Gammell’s gamble pays off, makes Buffett look ordinary

SIR Bill Gammell, the founder of Cairn Energy, may trump the world’s most acclaimed investor Warren Buffett for the top slot in investing, and Indian retail investors haven’t done badly either with him. Mr Gammell’s investments has returned 28 times between 1993 and now, compared to Mr Buffett’s favourite Coca Cola that has yielded 1.64 times. Berkshire itself has returned about 10 times during the period.
Mr Gammell’s gamble with $400-million investment in Cairn India is worth $11.1 billion, including the unrealised $3.2 billion, calculations by ET Intelligence Groupshows.
Vedanta Resources on August 16 announced an agreement to buy as much as 60% of oil & gas explorer Cairn India for $9.6 billion, which included 50 a share non-compete fee to the UK parent of Cairn. The biggest take-over deal this year brought to light the returns on the investments triggered a debate whether Vedanta was justified in paying the fee.
Retail investors’ wealth has more than doubled in the past three-and-a-half years since Cairn India’s initial public offering.
Investors may have to realise that this is just a typical example in the oil exploration industry where an explorer, which takes all the risks and invests early reaps the largest dividend, leaving minority holders lesser.
Cairn Energy, which is set to walk away with at least $6.5 billion for a 40% stake in Cairn India, had earlier taken away $1.4 billion out after selling shares in Cairn India’s IPO. Its remaining 23% stake will be worth about $3.2 billion at current market price. All this for a $400 million investments in 1993.
But all this comes after years of struggle to develop these fields and financial engineering.
Cairn India’s IPO was to raise funds to buy out Cairn India Holding (CIHL), which owned the three key assets — a 22.5% stake in Ravva field in the Krishna Godavari basin, 40% in a gas field in Cambay basin and a 70% stake in a large discovery in Rajasthan, which was three years away from production. The valuation of these assets depended on the IPO pricing. The IPO with a price band of 160-190 a share was at a time when the markets were shaky. It received subscriptions for 1.6 times the offer. This valued the company — or the assets it was buying in CIHL — at a market capitalisation of a little above 28,500 crore.
Out of the $2 billion raised in this IPO (including the pre-IPO placement), around $600 million were retained in Cairn India, while the rest were paid out to Cairn Energy for a 24% stake of CIHL. The rest 76% stake was transferred to Cairn against its own shares.
It has been long since Cairn Energy started exploring for petroleum in Asia. Initially entering Bangladesh in 1993, it obtained stake in India’s Ravva field in 1996, when it acquired an Australian company. With the discovery of Sangu field off Bangladesh in 1996, the company farmed out a part of it to Halliburton and Shell to fund the development programme.
The transaction with Shell involved Cairn Energy acquiring a 10% stake in the Rajasthan block with options to increase that stake to 40% by carrying Shell through certain work programme. In 1999, a joint venture between Cairn Energy and Shell made the first oil discovery in Rajasthan named Guda. In a further transaction Cairn Energy increased its stake in the Rajasthan block to 50% and took over the operatorship from Shell while transferring the operatorship in Bangladesh to Shell. In May 2002, Cairn Energy acquired the remaining 50% interest in the Rajasthan block from Shell. In less than two years after that, the Mangala field was discovered in January 2004. The Indian government retained back-in rights to acquire 30% working interest in any commercial discoveries made in Rajasthan block, which it went on to exercise through ONGC as its nominee. This asset went on to become the largest and most valuable asset in Cairn Energy’s portfolio.
The excessive rewards for a discovery are, perhaps, the need of the petroleum exploration industry, which is highly capital intensive and risky. With the company’s project well on schedule, retail investors can stay invested to be part of the steady growth.

