Global Offshore likely to Bounce Back with Petrobras Contracts

The company’s stock is trading at a P/E of 7.7 on a consolidated basis

Mumbai-based Global Offshore Services has heavily underperformed the market in the past one year due to a bad first half of FY12. With two of its vessels commencing high-value contracts with Petrobras, the scene will improve from the December quarter onwards. Global Offshore faced higher costs without matching revenues in June and September quarters on relocation of two of its vessels to Brazil on the Petrobras contracts. As a result, Global Offshore’s consolidated earnings for the first half of FY12 dipped 63.4% to . 3.6 crore.
Both these contracts have since commenced at rates that are substantially higher to the rest of GOSL’s fleet. At $24,000 per day and $30,000 per day, respectively, their earnings would be more than twice the average earnings of theremaining nine vessels. Similarly, these vessels would also earn a higher profit margin and improve the sagging bottomline in the coming quarters.
The company has 11 vessels — five anchor-handling tugs (AHT), five platform-support vessels (PSV) and one barge — that support the offshore petroleum exploration industry. Four of these vessels are in wholly-owned subsidiaries in Singapore and the Netherlands.
The Singapore subsidiary has sold its vessels to financial institutions and taken them back on long-term bare-boat charters to reduce the strain on balance sheet. The company has sold its older assets from time to time to improve the overall age of the fleet.
Today, except one, all the company’s assets are less than five years old. It has also placed a $48-million order for a PSV to be delivered mid-2012.
Five of the company’s assets will complete current contracts between May and November 2012 and will be available for redeployment. The company’s ability to secure higher day rates will be another positive for its earnings.
The company’s debt stood 2.7 times its equity on a consolidated basis at end-September 2011. This may be on a higher side, but the company has sufficient cashflows to take care of its debt obligations. The scrip is trading at a price-toearnings multiple (P/E) of 7.7 on a consolidated basis, which appears to capture a part of the future earnings growth. 

PETROLEUM INDUSTRY: Under-recovery in Q3 to Make Matters Worse

The cost of India’s imported crude oil has reached a historic high level on the depreciating rupee. As retail prices remain controlled, the money that India’s state-run petroleum retailers are losing has gone up at a dizzyingly rapid pace. These three companies — Indian Oil, BPCL and HPCL — are already neck-deep in debt and badly in need of compensation from the government.
In December 2011, India’s average cost of imported crude oil stood around . 5,673 per barrel — 8.2% higher since April 2011 — although in dollar terms, the price of India’s crude basket eased 8.7% to $107.9. According to the data published by the Petroleum Planning and Analysis Cell (PPAC), in the last week of December 2011, India’s cost of import stood at. 5,683 per barrel — surpassing the earlier peak of . 5,675 in July 2008, when oil prices had reached $147.
As the import cost reaches a historic high level, it is no wonder then that retailers are losing heavy money. The industry, which lost money at the rate of . 235 crore per day during the second quarter, is losing . 388 crore every day in the second fortnight of December — a jump of 65% in three months. The industry is expected to report total under-recovery of . 30,000 crore for Q3, which will be 40% bigger than the September 2011 quarter. The total under-recoveries had fallen to . 21,374 crore in the September 2011 quarter from . 43,526 crore of June 2011, thanks to decontrol of petrol and reduction in taxes in the last week of June. The heavy under-recoveries have put the cash flows of the oil marketing companies under strain. The borrowings of all these three companies have jumped nearly 48% in the last 12 months to . 129,283 crore at September 2011. In the first six months of FY12, these companies have been borrowing at an average of . 180 crore per day. Their debt-to-equity ratio has worsened to 1.7 for Indian Oil, 3.0 for BPCL and 5.1 for HPCL. Similarly, the combined interest burden of these three OMCs has zoomed up 93% in the first half of FY12 to . 3,877 crore.
As the rupee continues to depreciate, the urgency grows to find a lasting solution to the subsidy problem. Meanwhile, the sector remains highly unattractive to retail investors, as the government appears paralysed by its political compulsions and lack of economic leeway. 

Vinati to Gain from $-linked Contracts

In FY12 and FY13, co plans to invest . 150 crore

The Mumbai-based specialty chemicals maker Vinati Organics is investing heavily in expanding capacities and adding new products, which will drive its profitability growth in the next two-three years. Although, the scrip has fallen to its 52-week low, it has outperformed the BSE Sensex over the past one year. The economic weakness in the western countries is leading to an increase in outsourcing activity in manufacturing of specialty chemicals. Vinati Organics derives 89% of its revenues through US dollarlinked contracts at a time when the rupee has depreciated over 20% in the past five months. This, in turn, will prove to be positive factors for the company’s bottomline in the coming quarters.
Vinati Organics has enjoyed a high-speed growth in the past few years. Its net profit grew at a cumulative annualised growth rate (CAGR) of 93% between FY06 and FY11, while the revenues grew at 41%. In the first half of FY12, however, the company faced stagnancy due to a variety of factors. Sales of its IBB were low due to competition, isobutylene plant was running at sub-optimal capacity and expiry of sops increased tax burden. The things are, however, back to normal now.
The company has been investing heavily of late. Between FY09 and FY11, it doubled its gross block to . 149 crore, which will again double by end FY13. However, its debt-equity ratio has declined steadily to 0.56 at end September 2011, thanks to high profitability and healthy cash generation. Vinati Organics is the world’s largest producer of IBB — a chemical, which is the raw material of widely-consumed pharma drug ibuprofen. It is also the largest producer of ATBS — a monomer used in oil extraction industry. Thanks to backward integration, it has also built India’s biggest isobutylene plant. The company is now adding more specialty chemicals to its portfolio, catering to industries such as pharma, agrochemicals, oil & gas, among others.
In FY12 and FY13, it plans to invest . 150 crore, which will double ATBS capacity to 24,000 tonne apart from adding products such as Diacetone Acrylamide (DAAM), High Purity Methyl Tert Butyl Ether (HP MTBE) and Di-Ethyl Aniline (DEA). Most of these additional plants will commence operations by July 2012. Due to the weakness in the overall market, the scrip is currently trading at a price-to-earnings multiple (P/E) of 6. Its beta — a measure of volatility — to Sensex is around 0.36 for the past 12 months, indicating a stable stock.

Coal India: Govt Looks to Cash in on Rich PSUs

May ask cos to buy into each other or pay special dividends

India’s leading state-run companies are sitting on a mountain of cash, attracting the attention of the finance ministry that is struggling to meet its deficit-cutting target as a slowing economy has hit revenue collections. The country’s top 10 PSUs have cash of $26 billion, or . 137,576 crore, on their books, prompting demands from their dominant shareholder that they should either buy part of the government stake in each other, buy back their shares, or pay special dividends. Lending urgency to these demands is the postponement of follow-on offers by PSUs such as ONGC because of choppy market conditions. The government had targeted . 40,000 crore from disinvestment this fiscal. But this attempt to nudge PSUs to buy stakes in each other, known as cross-holdings, has met with opposition from both company managements and the administrative ministries that control them.

CILTops List 
They argue that in a growing economy, the cash pile is better spent to expand capacity.
But an analysis by the Economic Times Intelligence Group (ETIG) shows that operating cash flows far exceed investments by PSUs, rendering this argument doubtful.
The top cash-rich PSUs, which include Coal India, the monopoly miner of coal, and exploration companies ONGC and Oil India, collectively earned . 52,232 crore in FY11 through operating cash flows while they invested just . 20,103 crore. Coal India (CIL), which had more than . 53,600 crore (over $10 billion) of bank balance at the end of September this year, tops the list, followed by ONGC, NMDC, Oil India and BHEL. Current cash flows also appear to be enough to fund future capital spending or expenditure on machinery and expanding capacity, the analysis by ETIG indicates.
However, Saurabh Mukherjea, head of equities, Ambit Capital, says any policy adopted by PSUs should be consistent and not send a conflicting signal to the investors and the market. His point is that there are PSUs in sectors such as power, coal and gas where the capex requirements are huge and, therefore, the cash surplus generated by them could be utilised by these firms. There are also other PSUs such as Engineers India that may not have huge capex requirements but generate surplus cash. Such companies could be candidates for a potential buyback programme, he says. Mukherjea says unless the government announces a clear cash utilisation policy, it would sound opportunistic on its part and send a wrong signal. Amit Tandon, founder and MD of Institutional Investor Advisory Services, a firm that provides research and data on corporate governance, is also against the idea of dipping into the cash pile of state-run companies given their capex plans. " If private corporates were to do that, there would be an uproar and the market would react adversely," he says. 

