmati paddy increased annually at 55% as the company expanded its maturing period to 14 months from four months earlier, which necessitated huge investments in inventory.
As a result, the company’s cashflows from operating activities remained negative continuously in the past 10 years, requiring continuous debt financing. Since the company is not going to increase the maturing period any further, the growth in inventories is likely to fall drastically.
The company which markets its product under the Real Magic, Hungama and Kasauti in India brands, had earlier also entered the retailing business. Subsequently in 2008, the retail venture was demerged in a separate company named REI Six Ten Retail (RSTRL) that has 310 outlets mainly in northern and western India. REI Agro holds nearly 24.4% stake in this company, which had posted a net profit of Rs 26.4 crore in FY 10 and has a market capitalisation of around Rs 780 crore.
The company’s growth so far has highly been dependent on outside funds, which didn’t find favour with the general investors and resulted in continuous underperformance. However, the scene may change if the company manages to improve its earnings and cashflows along with its balance sheet. Despite its overall underperformance, the scrip is commanding a premium over its peers.
Based on the earnings for the past 12 months, the scrip currently trades at a price-to-earnings multiple (P/E) of 17.5 against a P/E between 4 and 5 for competitors such as KRBL and Kohinoor Foods.

CRUDE OIL PRICES: Excess supply, macro worries cloud outlook

THE recent reversal in the month-long steady uptrend in the global oil prices underlines the fundamental weakness that engulfs the industry. Oil prices, which gained nearly 15% from end-May to cross $78 per barrel by June end, have retreated to $71-72 levels in the first week of July. Today, the medium-term market trend appears to hinge on two main factors — the threat to global economic recovery from OECD sovereign debt issues and the sustainability of Chinese oil demand growth. As the Organisation of Petroleum Exporting Countries (Opec) had mentioned a couple of months ago, oil prices continue to depend on the estimates on global economic recovery, while an oversupply situation continues. Therefore, it is not that various global agencies are regularly giving warnings about downside risks to oil prices. The International Energy Agency (IEA) — the industry watchdog for industrialised nations (OECD) — upped its demand forecast for 2010 in its latest monthly report to 84.6 million barrels per day (mbpd), nearly 2% above last year’s. However, it clearly warned of downside risks, saying, “the high level of data could subsequently be revised down.”
Piling up inventories is another problem as the agency noted a sharp 48 million barrel jump in OECD’s petroleum inventories to 2.7 billion barrels, which was substantially higher than the five-year average.
With the supply comfortably overtaking global demand, a quick respite may not be in sight. The level at which Opec needs to produce to maintain the global demand-supply balance is lower at 28.7 mbpd against its current production above 29 mbpd.
“However, Opec output looks set to increase over the next two months, based on announced customer allocations for June and July,” mentioned IEA.
Since last October, crude oil prices have moved within a relatively stable range and was kept in balance by competing upward and downward forces. However, the recent drop in prices to low $70s appears to reflect a shift in sentiment about the world economic recovery. Other factors tempering higher price moves, include stubbornly high global oil stocks, with inventories holding at the higher end of the five-year range, and a relatively comfortable level of Opec spare capacity. Although demand has seen some improvement recently, this has been more than overwhelmed by the higher growth in supply. Additionally, in the light of ongoing risks, there is considerable uncertainty on the outlook for the second half of the year.