Steady Performance

The shares of Mumbai-based plastic products maker Time Technoplast (TTPL) touched an all-time high on the bourses on Friday, following an acquisition announcement. The company bought the plastic products division of Belgium-based Solutia Inc with a manufacturing plant in Romania and renowned brands such as ‘AstroTurf’. The company, which has a similar product range under ‘DuroSoft’ brand, will strengthen its portfolios of lifestyle and auto components through this acquisition.
This marks its fourth acquisition in two years. Last year, the company acquired composite cylinder maker Kompozit Praha in the Czech Republic. Recently, its
subsidiary NED Energy acquired majority stake in a Bangalore-based company manufacturing batteries for power and solar sectors. TTPL also acquired 90% stake in Taiwan’s largest industrial packaging company. TTPL has successfully set up a pilot project for composite LPG cylinders and produced prototype composite cylinders for the Asian market tested and approved as per European standards. TTPL’s another subsidiary, TPL Plastech, has set up a greenfield expansion for industrial packaging at Pantnagar, where the operations have commenced recently.
The company posted a healthy 24% jump in its consolidated net profit for the June 2010 quarter, thanks to a better performance by its subsidiaries. The company had 19% higher revenues with stable margins. It was the lower than proportionate growth in interest and depreciation that lifted the bottomline growth. The company has steadily improved its operating and net profit margin over the last four quarters.
With a strong and steady performance throughout last year, the company’s consolidated profit jumped 31% in the 12-month period ended June 2010 to 103.7 crore. Its current market valuation is 11.4 times the trailing twelve-month earnings, which appears attractive for long-term investors.

CAIRN BID: ONGC, OIL can make a counter-bid

CAN India’s state-owned firms join hands to mount a counter-bid for oil exploration firm Cairn India after the surprising entry of Vedanta? These firms, despite their huge capital expenditure programmes earmarked for the next few years, appear quite capable of making a counter-offer, considering that the valuation does not appear prohibitively high. Both ONGC and Oil India have debt-free, cash-rich balance sheets and strong and growing cashflows. Despite their own capital expenditure plans — ONGC is set to invest close to Rs 25,000 crore annually, while OIL has planned to invest Rs 8,500 crore over the next couple of years — it may not be difficult for them to raise funds for a counter-offer. The debt that these companies can raise could be as high as Rs 50,000 crore before their debt-equity ratio touches 0.5. However, the critical issue is whether such a move makes sense. It was just two years ago that ONGC acquired UK-listed Imperial Energy for $2.1 billion with reserves of 860 million barrels. Using that as a benchmark, paying $8.5 billion for 51% of Cairn’s currently estimated recoverable reserves of 1.4 billion barrels may appear expensive.
“It will need an underlying assumption of crude oil price at $100 per barrel to justify the Rs 405 per share price for Cairn India. All visible upside for next 3-4 years appears captured in this,” noted Sandeep Randery, research analyst in BRICS Securities.
But a few analysts have argued that the Imperial and Cairn comparison is not fair. While Imperial’s assets were at a preliminary stage of development, production is fully underway in Cairn’s Rajasthan fields. It is set to reach its plateau of 175,000 bpd by end 2011 and holds the potential to ramp it up to 250,000 bpd, unlike in Imperial’s case where the production is stagnating at close to the 20,000-bpd level. Besides, Cairn India also holds stakes in ten other exploration blocks apart from the Rajasthan fields.
For a long-term player who has a 15-20 year horizon, the pricing may still make sense. Networth’s Diwan said, “Given the promising prospects for Cairn, it certainly is a good buy from a long-term perspective.” With Sesa Goa’s open offer for Cairn’s shares already on, oil PSUs need to take a quick call on their future course of action.
Among the oil PSU pack, not all of them have the ability and the resources to participate in a buyout now. “Given their cash-strapped conditions thanks to the subsidy burden, barring ONGC & OIL, it would be difficult for other oil PSUs to fund an acquisition of the Cairn scale,” noted Prakash Diwan, head-institutional business at Networth Stock Broking.

REFINING INDUSTRY: Rise in global stock,output to weigh

DESPITE the lacklustre performance of petroleum refining industry in the June quarter, the stocks of pureplay refining companies have started rising again. Crude oil prices have fallen nearly 10% in the past couple of weeks and refining margins across Asia are looking up. However, the improvement in refining margins appears a temporary blip in an otherwise bearish trend requiring the investors to be cautious on these stocks in the near future.