CAPEX PLANS Coal India plans to invest about . 30,000 crore in the 12th Five-Year Plan (FY13-FY17) in its own business apart from acquisitions. This means it will invest . 6,000 crore annually on an average while in the last five years, the company had annual operating cash flows of . 9,000 crore. In other words, the company’s annual capital expenditure plans can be easily funded through its annual cash flows. Similarly, in the case of ONGC, operating cash flows have consistently been higher than its annual capital expenditure during the past five years. Although the oil exploration firm has aggressive capital expenditure plans for the future, its operating cash flows should be adequate to fund them. At the end of September 2011, ONGC had a cash balance of . 27,000 crore. Another state-run exploration company, Oil India, also generates enough cash every year to cover its capex plans. It will invest . 3,180 crore in FY12, which includes acquisitions, if any.
    

GAIL INDIA: Expansion Drive to Consolidate Position at Top

India's premier gas transporter is gearing up for bigger things. And it is spending big to fuel those plans. While there are some concerns over gas volumes, Gail is still a good bet in a turbulent market.

Astable business, government parentage, strong balance sheet and low valuations make Gail India a good defensive bet in the current turbulent market conditions. The company's expansion plans will hold it in good stead once concerns over availability of domestic natural gas ease. 

BUSINESS The company is India's largest natural gas transporter with 8,700 km of pipelines and capacity of 175 million metric cubic meters per day (MMSCMD). It is no wonder then that Gail has been affected the most by the ongoing stagnancy in domestic natural gas volumes. With Petronet LNG's Dahej terminal working at almost full capacity, further growth in volumes has been a concern weighing on Gail's market valuation.
After the setting up of the Petroleum and Natural Gas Regulatory Board (PNGRB), the company has had to adjust its transportation tariffs to the regulator's norms. The company also has to share a part of the under-recovery burden of the oil marketing companies. Both these things have added to the pressure on the company's valuation due to the uncertainties involved.
Gail transports more than 70% of India's natural gas. It owns and operates India's largest pipeline -- the 2,300 km long HBJ pipeline -- connecting Hazira on the western coast to Delhi in the North. It also produces around 0.42 million tonne of polyethylene and 1.4 million tonne of LPG.
The company also has stakes in 27 petroleum exploration blocks, six of which have reported hydrocarbon discoveries. In September 2011, the company bought a 20% stake in Carrizo's Eagle Ford shale acreage in the US where it will invest $300 million over the next five years.
It is also one of the promoters of Petronet LNG and seven city gas distribution companies including Indraprastha Gas. It plans to enter city gas distribution (CGD) business in around 50 cities within the next three years. 

GROWTH DRIVERS A few of Gail's immediate concerns are likely to be resolved soon. The PNGRB norms that assure a fixed rate of return on new pipelines will mean the company's average tariff would steadily go up as it commissions more pipelines.
Since Gail shares the under-recovery only on LPG, there may not be any significant growth in its overall burden, even though the industry's overall under-recoveries for FY12 jump due to a weaker rupee. 
The company's gas volumes could see some growth in FY13 after the LNG import terminal at Dabhol is commissioned by mid-2012 and the one at Kochi by end-2012.
Gail is gearing up for an increase in domestic gas supplies in the long term and is working on five major new pipelines and upgrading two existing ones. Last year it disclosed a mega capex plan of 29,000 crore by FY13 to double its natural gas transportation capacity and also double its ethylene capacity. Its 70% subsidiary Brahmaputra Cracker is set to commission its 0.28 million tonne per annum plant by mid-2012. 

FINANCIALS Gail posted steady growth in its net profit growth of 14.8% to 2,079 crore in the first half of FY12, while revenues were up a healthy 22.1% at 18,566 crore.
The company lost its debt-free status on a net basis in FY11 as its standalone debt surpassed its cash & bank balance. This was on account of the company's borrowing plans to fund its capex plans. 

VALUATIONS:
Gail is currently trading at a priceto-earnings multiple (P/E) of 13 based on standalone profits for last four quarters. Assuming the company is able to maintain its earnings growth in the first half of FY12 in the full year, its consolidated net profit would stand at 4,623 crore, which will discount the current valuation at 10.7 times.

The company shed its debt-free status last year thanks to aggressive investment plans

LNG: High Japanese Appetite to Hit Spot LNG Supply

High Japanese demand keeps spot LNG prices high, which remain just below the crude oil on energy equivalent basis. As the winter sets in the northern hemisphere a further boost in demand and prices could render LNG unviable for Indian importers. Indian natural gas players could see a dip in volumes in such an event.
Japan’s imports of LNG have grown substantially since the Fukushima nuclear disaster in March ’11. Today, nearly 80% of the country’s nuclear power capacity is offline and the power companies are trying to make up the shortage through LNG and coal.
Japan is approaching its winter season, with power demand peaking from December to February. The colder weather has a direct impact on kerosene, fuel oil and LNG consumption for power and heating.
According to the Federation of Electric Power Companies, Japan, the LNG imports of top ten power companies grew at 28.3% in October and November 2011 after growing at 21.3% in the April-September period. The total imports stood at 34.6 million tonne for the April-November 2011 period — up 23% against year ago.
Higher imports by Japan have directly impacted the availability of spot LNG cargos and boosted prices. The spot LNG prices in Asia have moved up from around $16 per MMBTU in September 2011 to $17.5 in December. While in the same period, the benchmark Brent crude oil prices have marginally eased from $113 to $106 per barrel. As a result, on an energy equivalent basis, the differential between spot LNG and the crude oil prices has narrowed to just $1-1.5 from $3-3.5 a couple of months ago.
Industry experts fear that if the situation were to worsen from here on, Indian consumers could find liquid fuels cheaper to the imported natural gas. The result will be a reduction in India’s LNG imports — at least temporarily — that can impact revenues of companies such as Petronet LNG and Gail.
Things may not be too bleak at present, with South Korean LNG demand going down substantially of late. Platts, the leading energy information provider, noted that the country’s LNG imports fell 35% in November to 2.32 million tonnes due to inventory buildup. Media reports suggested Japan could face a similar inventory glut in January — there was a 1.8 million-tonne differential between the LNG purchased and consumed by Japan’s power companies till November ’11. Any easing of LNG prices will be a great relief for Indian companies in the natural gas sector. 

New Products, Higher Capacities to Drive Balaji Amines Earnings

Co’s consistent history of positive cash flows may help it bring down debt

Specialty chemicals maker Balaji Amines is investing heavily in higher capacities and new products. All these projects will be operational in phases next year and add to the company’s FY13 earnings. The company should, however, ensure that the rising debt burden and interest costs do not weigh on its performance.
Balaji Amines is India’s largest producer of specialty chemicals ethyl and methylamines and their derivatives. A shortage in the global market leading to a price rise in its main product boosted the company’s September ’11 quarter profit margin to 20.1% — the best in the past two years. Its net profit at . 10.6 crore was the best ever for any quarter.
At present, the company is tripling the capacity of its methylamines plant and adding two derivative products at a capital cost of . 60 crore. These three units will commission between January and July of 2012. The company will become the biggest producers in India of the two derivatives — dimethyl formamide and dimethyl hydrochloride — and replace current imports. Balaji Amines is also setting up a 100-room 5-star hotel on its land in Solapur with . 50 crore of capex to be completed by end 2012.
The company’s expanded capacity of specialty chemical NMP remained under-utilised in the first half of FY12 due to raw material shortage. It expects approvals from USFDA and EU authorities for its product PVPK 30, which is used as a binder in tablets. The approval and better utilisation of NMP plant will also add to FY13 revenues and profits.
While the company pursues aggressive growth options, it needs to mind its debt burden. The company ended September ’11 quarter with a debt of . 158.6 crore and debt-equity ratio near 1. Its interest burden in the first half of FY12 at . 9.8 crore was up 78% against the year ago period. The company will be funding the ongoing capex of . 110 crore with . 73 crore of debt, which will increase its debt pile. However, it has a consistent history of positive cashflows from operations, which will be key in paying down the burden in future.
In the past one year, the scrip has fallen around 6% against a 15% drop in the BSE Sensex. It is currently valued at 4.3 times its earnings for the past 12 months with a beta of 0.65, indicating less volatility as compared to Sensex.