The shares of standalone refiners such as Mangalore Refinery, Chennai Petroleum and Essar Oil have gained between 2% and 10% in August 2010 so far, after a sombre show in July. The financial results of these companies had been disappointing with only MRPL managing to stay in the black as refining margins weakened.

The gross refining margins or GRMs — the differential between the cost of crude oil and sale proceeds of products made there from — have remained weak for nearly a year now. After dipping to a multi-year low level in the December 2009 quarter, the refining margins had witnessed a jump in the March 2010 quarter. However, the June 2010 quarter proved a dampener. The overall weakness continues.

The benchmark global indicator margins calculated by BP also show a weakness in refining margins till date in the third quarter of 2010 from the preceding quarter. However, refining margins in Asia appear to have improved to $2.56 per barrel from below $1 in the preceding two quarters.

This regional improvement in GRM can be attributed more to temporary supply disruptions rather than any strength in demand. Taiwan’s largest 540,000 barrels per day refinery underwent an unplanned shutdown due to a fire incident in the last week of July. Similarly, maintenance shutdown at a couple of refineries was prolonged such as the 230,000 bpd Cilicap refinery in Indonesia.

The summer driving season in the US, starting July, has encouraged refiners to increase capacity utilisation rates, which rose to a two-year high of 90.7% in the US. However, the inventories of refined petroleum products remain high globally, with substantial spare refining capacity, according to Opec’s latest monthly report on the oil industry. The refining industry is expected to remain bearish on continued ample stocks across the globe and high production levels.

CAIRN INDIA & SESA GOA: Investors can afford to shrug off deal shock

THE Cairn-Vedanta deal may have upset shareholders of both the Indian companies involved — Cairn India and Sesa Goa whose shares fell between 6% and 9% — while their UK-listed parents — Cairn Energy Plc and Vedanta Resource Plc — gained. The deal indeed raises certain concerns about these two Indian companies. However, long-term investors should not act based on the market reaction on Monday.

The promoters of the oil exploration company do appear to have made a killing, selling off their controlling stake in Cairn India, without sharing the spoils with local retail investors. Cairn India’s shares were hammered on Monday with record volumes — a testimony of the disappointment this caused among retail shareholders. As a new promoter group gains control without any attractive exit route for retail shareholders, those hoping to stay invested in the company for the long haul will have to live with worries about Vedanta Group’s lack of experience in the oil industry and its stretched balance sheet.

For Sesa Goa, which will pick up a 20% equity stake in Cairn India by investing over $3 billion, the longer-term perspective doesn’t appear as bad as its 9% fall on Monday leads one to believe. The company had nearly $1.5 billion of cash and equivalents at the end of March 2010. Its relatively unleveraged balance sheet as well as strong operating cashflows will enable the company to fund the transaction effortlessly.

The management has strictly maintained that the company’s growth plans in iron ore business won’t get hampered due to this deal. The deal will be earnings-accretive for Sesa Goa as Cairn India continues to ramp up its production, while a future stake sale can unlock value. Cairn India, which has raised production from its Rajasthan fields to 120,000 barrels per day from close to 17,500 bpd in the March 2010 quarter, is set to attain the target of 175,000 bpd by 2012. The company is hopeful of ultimately moving up to 240,000 bpd depending on government approvals. The company had $0.55 billion of cash on hand and $0.74 billion of unutilised loan facility at the end of June 2010 in addition to growing cashflows from operations to fund its expansion plans. The exit option for Cairn India’s retail shareholders will come at Rs 355 per share, although Cairn Energy Plc nicked a 14% higher price — Rs 50 premium for agreeing not to compete in India, Sri Lanka, Bhutan and Pakistan. The open offer price of Rs 355 per share is barely higher than the scrip’s average price in the first fortnight of August 2010 and effectively means that the scrip will remain range-bound in the coming months between Rs 355 and Rs 310, which appears to be its fair value.Although the Vedanta Group is planning to replicate the success of BHP Billiton by entering the oil production business after mining, the analyst community is concerned about its lack of familiarity with the new business. The oil exploration business has become an extremely hightech industry over the past few years with oil prices staying high and new discoveries becoming difficult.

Although the deal signals a disappointment for shareholders of both Cairn India and Sesa Goa, the long-term view should remain stable for both. For Sesa Goa it is a strategic investment, which puts to use its surplus cash. The existing strong management team at Cairn India can take care of the concerns of its shareholders over the entry of new owners who are inexperienced. One needs to also watch how institutional investors — particularly Petronas of Malaysia, which holds 14.9% in Cairn India — react to the deal and the ensuing open offer.

Indraprastha Gas (IGL): Full Steam Ahead

Although growth in quarterly profits of Indraprastha Gas (IGL) was lower in the June 2010 quarter as compared to the previous two quarters, its outlook remains positive. The company witnessed a jump in its costs, eroding operating margins during the quarter. However, the price hikes it imposed towards the end of the quarter will revive its profits in the coming quarters. The company, which primarily depended on the APM gas for its business, witnessed a massive jump in costs with the government decontrolling gas prices. Higher volumes of RLNG and RIL’s KG basin gas also raised the raw material cost. The company increased its CNG as well as PNG prices subsequently but with a lag. IGL’s June quarter profit was 18% higher y-o-y at 57 crore on a 44% jump in sales at 335 crore. The company, which typically enjoys operating margins of around 35% on its net sales, registered a lower 32% margin during the June 2010 quarter. A fall in other income and higher depreciation lowered the growth rate in profits to 18%. Indraprastha Gas continues to do well on volumes with a 17.8% jump in CNG and doubled PNG sales during the June quarter against the year-ago period. The growth is expected to remain in double-digits at least for the next couple of years, thanks to the increasing number of CNG vehicles. The scrip, which is trading above 313, is now being valued at 19.6 times its earnings for the past 12 months. The company has marginally raised dividend to 4.5 per share for FY10 after paying 4 for two consecutive years. With the dividend yield of just 1.4% and a high P/E the company appears richly valued. While existing investors may continue to hold, new entrants may not find investment remunerative.

Jain Irrigation System: Investors need to wait for the cool-off phase

ALTHOUGH Jain Irrigation System’s (JISL) operational performance for the June 2010 quarter appears strong, weaker consolidated numbers for FY10 mean the scrip is trading at unsustainably high levels. The company, which doesn’t publish consolidated numbers every quarter, revealed a lower consolidated net profit compared to the stand-alone, indicating its subsidiaries had made a loss during FY10 in spite of a net profit in FY09.
For the year ended March 2010, the company reported a net profit of 271 crore on a stand-alone basis, while reporting 248 crore of consolidated profit as subsidiaries made loss of Rs 23 crore. The subsidiaries contribute nearly one-fifth to the company’s consolidated net sales. The company’s current market valuation stands high at 10,055 crore, which translates into a price-to-earnings multiple of 40.5 based on the fullyear numbers.
During the June 2010 quarter, it was mainly the forex losses of 20 crore and a 36% jump in depreciation that played a spoilsport on an otherwise operationally strong stand-alone performance. JISL had booked 21 crore of forex gains in the year-ago period. The company improved its operating margins and registered a 31% growth in operating
profits. However, the pre-tax and post-tax profits were down marginally against the year-ago period.
JISL’s largest business segment of agri-input products enjoyed a healthy jump in net sales as well as profits during the June quarter, while the industrial products suffered a significant margin erosion. This business, which contributed one-fourth of JIL’s stand-alone revenues, reported a 3% fall in the pre-interest-andtax profits.
The company continues with its strong volume growth in the micro-irrigation and PVC pipes segment with healthy operating margins. It has announced a dividend of 4.5 per share and proposed to split shares in 1:5 proportion. However, its valuations appear to have run ahead of its fundamentals with the price-toearnings ratio above 40 — a level it had not crossed even at the height of market euphoria in the month of January 2008. Long-term investors should wait for the scrip to cool off before investing.

Gei Industrial Systems (GEIISL): High return seekers can bet on Gei Ind’l

SHARES of Bhopal-based Gei Industrial Systems (GEIISL) have outpaced the market over the past one year on a consistent basis, rising 176% against benchmark BSE Sensex’s 14% gain. The company’s consistent profit-growth trajectory in FY10 has contributed to its performance on bourses.