CRUDE OIL: Low Inventory and Iran to Keep Oil Prices High

With Europe as well as the US facing economic slowdown, Libya recommencing its oil production and International Energy Agency (IEA) slashing its global oil demand forecast, it may seem oil prices are bound to crash. However, prices have refused to ease. This means the world has come to acknowledge the oil industry’s supply-side risks.
As dark clouds gather over large western economies, the growth in crude oil demand is expected to slow down. IEA, which advises industrially-advanced countries (OECD nations) on energy-related issues, has slashed its demand forecast for 2011 to 0.9 million barrels per day (mbpd) in November 2011 from 1.4 mbpd in January 2011. The Libyan crisis has also got over recently and the country’s oil production has rebounded quickly in the past few weeks. From an average 75,000 barrels per day (bpd) in September, it rose to 350,000 bpd in October and 500,000 bpd by early November, with an expectation that it shall rise to 700,000 bpd by end-December.
These factors have not sufficed in taming international oil prices. In fact, the fall in October was quickly reversed and Brent crude oil is back at around $110 per barrel level.
The reason is that there are genuine supply-side concerns. The oil production from Organisation of Petroleum Exporting Countries (Opec) has consistently remained below what they should produce to fully meet global demand. The result is, there is a global drawdown in oil inventories. The 11.8 million-barrel fall in inventories of OECD nations in September took the inventory level below five-year average for a third consecutive month — something that has happened for the first time since 2004. Preliminary data suggested another 34 million barrel fall in stocks in October.
Even at the reduced demand estimate of 90.5 mbpd for 2012, Opec will need to ramp up its production from the current level to 30.4 mbpd to fully meet world demand. The upcoming meeting of Opec ministers on December 14 in Vienna is unlikely to take any decision on this issue due to pressure from price hawks — Iran and Venezuela.
In addition to these minor concerns, Iran’s nuclear ambitions pose a grave risk of sudden supply shocks. With its current 3.5 mbpd oil production and control over the Strait of Hormuz — the most important oil transit channel in the world — Iran holds the potential to cause significant supply disruption. Recently, the European Union expanded a sanctions blacklist against Iranian firms and individuals and warned it was considering extra measures against Iran’s financial and oil sectors. In verbal retaliation, Iranian authorities predicted doubling of oil prices in case of sanction on oil.
As the world acknowledges dangers posed by these potential challenges to global crude oil supply, oil prices refuse to bow low. A country like India, which heavily subsidises petroleum consumption of its people, will be at a greater risk to face any sudden spike in oil prices. 

PRAJ INDUSTRIES: Co Diversifies to Cut Risk & Fuel Growth

Praj Industries is tapping new growth avenues in related areas to cut dependence on its core ethanol business

After losing two years to bad business conditions ethanol solution provider Praj Industries has made a comeback in the first half of FY12. The company is tapping a number of new growth avenues to bring down dependence on the ethanol business. As business conditions for its core business improve and the new businesses achieve critical mass, Praj could be back in favour with the market.
BUSINESS Pune-based Praj Industries is among the world's top 5 engineering and technological solution providers for fuel, industrial ethanol and breweries. Many countries across the world have mandated ethanol blending with gasoline, which has increased the demand for ethanol plants.
The company derived 51% of its FY09 revenues from its international business, which dropped to 30% in FY11.
GROWTH DRIVERS The company has now diversified into a few related businesses. In Kandla, it has set up a facility to contract manufacture heavy engineering goods for third parties. It has also started taking up projects in treating industrial waste water or zero liquid discharge plants. It is setting up a unit at Jejuri, Maharashtra, to manufacture bio-consumables.
The company was hitherto undertaking all these activities only for its clients in the ethanol and brewery industries. It has now decided to leverage these capabilities to cater to other companies as well. Its orderbook stands at 900 crore to be executed in one year. This is 1.5 times its revenues of FY11 and gives visibility to growth.
The company plans to grow its non-ethanol business to 25% of total revenues by FY13. Praj is undertaking intensive research for a break-through technology to develop a commercially-viable cellulose-toethanol technology.
FINANCIALS After growing at almost 50% annually between FY04 and FY09, the company's performance was hit by the global economic turmoil. For two consecutive years the company's sales fell to touch 552.9 crore in FY11.
The company's revenues at 393.2 crore in the first half of FY12 were double that of the corresponding period last year. Net profit was 77.6% higher at 34.2 crore.
As at September 2011, it had cash & bank balance of 460 crore with no debt.
VALUATIONS: Praj Industries is currently trading at a price-to-earnings ratio of 20.3 on profits for the trailing 12 months. Its priceto-book-value ratio stands at 2.3 times. More than one-third of the company's market capitalisation is represented by its cash and liquid investments.

SHREE RENUKA SUGARS: Bad Weather, Weak Re Add to Woes of Company

Shree Renuka Sugars has fallen to one-third of its value from a year ago after its dismal September 2011 quarter results.
The company appears to battling bad weather, adverse government decisions, a weakening rupee, faltering economic growth and an over leveraged balance sheet. While sorting out these issues will take time, the company is now taking steps to reduce its debt pile. But it will take a while before the stock can regain lost ground.
The September 2011 quarter saw the company post its first-ever loss since its listing. The loss, at . 615.9 crore at the consolidated level, equalled profits for nearly six preceding quarters, leading to the company losing almost 40% of its market capitalisation in a few days.
The main blow came from the appreciation of US dollar leading to a forex loss of . 570 crore. This was mainly in its Brazilian subsidiaries, which have a debt of $485 million, apart from trade advances of $117 million.
Even excluding these forex losses, the company had a consolidated loss of . 46.1 crore, mainly due to operational problems. Its subsidiary in Brazil, Renuka Do Brasil, were hit because of exceptionally dry weather and two instances of frost in the state of Sao Paulo which resulted in a heavy drop in sugarcane yields. Lower production of sugarcane raised the cost of raw materials and also led to under-utilisation of plant.
After its two acquisitions in Brazil last year, the company’s balance sheet health has deteriorated. Its debt-to-equity ratio rose from 2.8 last September to 4.1 at the end of September 2011. Interest cost, too, jumped nearly three-fold in the last 12 months adding to investor concerns.
In the near term, there may not be a major improvement. In India, higher sugarcane prices are going to add to costs. The government’s decision to allow one million tonne of exports boosted local sugar prices. However, that will be shortlived considering that this move weakened global prices. Similarly, domestic crushing will soon start in full swing which will increase supply.
Brazil too will take two seasons to reach full utilisation levels. It is, however, taking steps to sell a part of its co-generation assets in Brazil to prune its debt. While it attempts to further clean up its books, the company will have to wait for overall market conditions to improve. 

SECTOR ANALYSIS: NATURAL GAS INDUSTRY

Natural Gas Cos Under Pressure as Output’s on the Decline

Indian companies in the natural gas industry have underperformed the broader market in last three months in spite of healthy quarterly numbers as stagnant domestic gas volumes raise concerns over their future growth. Domestic production of natural gas has been on a steady decline after reaching a peak in the March 2010 quarter. While both the public sector oil majors — ONGC and Oil India — have increased their output since then, that raise was unable to compensate for the nearly 27% decline in production from the private sector — mainly represented by the KG basin production from Reliance Industries’ block. ONGC’s production of natural gas has been stagnant at the current level for the last decade or so with new wells compensating for the natural decline from ageing fields. On the other hand, Oil India has been steadily growing its gas production, which reached a historical high level of 228 million cubic metres in September 2011.
India’s biggest gas importer —Petronet LNG — has done well to mitigate the shortfall from dwindling domestic production. Its imports in the September ‘11 quarter were 47% higher at 3,825 million metric standard cubic metres (MMSCM) compared to the March 2010 quarter. In the last one year alone, its volumes jumped 35% as it commissioned expanded capacities. Petronet will see a further substantial jump in its volumes only after its Kochi terminal commences operations in 2013. Till then increase in the imports of LNG, if any, will remain limited.
After reaching a peak of 60 MMSCMD in September 2010 quarter, RIL’s natural gas output has declined steadily. According to recent media reports, it has now fallen to 35 MMSCM per day.
We are today seeing a situation where the domestic natural gas availability is gradually going down even as there is little visibility on improvements in the near future. This has impacted the performance of domestic natural gas players over the last three months on the bourses. Companies like Gail, Gujarat State Petronet, Gujarat Gas and Indraprastha Gas have lost between 7% and 14%, while the BSE Sensex lost just 2%. This is in contrast to the group’s outperformance in the 12-month period till date.
The natural gas companies have embarked on a capex binge since a couple of years in anticipation of higher gas volumes. With the volume growth not materialising, investors are worried about the utilisation levels of their proposed gas pipelines and return on investment. Regulatory uncertainties pertaining to transportation tariffs have added further to their woes. However, the companies retain their inherent strengths and healthy financials, and long-term investors need not worry too much over these mediumterm volatilities.