After reporting a 43% profit growth for FY10, the company continued with its growth momentum for the June 2010 quarter, posting a 50% jump in its net profit to 4.1 crore, as net sales grew 29% to 50.3 crore. Improvement in the operating margin, higher other income and lower interest costs have mainly driven up the company’s performance.

The company is greatly benefiting from the rising demand for its airbased cooling systems from power and petroleum industries, since availability of water recedes. In India, these two industries are highly dependent on water for their cooling needs and have faced operational problems at times, when sufficient water is not available. Gei Industrial Systems dominates the market with a 70% market share in airbased cooling solutions.

After successfully converting several captive power plants to this system, GISL has shifted towards commercial power plants, enabling it to obtain orders with large ticket sizes. In February this year, the company for the first time obtained single order worth nearly 100 crore for a 150-MW power plant. The company is well placed to obtain orders from new as well as existing power plants in India.

The company currently carries an order book of 500 crore — which is more than twice its net sales of FY10 — to be executed over the next 12 months. Almost 75% of the order book is represented by the power industry. The company has embarked upon an 100-crore expansion, which will ultimately quadruple its capacities by the end of 2011. Under the first phase, it invested 20 crore in FY10 and has a planned capex of 35 crore for FY11. This capex programme is set to more than double its gross block within three years from 57 crore in March 2009.

The company, which had been struggling till FY05 when it had to undergo a debt-restructuring programme, has grown consistently since then. Its profits in the past five years grew at a cumulative annualised growth rate of 50%, as sales grew at 32%. In the process, operating and net profit margins have improved. Considering the rising demand for its products and services, the company could offer healthy returns to investors in the coming years.

Natural gas biz seen future growth trigger

UNLIKE its larger peer in the oil E&P industry, Gail was able to shrug off the heavy subsidy burden in the June ’10 quarter and post a handsome profit growth, mainly due to higher volumes and improved margins across all its segments. The results have been more or less better than the Street’s expectations and should strengthen investor confidence in the company’s growth, going forward. Although the company’s current valuations appear somewhat stretched, a majority of broking firms have this stock in their ‘top picks’ from the petroleum sector. Although Gail’s subsidy burden rose for the June ’10 quarter, it jumped only six times against the year-ago period, unlike the 12-fold jump in ONGC’s case. In view of the overall volumes and margins expansion, this spurt in subsidy burden proved benign. In fact, it’s the LPG & hydrocarbons business, which absorbs the subsidy burden, registered a strong 56% profit growth to Rs 233.3 crore due to higher volumes as well as higher prices. The segment’s 14% net sales growth was contributed equally by volume and price hikes.

The company owning the longest natural gas transmission capacity has found itself in a sweet spot, as the natural gas availability within the country grew steadily last year. Similarly, the government’s diktat to decontrol the natural gas pricing enabled it to charge marketing margins. Both these factors boosted the profitability of its natural gas trading segment by nearly 50%, as the margin improved 60 basis points to 2.9%. The transmission business also registered a double-digit profit growth.

In the polymers segment, the company registered a 4% volume drop, which was made up for by 4.4% higher prices. The company posted a 7.7% increase in the segment’s profits. After scaling to a high of Rs 516, Gail’s shares have retreated below Rs 450. Considering the current quarter’s earnings, the share is now trading at a price-to-earnings multiple (P/E) of 16.8. Going by its historical valuations, Gail’s current valuation appears somewhat stretched. However, its stable business and plans to lay new pipelines over the next 3-4 years appear to justify it.

The company has embarked upon a heavy capex programme that will triple its gross block within the next four years. At present, the growth in India’s natural gas consumption has slowed down due to lack of transmission infrastructure. As Gail’s new pipelines come up, the availability of gas in India — through production as well as imports — is set to grow rapidly. With a strong balance sheet and an array of supporting businesses to diversify earnings, Gail’s growth in the future will continue unabated. Natural gas being a cheaper alternative to liquid fuels also makes it a recession-proof business.