Should You Stay Invested after BG’s Exit from Gujarat Gas?

More headwinds ahead for co; Stock likely to take further hit in short term

The announcement that British Gas has started the process of divesting its stake in Gujarat Gas triggered a 10% correction in the gas distributor’s shares in two trading sessions.
The latest development only adds to the list of uncertainties that the company faces and is likely that the stock could be under pressure in the near term.
Gujarat Gas has had a healthy balance sheet, a record of steady growth and clocks returns in excess of 35% on its invested capital. Its performance during the last two years has been stellar with its profits for 2010 rising 48% and by a further 41.5% in the first nine months of 2011.
Still, there are strong headwinds which could have a bearing on the company’s future growth. These risks stem mainly from the fact that the company is increasingly depending on imported LNG for its needs. Apart from being costlier, the fluctuating prices of imported LNG make it an option that a city gas company cannot rely on.
In India, availability of natural gas is limited compared to demand and its allocation is based on government policies. Gujarat Gas sells over 83% of its natural gas to small industrial customers — something that does not rank high in the government’s priority list. As a result, only about 5% of the company’s natural gas comes from government allocations while the rest has to be sourced at market rates.
In the last quarter of 2010, close to 37% of its 3.58 million metric standard cubic meters per day (MMSCMD) gas sales came from regassified LNG, leaving the company with little option but to raise prices regularly. As costs started rising, the company preferred supplying to customers who could replace costlier liquid fuels. Liquid fuel replacement demand grew to 40% of total volumes in 2010 from 29% a year ago. However, its customer profile is making it more difficult to pass on price increases.
The company’s superior results in the last couple of quarters were a result of the price increases starting April in anticipation of higher LNG prices. However, the stress is already visible. After shooting up in the June 2011 quarter, the company’s operating margins in the September 2011 quarter fell to the lowest level in the last four quarters. There is a risk that customer resistance or government intervention could make it difficult to further raise prices, thus putting pressure on margins.
With the latest correction, the scrip is now trading at close to 15 times its profits for the last 12 months. A weak sentiment could push prices lower in the short run.

Only Govt Payout can Rescue Forex-hit Jain Irrigation Now

If not for forex losses, company could have put out a healthy performance

Jain Irrigation became another victim of foreign currency fluctuations and rising interest rates as its September quarter net profit dipped 81% to . 11.6 crore. The company displayed reasonable revenue growth, however, it has come at a cost of record high debts. The company doesn’t seem to have addressed its structural problem related to very high working capital, which alone could re-rate it on bourses.
Jain Irrigation’s share price has nearly halved from February this year as the mounting problems of working capital became evident. The company depends heavily on the subsidy payments from government in its key micro-irrigation business and delays in these payments have created a huge burden. Almost the entire . 1,730 crore of the company’s receivables as of September 2011 represented these.
As a result, it needed to borrow heavily to keep the business running. The company’s debt burden at . 2,746 crore was nearly 41% higher compared to a year ago. This translated in a debt-to-equity ratio of 1.55 as on end September 2011 compared with 1.33 a year ago. To service this huge debt, the company had to shell out . 81.4 crore as interest payments —a hefty jump of 56% from the yearago period.
The company’s tied-up investments in its working capital have reduced the efficiency of its overall investment in the business. This had prompted a foreign brokerage JP Morgan to downgrade the company in a recent report. “For the Jain Irrigation stock to re-rate from here, it will have to demonstrate improved discipline in capital deployment. We believe that besides improving its receivables cycle (necessary, but not sufficient), the company also needs to demonstrate better fixed asset efficiency, lower capex intensity and divestments of unrelated ventures, like plastic sheets,” it mentioned.
The biggest hit came in the form of mark-to-market foreign exchange losses on the company’s foreign currency loans of $150 million. The company had to provide for . 59.3 crore in the September 2011 quarter, when in the corresponding quarter of last year it had a gain of . 21.6 crore.
Had it not been for the impact of foreign exchange, the company’s operational performance for the quarter was healthy. It posted a 20% revenue growth with margins inching up 150 basis points. Its operating profit was 28% higher on year-on-year basis. Earlier this year, the company had discussed two alternatives to bring down its debts and debtors. Its first plan to issue more shares is not feasible at the currently low stock price.
Its second plan to float an NBFC is under process and could take another 6-8 months to fructify. As a result, there is little the company can do but hope for the government to pay its dues at the earliest. 

BPCL & HPCL: Rising Debt, Rupee Fall Make it Tough for Cos

After forcing state-run refiners to sell products below cost, the government did not compensate BPCL and HPCL for under-recoveries — the major reason why their balance sheets are awash in red.
The losses of these companies in the first half of FY12 have now zoomed to almost four years of their profits. Both the refiners continue to carry the burden of debt and servicing of interest. With no clarity on subsidy sharing and given the government’s patchy record on payments, the future of these OMCs appears bleak.
Over the past few years, the government has adopted a formula to ensure that the burden of under-recoveries is shared equally by all the stakeholders — the government, state-run oil companies and consumers.
However, during FY09, FY10 and FY11, the government steadily reduced its own burden from 69%, 57% to 52% of the total under-recoveries. After maintaining the share of upstream oil producers at close to 31% for several years, it was suddenly raised to 39% in FY11. In the April-June 2011 quarter, the government further reduced its burden to 34% of total under-recoveries apart from easing the burden by slashing taxes. Yet, the government’s share was low, further pushing oil retailers into the red. At that time, it was assumed that the government would make good the losses of these companies in Q2.
That the government did not pay — nor even agree to pay —a single rupee in the second quarter was quite unexpected. Outstandings of state-run oil companies for selling below cost aggregated . 64,900 crore during the first half of FY12 while their daily losses from November are estimated around . 319 crore. The oil ministry has sought . 28,000 crore for the first half of FY12 from the government, in addition to . 15,000 crore received in Q1, towards under-recoveries.
Delayed government payments forced oil companies to borrow heavily to keep operations running. The losses in the last two quarters, coupled with fresh debt, led to HPCL’s debt-equity ratio shooting up to 5.1 while BPCL’s was 3.0 at end September 2011.
There are other worry lines too. Global oil prices remain high. Compounding the problem is the weakening of the rupee. The industry’s total under-recoveries for FY12 are estimated to top . 120,000 crore. With tax revenues moderating and expenditure still high, the government has very little headroom to fund huge under-recoveries.
Hence, risks of public sector OMCs being kept on a bare minimum life support system for an extended period remains high.

ESSAR OIL: Forex Loss Adds to Woes, but Expansion to Help

Essar Oil stumbled once again as it posted a net loss for the September ’11 quarter, after making profits for four consecutive quarters. Although, operationally, it did well, foreign exchange losses of . 407 crore proved the culprit. The company continues to progress on its expansion project and sale of CBM gas, which should brighten up its performance in FY13.
Essar Oil plans to complete its refinery expansion from the current 10.5 million tonne to 18 million tonne by December 2011 and start commercial operations by March 2012. This will not only bring in a substantial volumes growth, but also improve its margins. The higher complexity planned under this expansion will enable it to process lower quality crude oils to produce premium quality fuels. The company also commenced test sales from its coal-bed-methane block in Raniganj at $6.25 per million BTU. Both these developments will make sure that the company earns substantially higher profits and cash flows from FY13 onwards. This is essential for the company, which has seen its mountain of debt rise consistently over the past few years to . 21,290 crore at end-September ’11, which is 3.1 times its equity. As the commissioning date of major projects nears, a number of broking houses have turned bullish on the company. “Essar Oil’s phase I expansion project is on track for completion by CY11-end and should be a key driver of superior GRMs and profitability, going forward. The expansion would also increase Essar’s complexity to 11.8 from 6.1 currently, making it the second-most complex refiner in India after RIL,” mentioned a recent Citigroup research report. In the September ’11 quarter, the company was able to maintain its high capacity utilisation and posted a revenue growth of 19% at . 13,026 crore. However, forex losses of . 407 crore impacted its margins and lowered profits. The company is carrying foreign currency convertible bonds of $262 million issued to its parent company.
The weak results impacted the scrip, which lost 3.6% to close at . 83.75. The scrip has continually underperformed losing over 45% over the past one year against a 14% fall in the BSE Sensex. The scrip trades at 12 times its earnings for the past 12 months, which is slightly lower than RIL’s, and could generate higher returns once its projects commission. 