TATA CHEMICALS: Consider it a good proxy to bet on farm sector

TATA Chemicals’ strong results for the June 2010 quarter, although not repeatable, confirm the change in trend. The company, which was weighed down both operationally as well as financially by its overseas subsidiaries for the past couple of years, has turned the corner and is expected to resume its normal growth trajectory.

There were three main reasons behind Tata Chemical’s 408% profit spurt in the June 2010 quarter against the year-ago period. The company had written off Rs 87 crore in the June 2009 quarter towards closure of the Netherlands unit of Brunner Mond. That quarter, the company was also saddled with high-cost inventory that further pulled lower its margins, particularly in the fertiliser business. Thirdly, the company went on to acquire over 50% of the shares of sister concern Rallis India in November 2009 — the numbers of which are now included in the June 2010 quarter, but not in the June 2009 quarter. All these factors were one-time in nature.

The focus of the company, which in FY10 was mainly on slowing demand and falling prices, has now shifted to managing costs — particularly energy costs — to maintain margins. The company spent almost the entire FY10 on consolidating the acquired businesses, streamlining operations and strengthening balance sheet. It divested non-core investments and repaid debts to bring down its net debt to equity ratio from nearly 1 in June 2009 to 0.7 by end June 2010. It further arranged Rs 400-crore equity infusion from Tata Sons on a preferential basis.

Among the operational set-backs of last year, the company lost about 20 days of production in Brunner Mond, around eight days of operations in General Chemicals due to extreme cold weather and close to 60 days of production at Haldia due to industrial unrest.

Although the scenario was challenging, the company took upon several strategic decisions for future growth. Firstly, it raised its stake in Rallis India beyond 50% to make it a subsidiary. It also launched a domestic water purifier under the brand ‘Tata Swach’ as part of its consumer product portfolio, commissioned pilot plant for bio-ethanol and initiated process to set up 1.5 lakh tonne per annum speciality fertiliser unit in Babrala. The company is planning to set up another 10 such units in the next three years. It also readied its plans to double its urea capacity at a capex of Rs 4,000 crore, subject to firm allocation of natural gas. For the past two years, the company’s scrip has generated almost no returns for its shareholders — a scene which is likely to change. Since the company has streamlined its international businesses and is now present in both fertilisers and agrochemicals businesses, it can be considered a good proxy to bet on India’s agriculture sector.

Cairn India: Sound investment

Cairn India’s results for the June ‘10 quarter, although substantially better compared to the year-ago period, fell short of analyst’s expectations. However, they underline the key change in the company’s growth trajectory, which is likely to continue growing till its production from Rajasthan fields reach a plateau level of 175,000 barrels per day by mid-’11.

It was mainly the multi-fold spurt in interest and depreciation cost that weighed heavy on Cairn’s profits. The interest cost jumped to Rs 49.3 crore from Rs 0.73 crore in the year-ago period, while the depreciation rose to Rs 166 crore from Rs 41 crore.With the commissioning of its pipeline, the company ramped up its Rajasthan production to an average of 44,400 barrels per day from 17,500 bpd in the March quarter. At present, the production has been further increased to nearly the 100,000 bpd level, which will be scaled up to 125,000 bpd by end-’10.

Rising oil production as well as higher oil prices also brought in substantially more cash in business. Cairn’s operating cash flows increased to Rs 493 crore compared to Rs 108 crore in the year-ago period. As the company chose to repay a part of its debt, the unutilised portion of its debt increased to Rs 3,991 crore by end-June from Rs 3,387 crore as at end-March ‘10, while the cash kitty came down marginally to Rs 2,544 crore from Rs 2,631 crore.The average oil price realisation in the June ‘10 quarter was $72 per barrel as against $60.2 during the corresponding quarter of the previous year.

Cairn’s scrip has continued its steady upward movement even in the last few days of market turbulence. Since its results, the scrip has gained 1% as against a 1% fall in BSE Sensex. Although considering historical profits, the company’s valuations appear stretched over the next 12-18 months as it reaches its full earning capacity from current assets, the valuations will appear attractive. Long-term investors should remain invested in the company for rich returns.