Weak Gives India a Crude Shock

Despite the easing of global oil prices, the cost to India has been rising due to fall in rupee

    The steep depreciation in rupee in the past couple of months is worsening the problem of high crude oil prices for the Indian economy. Although, the global oil prices have somewhat eased recently, the cost to India has been going up. At a time when India is battling several woes such as high inflation, rising deficits and slowing growth, a combination of weak rupee and high crude prices could further complicate matters. 

After reaching a peak in April 2011, the global crude oil prices have eased subsequently. Accordingly, the average price for India’s crude oil basket at $106.9 in September and October was 4% below the average in the April-August 2011 period. However, in rupee terms, India’s net import cost in the past couple of months at almost . 5,200 per barrel turned out to be nearly 4% higher than the preceding four months.
It is not that the current global oil prices are at their historic peak or the rupee is at its historic low. Brent oil prices touched $143 in July 2008, while the rupee-dollar exchange rate had touched 52 in March 2009. FY09 witnessed India’s fuel under-recovery zoom above . 1,00,000 crore. The government then could afford to plug the hole with a huge heap of oil bonds. Things are different this time as both the perils — weak rupee and high oil prices — have come back to haunt the economy and the government lacks the firepower it had three years ago. It is already seen falling behind its revenue targets and overshooting expenditure targets and hence looking at a wider fiscal deficit. India imports around 80% of the crude oil it needs. Although, the country is a net exporter of finished petroleum products, the domestic consumption has been growing at a high pace. Since FY07, India’s consumption grew at a cumulative average growth rate of 4.1% to 142 million tonne in FY11 and is expected to grow 4.6% in FY12 to 148.3 million tonne, according to the petroleum ministry. This is more than twice the global growth in oil demand during this period. 
Rising global prices, apart from growing domestic consumption, have also created a huge fiscal burden on India as the costs are not fully passed on. According to the petroleum ministry’s estimates, India’s total petroleum under-recoveries for FY12 will be . 1,21,571 crore, if Indian crude basket averages at $110 per barrel for the whole year. However, these estimations were made in June 2011 when rupee-dollar exchange rate was . 44.85. The currency has weakened 10% since then. The industry lost . 64,900 crore in the first half of FY12 and . 272 crore daily in the first fortnight of October 2011. The rupee depreciation could necessitate an upward revision to the overall under-recovery numbers in the near future.
The composition of the Indian basket of crude is based on total industry processing of sour and sweet crude, including domestic output of crude. With Indian refiners improving their ability to process more and more sour crude oil — or crude oil with high sulfur content — the Oman — Dubai grades have gained weightage in the composition of Indian basket over the years. From 58% weightage in overall basket in FY06, the sour grades represented by Oman & Dubai grades now account for 67.6% since April 1, 2010. Naturally, the proportion of Brent crude in the Indian basket has fallen to 32.4%, from 42%, in this period.
Risk appetite returned to the markets in the past few trading sessions due to the Eurozone’s plans to bail out the Greek economy, while the rupee appreciated with FII money flowing in. On the other hand, this also boosted the international oil prices.
Looking at the fundamental picture, over the next 6-12 months, the oil prices could stagnate particularly with moderate global economic growth and rising oil production from the Gaddafi-less Libya and Iraq. The rupee’s fate will depend on how India is able to contain foreign investors’ worries about widening budget deficit and slowing economic growth. In this regard, what the government does with its mountain of fuel subsidy is something the world will be watching for. 

Digging Deep 
• In rupee terms, India’s net import cost in the past couple of months at almost . 5,200 per barrel turned out to be nearly 4% higher than the preceding four months

• Since FY07, India’s consumption grew at a cumulative average growth rate of 4.1% to 142 MT in FY11 and is expected to grow 4.6% in FY12 to 148.3 MT

• India imports around 80% of the crude oil it needs

Lead Story: SMALL & STARRY-EYED

Every investor dreams to have a future Infosys or Titan Industries in her portfolio. But choosing the right gems out of over 5,000 listed companies is no mean task. Take heart, ET Intelligence Group has done the job for you. Here’s a list of 100 Fastest Growing Small Companies that could be future giants.

The phrase “nothing succeeds like success” might be a cliché, but when it comes to demonstrating the success nothing quite succeeds like growth. It is the growth in revenues and profitability that validates the correctness of a business strategy or a robust business model. Better still, if this is achieved consistently over a period of time. Both large corporates and the smaller ones have their own set of growth stories. Still the limelight is never the same. Bigger companies are always the ones that are talked of more and corner the bigger share of attention. After all, their growth into biggies has already confirmed their success. However, as they say, ‘the great thing in the world is not so much where we stand, as in what direction we are moving.’ Going by this logic, we feel it is important to celebrate the growth stories even of smaller companies. They may be standing low on the ladder, if size were a criteria, but their consistent growth indicates that they are moving in the right direction. They hold the potential to become India Inc’s poster boys in years to come.
While the ubiquitous disclaimer about future’s uncertainties is definitely in order here, we recommend investors cherry pick companies from our list based on their individual research. Such investments
could prove immensely fruitful over next the few years. 

THE STREET SHOW Last one year has been bad for the stock market and in times like this small and mid-cap companies tend to suffer the most. However, that was not the case with our last year’s list of 100 Fastest Growing Small Companies. Between last and this October BSE Small Cap lost 36%, BSE MidCap fell 27% and BSE Sensex slipped over 15%. However, three in every four companies from the 2010 list of Fastest Growing Small Companies have outperformed the BSE Midcap Index in this period, while 52 companies have performed better than the BSE Sensex itself. One in every three companies gave a positive return during this period. It is worth noting that this performance is calculated based on monthly average prices and not point-to-point comparison. 

THE STAR CAST OF 2011 The list of Fastest Growing Small Companies remains, as usual, a representation of varied sectors from auto ancillaries, pharma & FMCG, chemicals to packaging and mining. Only about half the contenders of last year could make it to the list this time. In a few cases this was on account of the company’s inability to continue to perform well. However, quite a few had to lose their rankings due to the raised bar. The list this year is topped by Ester Industries, maker of polyester film, which made a dashing entry into the list, thanks to the runaway prices of its final product. Zydus Wellness, our last year’s topper maintained its momentum to secure the second place. While National Peroxide and Mayur Uniquoters improved their last year’s rankings to take third and fourth places, respectively. A brief analysis of our 10 toppers follows the main story for readers’ easy reference. 

ACTION & DIRECTION One of the key challenges in compiling this list was to weed out unsound and potentially dubious candidates. This is important because one can’t worship growth just for the sake of it.
We tried to achieve this by putting strict parameters for companies vying to enter the list. Only companies qualifying on all these accounts were considered for ranking. As such, making it to the ranking is itself quite an achievement.
The first thing considered was the debt-equity ratio — the gauge of leverage. Any company with a reading of above 1.5 in last three years was dropped for being too leveraged. Similarly, interest coverage ratio, indicating the ability to service the debt, had to be above 5 for three consecutive years for the companies to make it to the list.
The next criterion considered was the return on capital employed (RoCE). RoCE is a measure to figure out how efficiently a company utilises its capital invested in the business. Too low a return and the company could end up in a debt-trap. Hence, companies that could get RoCE of above 15% for the past three years were only considered. Additionally, companies unable to generate positive cashflows from operations for at least two of the past three years were removed. Finally, the revenue benchmark to qualify as a small company was raised to 1,200 crore or below for the current financial year to accommodate the overall growth and inflation against 1,000 crore or below in the previous year. At the lower end, companies with a market capitalisation below 100 crore were excluded.

Top 10 Companies

ESTER INDUSTRIES 
FY11 saw the demand for polyester film — also known as BOPET film — move up strongly on products such as mobile touch screens, LED televisions and solar panels. The prices soared as supply failed to keep pace, enabling companies to make a killing. However, as supplies grew, BOPET prices came down substantially. Ester Industries’ June 2011 quarter net profit tumbled 81% y-o-y. This means the company is unlikely to maintain its feat next year. However, with its capacities more than doubling last year there will be a substantial volume growth.

ZYDUS WELLNESS 
Zydus Wellness, the 350-crore FMCG arm of Zydus Cadila group, has a strong product portfolio with an underlying health plank. The company has invested heavily on building its brands such as Sugar Free, Nutralite and EverYuth. Despite a subdued performance in the June quarter, the company’s business continues to hold the promise of strong growth. Sugar Free is India’s largest-selling low-calorie sweetener with an 86% market share. EverYuth range of skin-care products enjoy their leadership position in the scrubs and peel-offs category despite competition from MNCs and other Indian players. However, the company is facing intense competition in the face-wash category. Growing at over 20%, the company is poised to achieve its target of 500-crore revenue by 2013-14

NATIONAL PEROXIDE 
Improvement in the prices of chemical hydrogen peroxide helped the industry leader National Peroxide in FY11. The company achieved 49% jump in revenues and 255% in net profits, while its production improved 11.4% to 71,826 tonne. The company expanded its hydrogen peroxide capacity by 24%, for which it had to shut down its plant in the April-June quarter for 70 days. Even after commissioning the plant, the commercial production could begin only from September 2011 onwards. This is set to affect its numbers in the first half of FY12. However, the second half of FY12 onwards it will enjoy the full benefits of expanded capacity.

MAYUR UNIQUOTERS 
Mayur Uniquoters is India’s leading manufacturer of artificial leather and supplies to domestic automakers such as Maruti, Tata Motors, Hero MotoCorp, M&M, etc, and footwear makers such as Bata, Liberty, Action, etc. It has continued to grow well over last few years without leveraging its balance sheet and is one of the few companies giving quarterly dividends. The company has started supplying to overseas automakers such as Ford and Chrysler and is trying to enlist with GM, Toyota, BMW and Mercedes Benz. The company has maintained its position in the 100 Fastest Growing Small Companies list for second consecutive year and has proven a multibagger in last one year. It appears well placed to continue its steady growth in coming years.

SANDUR MANGANESE 
Sandur Manganese & Iron Ore is India’s secondlargest manganese ore miner and also operates a ferro-alloys plant with almost all its 2,000-acre mining land in Karnataka. The company benefited from the improved pricing scenario in FY11 although its sales volumes dipped on export ban in Karnataka, high freight costs and 20% export duty imposed on iron ore. The company’s June 2011 quarter numbers were hit by Supreme Court’s blanket ban on mining activity in Karnataka. This factor is likely to weigh on its overall performance of FY12 like other mining companies and could make it difficult to maintain its position in the list next year.

LUMAX AUTO TECHNOLOGIES 
Lumax Auto Technologies is an auto-component maker supplying transmission and steering components, body and chassis and electrical components. Growing production of automobiles by both Indian and foreign players, a buoyant replacement market and rising costs have benefited Lumax. It is a debt-free, cashrich company and is planning to add two more plants to the existing six facilities in Maharashtra. Its entry into infrastructure lighting, although small at present, could safeguard it from cyclicality of the auto industry in the future.

WABCO INDIA 
WABCO India, now a 75% subsidiary of WABCO Holdings of the US, is a supplier of auto components to commercial vehicles industry. A significant revival in Indian commercial vehicles industry, thanks to investments in development of road and infrastructure, enabled it to post a strong revenue growth. As investments in roads grow with more and more private participation, the long-term growth trajectory will remain strong for the commercial vehicle segment. However, in the shortterm, cyclicality in the commercial vehicle market and rising raw material costs could be a concern.

ECLERX SERVICES 
Mumbai-based KPO operator eClerx has benefited from the buoyancy in the demand from the global financial market. Despite talks of a global slowdown, eClerx reported a strong sequential growth of over 6% in the five out of the six quarters ended September 2011, validating success of its business model. PBDIT margin above 33% shows that the new business did not come at the expense of profitability. This has helped in offsetting the impact of higher taxes due to minimum alternate tax on SEZ income. The company offers critical back-end services to the financial sector, which are not affected by the movement of business cycles. This should keep the company going during tough times.

HAWKINS COOKER 
Hawkins Cookers is seeing a huge demand for its products but was unable to meet it because of labour issues at its plants. Last year, the company’s net sales grew 17%. The profit declined due to higher raw material prices. But now most of the labour issues have been resolved and input prices have come down from their peak. Hence the company will be able to run its plants more efficiently and higher growth can be expected. Besides, the company is financially sound with high return ratios, strong cash flows and low debt.

EVERONN EDUCATION 
Education services provider Everonn Education has reported strong buoyancy over the past three years backed by sound return and liquidity ratios. Its stock has, however, plummeted 44% from the year-ago level following the judicial action against its erstwhile MD in early September.
The company has appointed new leadership and has ensured the soundness of its business fundamentals. In the past one month, its stock has recovered from the lows of 228 to the current level of 380. Its performance under the new leadership in the next few quarters will be crucial to restore the investor confidence.

SECTOR ANALYSIS: PETROLEUM INDUSTRY

Refining Industry Faces Hard Times as Global Growth Cools

Crude oil prices have remained volatile through the last quarter amid growing global economic uncertainty. Worries about the pace of economic growth on one hand and rising hopes of a Libyan production recovery on the other have weighed on oil prices. Consequently, average Brent crude oil price ruled some 4.2% lower in the September quarter from the June quarter. It had fallen over 20% from its peak in April 2011 indicating a ‘bear market’. However, the prices later recovered. In the last week of June, the government reduced various duties and increased diesel and LPG prices marginally to help bring down the local oil industry’s losses. However, the rupee’s depreciation in September is likely to increase the burden further. The performance of the stateowned oil companies in the September quarter will, therefore, be again dependent on government aid. Reliance Industries’ results showed signs of a slowing growth that had investors worried over a possible phase of stagnation. Similarly, Petronet LNG’s stock fell although it doubled its September quarter net profit on fears that further growth will be difficult to come by. Heavy rupee depreciation led to a forex loss of 352 crore forMRPL impacting its profits. 

The refining industry could be entering a long phase of downturn if global economic growth continues to cool off, as 2012 and 2013 are likely to see substantial capacity addition. Substantially lower prices of WTI crude oil will help shield US refiners, but European refiners could see a number of closures in the coming months.
The industry’s performance on the stock market continues to remain subdued. While industry leader RIL suffers from its own woes, ONGC’s performance has been languishing due to government’s followon public offer plans. Similarly, Cairn was hit by the hangover from the Vedanta deal. Natural gas major Gail has fallen due to worries over volume stagnation after domestic natural gas production continued to dwindle.

CAIRN INDIA: Royalty Burden Bites, but Future Seen Secure

Cairn India’s profits for the September ’11 quarter took a hit as the company provided for the cumulative royalty payment to ONGC for the Rajasthan fields. On booking this one-time expense, the problems attached to the acquisition of its holdings by Vedanta seem to be behind it and the company appears poised to capitalise on its upcoming volume growth.
In its bid to obtain government approval for the Vedanta deal, Cairn India had to accede to the government’s demands to bear royalty and cess burdens in proportion of its stake in the Rajasthan block. This also meant it had to refund ONGC the royalty it had paid on Cairn’s behalf since production was commissioned in August 2009. As a result, Cairn booked . 1,355 crore of extraordinary expenditure towards its share of royalty up to June 30, 2011.
Although the company received nearly 48% higher revenues from selling every barrel of crude oil in the September ’11 quarter compared to the year-ago period, its revenues stood 1% lower at . 2,652 crore. The key reason was the royalty burden, which amounted to nearly . 770 crore, which it did not have to bear last year. A sharp jump in other income meant that the pre-tax profit for the quarter was up 28%.
Within just two years of operating the Rajasthan fields, the company has reduced its debts substantially and is now a cash-rich company. As of end-September ’11, it held net cash of . 7,129 crore, or almost $1.5 billion. With strong operating cash flows, it is ready to meet all its capex requirements. The company faces a bright future ahead with a scalable reserve base in the Rajasthan fields and discoveries in other blocks. In the Rajasthan fields, it is scheduled to increase the output 40% to 175,000 bpd by March ’12. The production from the Rajasthan block could touch 240,000 bpd. However, these plans are dependent on receiving timely approvals from its joint venture partner ONGC and the government.
The Q2 results would appear dismal at first glance. However, it was known that it had to book the one-time loss on royalty burden. Its profitability will resume the new normal trajectory from the December quarter onwards. Its share price is expected to show a better link, with crude oil prices in the coming months. 

Petronet LNG: A disproportionate rise in operating cost squeezes margin by 50 bps to 8.4%

Petronet LNG posted yet another quarter of strong performance with its profits for the September ’11 quarter doubling from the year-ago period. The strong domestic demand for natural gas enabled it to operate its LNG importing plant at 106% capacity. The company appears well placed to maintain its performance in coming quarters.
Petronet LNG’s net sales for the quarter were 76% up against the September ’10 quarter as volumes jumped 35.4% to 135 trillion British thermal units (TBTUs). Other factors to boost revenues were a strong jump in LNG prices that are passed on to customers and a marginal growth in re-gassification charges.
A disproportionate jump in operating costs dented its operating profit margins, which dropped 50 basis points to 8.4%. Depreciation and interest costs, which are the largest cost items for the company, fell 1% and 7%, respectively, thereby boosting the pre-tax profit by 94%. A marginal dip in the effective tax rate took net profit higher by 99% to . 260.3 crore.
Rising LNG prices in the spot market had raised concerns about demand destruction, if it became cheaper to use fuel oil. The current spot LNG prices translate into $15-17 per million BTUs (MMBTU). Nearly 15% of the company’s volumes come from spot cargos.
However, the management explained in its post-results conference call that its capacity is fully booked for the next three-four months with customers ready to pay the increased prices. The volumes from the long-term contract with RasGas had averaged 90 TBTUs in the first half of FY12, which should move up to 94 in the second half.
The company is setting up another LNG terminal at Kochi with 5 MTPA capacity at a cost of . 4,200 crore to be commissioned by December 2012. It is also setting up a second jetty at Dahej at a cost of . 900 crore, which will enable it to improve utilisation of its existing capacity by another 20-25%.
The scrip is trading at a price-toearnings multiple (P/E) of 13.5 considering its profits for the last 12 months. However, based on annualised profits for the first half of FY12, the P/E works out to 11.7. 

Petronet LNG: A disproportionate rise in operating cost squeezes margin by 50 bps to 8.4%

Kajaria’s Prospects Justify Valuation

Co aims to maintain growth momentum in H2 too

In spite of turbulent market conditions, Kajaria Ceramics achieved a rare distinction of hitting an alltime-high on October 13, when it announced its September ’11 quarter results. Braving the strong cost pressures that lowered its margins, the company posted a strong 42% net profit growth.  

The company achieved a 42.7% jump in net sales to . 316.4 crore supported by 37% growth in volumes to 9.6 million square meters (msm). Its operating profit margin for the quarter slipped 90 basis points to 14.8% due to higher raw material costs, increased gas prices and a depreciating rupee. With its expanded and new capacities, the company is replacing its earlier imported products with indigenously manufactured ones while outsourcing the low-value products — a strategy which is supporting its margins. 

This is reflected in its trading activity. Revenues from trading, which stood at 45% in FY11, dropped to 40% in Q2. This was achieved in spite of a 50% jump in traded volumes to 3.05 msm, indicating a nearly 12.9% fall in realisation per unit of traded product. In the manufactured segment, revenues grew at 51.8% to . 189.4 crore even as the volumes grew 31% to 6.59 msm indicating an 8.9% improvement in realisations. Over the past six months, the company’s debt remained unchanged at . 285 crore. Its debt-to-equity ratio at end of September ’11 was 1.1 against 1.3 at end of March ’11. Its working capital cycle has improved substantially to 38 days in the September quarter from 100 days a year ago.
The company plans to maintain its revenue growth momentum in the second half of FY12 as well with increasingly more revenues coming from manufactured products.
Its Gujarat-based subsidiary Soriso Ceramic is doubling its 2.3 msm capacity of ceramic floor tiles by February 2012. The company has also forayed in high-end sanitary ware and wooden flooring and is aiming to become a complete solution provider.
The company’s growth momentum and promising prospects have helped it command a premium valuation over its peers. The scrip is trading at a P/E multiple of 12 times compared to a P/E between 5 and 7 for its peers such as Somany Ceramics, Nitco Tiles and Asian Granito. 

RIL: Balance Sheet Healthier Now, but Global Slump may Affect Margins

The quarter to September ’11 results of Reliance Industries was mostly in line with market expectations. A strong performance in the refining segment compensated for the weak performance in petrochemicals and oil and gas segments enabling the company to post a 15.8% net profit growth. However, the most noteworthy development of the quarter was the improvement in RIL’s balance sheet following the deal with BP.
With the deal to sell 30% participating interest in 21 oil blocks to BP having been consummated, RIL’s cash balance has swelled. It ended the quarter with cash and cash equivalent of . 61,490 crore lowering its net debt-to-equity ratio to a mere 0.06 — which is as good as being debt free.
The company’s cash generation of . 17,828 crore for the first half of FY12 remained far ahead of its capital investments of . 6,691 crore. Hence, the company can be expected to become net cash positive by the end of the December ’11 quarter.
The company’s decision to route the impact of the BP deal through its balance sheet rather than the profit and loss will also positively impact its return ratios. RIL reduced the book value of its fixed assets by close to . 33,250 crore on the stake sale, instead of showing that as a one-time gain and boosting reserves. As a result, the company will show better numbers when calculating ratios such as return on equity (RoE), return on capital employed (RoCE) or asset turnover in future.
The company was able to post its highest-ever quarterly profits in the September ’11 quarter, thanks to a $10.1 per barrel refining margin, refineries running at a 110% capacity and a 40% jump in petrochemical revenues. However, on a sequential basis, the incremental profit was very low. The September quarter profit grew just . 42 crore from the June ’11 quarter, compared to . 285 crore improvement in the June versus March ’11 quarter. In fact, the operating profit for the September quarter at . 9,844 crore was lower than . 9,926 crore for the June ’11 quarter. This raises concerns of stagnation in profits, going forward. Similarly, the company’s year-on-year growth performance has been showing a slowdown effect at the operating profit level. Although RIL’s net profit grew 15.8% in the September ’11 quarter against the year-ago period, the growth in operating profit was merely 4.8%.
It was mainly the jump in other income, thanks to growing cash balances and reducing depreciation besides lower depletion charges that boosted its bottomline. At the operating profit level, year-on-year
growth has been falling steadily from 21% in the December ’10 quarter to 7.7% in March ’11 to 6.3% in June ’11 and now 4.8% in the quarter to September. At a time when there is a great deal of uncertainty on global economic growth, the improving strength of its balance sheet will be a key positive factor for RIL. However, the risks of profit stagnation are growing. Its sagging output from KG-D6 block is unlikely to see any improvement in the next one year. Significant refinery capacity additions in 2012 and 2013 globally are expected to keep refinery margins in check.
A slowdown in global economic growth could weaken demand for petrochemicals and increase pressure on margins that is already visible. Of its various projects, the company’s investments in US shale gas appears to be the best bet to make a notable positive contribution to its earnings within the next one year, mainly due to the production shale oil or condensates.

CAIRN INDIA: Well-oiled Strategy to Help Co Ride the Growth Phase

Despite the compromises that Cairn India had to make to clear its deal with Vedanta, the company holds significant potential to be a good long-term investment. Investors may accumulate shares on dips

Last year has been a bad phase for Cairn India. The close relationship between the company’s stock market performance and crude oil prices was broken when its UK-based promoters tried its sale to the Vedanta Group.

The final culmination of this deal left the company with compromises in the form of royalty and cess payments that will forever mar its profitability. Still, the company holds significant potential to be a good long-term investment and can be accumulated on dips. 

INVESTMENT RATIONALE Cairn has implemented the development project for Mangala field in the Rajasthan block in a timely manner. It also demonstrated its ability to proceed with its planned investments even without full statutory clearances to maintain the time schedule.
The company is already at 125,000 barrels per day (bpd) production level and has approvals to increase it to 175,000 bpd by developing Bhagyam and Aishwarya fields. This gives the company 32% production upside achievable by the end of this year and a further 8% by the end of next year. No other Indian exploration & production company has such large production ramp up planned for the near future. Cairn’s production may ultimately touch 240,000 bpd, subject to further investments and regulatory approvals. Cairn is working on a pilot project to introduce an early enhanced oil recovery (EOR) technique in Rajasthan. This is expected to add nearly 300 million barrels to its proven and probable (2P) reserves and take it to 1 billion barrels.
Cairn India is also making progress on other exploration assets. One of its KG basin blocks had a hydrocarbon discovery in an exploratory well. Similarly, it recently discovered natural gas in its block near Sri Lanka. In most other blocks it is gathering 2D/3D data. By the time its Rajasthan field reaches its plateau, the company will be ready to move ahead with exploration and development of its other fields.
The lost link between Cairn’s share price and the oil prices is expected to resume now that the deal hangover is over. Cairn typically sells at 10-12% discount to the Brent crude oil price and is a direct beneficiary of rising oil prices. In the near future crude oil prices may be expected to remain weak, however, the outlook should be more bullish for the long term.
The most significant hurdle, and perhaps the last one, that still remains is the payment of royalty to ONGC for the crude oil produced hitherto. This amount is estimated at 1400 crore and would halve a quarter’s profits. However, this is a one-time expenditure for the company. 

BUSINESS Cairn India currently produces nearly 15% of India’s crude oil output from its fields in Rajasthan. The company owns 70% stake in the block, while the rest 30% is with ONGC. Cairn India’s parent company the UK-based Cairn Energy Plc sold a majority stake in it to the Vedanta Group at 355 a share. To obtain necessary approvals, Cairn India had to agree to bear the royalty and cess burden related to its share of production. 

FINANCIALS Cairn India’s consolidated revenues and profits jumped more than six-fold in FY11 as it ramped up production at Mangala field. It is just four quarters since the Mangala output commenced, hence year-on-year comparisons have little relevance for the company. The company ended FY11 as a cash-surplus company. With around 2,500 crore of cash generation every quarter it is well placed to carry out E&P projects in its other fields. 

VALUATIONS Cairn India is currently trading at a price-to-earnings multiple of 6, which is substantially lesser to ONGC’s 10.7 and Oil India’s 11.6.

RIL likely to Post a 15% Growth in Net Profit

Though y-o-y numbers may look good, sequential growth will be hard to come by

The timing of Reliance Industries’ (RIL’s) quarterly results this time may appear a bit surprising. First, they are scheduled for a Saturday — October 15. Besides the results are being unveiled in the first fortnight of the quarter end, which is relatively early in the season for the company. In fact, this will be just the third time in the past decade that RIL’s results are being announced on a Saturday and only the second time that is being done within the first fortnight of the end of the quarter.
However, investors need not read too much into the timing of the results. For, on the previous two occasions when RIL chose to announce results on a Saturday — for quarters ending June 2007 and September 2010 — the numbers were indeed robust.
Its June ’07 profits had surged 42.5% y-o-y, while in the September ’10 quarter it was up 27.8%. And when its December ’05 quarter numbers were announced on January 10, 2006 — the only other instance of an early result — it was subdued with net profit falling 15%. Going by estimates of various brokerage houses, the company is expected to post a 15% net profit growth year-on-year. However, falling gas output and margin pressure in the petrochemicals business means it will be barely able to maintain its performance over the June ’11 quarter. The company is likely to benefit from a stronger refinery margin and a weak rupee.
RIL, which had reported a gross refining margin (GRM) of $10.3 per barrel in the June ’11 quarter, is expected to post a GRM between $10 and $11 in the September ’11 quarter, according to various estimates. The average gas production is estimated between 44.5 and 46.2 mmscmd, against 48.6 for the June’ 11 quarter. Similarly, the pre-interest-and-tax profit from the petrochemical business is likely to have taken a hit of 5-15% from the previous quarter. In effect, the quarter will show a flatto-negative performance compared to the June ’11 quarter. However, considering the low base of last September quarter, there will be some y-o-y growth.
Important developments that could significantly impact the numbers include the consummation of the RIL-BP deal. Although the government approved it in the last quarter, these estimates do not include its impact. While RIL is set to recognise a one-time revenue on sale of 30% stake in 21 oil fields, its share of production from the KG basin will drop proportionately. Treatment of depreciation hitherto provided by RIL on the KG-basin asset on the principle of reserve depletion is something that remains to be seen. It had undertaken a partial shutdown at its SEZ refinery in the second half of September month for maintenance and inspection. It is not known if this will have any material impact on the company’s earnings for the quarter.
RIIL could face a growth challenge with gas output dwindling and its share of output going down following the stake sale. Similarly, a faltering economic growth globally is bound to impact margins in the petrochemicals and refining businesses. Most brokerage houses have trimmed their earningss forecast for the company before reiterating their ‘Buy’ calls. 

Sintex Must Rein in Financial Costs for a Better Show

Company can bank on a stronger rupee to boost operating margins

The September quarter results of Sintex Industries reveals a number of woes the company is facing, both operationally and otherwise. Although fluctuations in foreign exchange was the chief reason behind its dismal quarterly numbers, the poor show is also due to the impact of falling margins and rising interest costs. 
A depreciating rupee hurt Sintex the most as it wrote off nearly . 60 crore towards unpaid borrowings in foreign currency (FCCBs) during the September ’11 quarter. As compared to this it had booked . 20 crore gain in the year ago period. Thus, the currency movement alone knocked off nearly . 80 crore of profits compared with the yearago period.
Still, excluding the impact, the scenario was not much exciting either. The company’s pre-tax profits from the business activities were just 8% higher on y-o-y at . 125.8 crore. This was low compared to 49.2% PBT growth in FY11 and 31.8% in the June ’11 quarter.
The lower growth in profits excluding the impact of extraordinary items was reflective of an increasingly difficult business environment. Although it could growth revenues by 25% during the quarter, the company’s operating profit margin fell by 90 basis points to 17.7%. Similarly, the 56% jump in interest costs due to higher interest rates was on a higher side considering it grew at 49% during FY11 and 41% in the June ’11 quarter.
The company had already lost the market’s favour in the weeks leading to the results. The scrip lost 23% in past 13 trading sessions as against a mere 3.2% drop in BSE Sensex.
The net consolidated debt on the company’s books rose marginally to . 1,991 crore as at end September ’11 from . 1,788 crore at end March ’11. The net debt-to-equity ratio inched up to 0.78 from 0.74 in this period. Net debt refers to debt net of cash and bank balance.
Its building materials business is doing well with a 22.5% revenue growth in the September quarter and an unexecuted order book of . 3,000 crore. Similarly, it has set up a new plant at Chennai for custommoulding products. It will need to manage its operational performance well while reining in the financial costs and hope for a stronger rupee to post better numbers in coming quarters. 

CRUDE Excess Supply to Lighten Burden of State-run Oilcos

CRUDE Excess Supply to Lighten Burden of State-run Oilcos 

Just as the equity markets the world over are threatening to enter a bear phase, the energy markets too seem poised to follow suit.
The European Brent crude oil prices have already fallen 20% — the benchmark for a bear market —from its peak in April this year. Although oil prices have gained in the past few days, the overall scenario bodes well for India and state-owned energy firms. At a time when everyone is revising global GDP growth outlook downwards, supply worries plaguing the oil industry have started diminishing.
Since economic growth and oil demand go hand in hand, lower GDP growth is leading to lower oil demand forecasts. In August, International Energy Agency lowered its global oil demand estimate by 0.2 million barrels per day (mbpd) for 2011. It also noted that supply rose by 1 mbpd.
Supplies in August rose mainly in the US and Latin America, while European output was constrained due to maintenance work in the North Sea. However, the quick recovery in production from a Gaddafi-less Libya appears the key factor in the sustained drop in oil prices last week. Libya is expected to achieve over three-fifths of its output capacity on stream by March ’12 — something that was not considered possible earlier. Iraq’s production is also expected to go up from 2012 as it plans to double output in three years. This will ultimately lead to other Opec countries cutting their output. However, the next Opec meeting is not scheduled until mid-December. A cut-back will also add to the reserve capacity of these countries, thus, helping ease the risk premium on oil prices. For India, lower oil prices will not only reduce the pressure on the country’s trade deficit, but also ease the government’s oil subsidy burden.
Increasing number of analysts have cut their forecasts for 2012 around $115-120 per barrel, slightly higher than the average of $110 in 2011 so far.
The direct beneficiaries will be the three state-owned oil marketing companies — Indian Oil, BPCL and HPCL — as their operational losses will go down. Similarly, the upstream majors ONGC, Oil India and Gail will see their burdens easing.