ONGC: Subsidy Burden Takes a Toll, and Street isn’t Likin’ it

Government-owned ONGC reported more than 60% sequential decline in net profit in January-March as it gave away about two-third of its oil revenues to subsidise losses of retailers amid soaring crude prices, reviving memories of fiscal 2008-09 when global crude peaked pushing up subsidies on fuel.
The huge sequential fall in earnings stands in sharp contrast to private sector explorers such as Cairn India, which reported 22% growth in net profit helped by higher prices even though production fell.
ONGC’s share in subsidy at . 12,135 crore in the fourth quarter was almost equal to the total of past three quarters. This took the total subsidy toll to . 24,892 crore for fiscal 2010-11, more than double than previous year.
In January-March, although ONGC earned an average oil price of $108.90 per barrel, it ended up with just $38.75 in hand as the government took away the rest. What remained was nearly 25% below the year-ago period causing a 26% fall in net profit.
State-run fuel retailers sell products such as diesel and cooking gas to end-customers at subsidised rates. The subsidy burden arising from selling the products below market price is shared between retailers, upstream companies, and the government.
The company reported net profit of . 2,791 crore in the last quarter driven by higher profits on natural gas, whose prices were revised in fiscal 2010-11, and increasing share of production from joint ventures. As there is no subsidy burden on production from joint ventures, the 60% incremental volumes helped. Although oil prices have jumped more than five times since 2004-05, ONGC’s average profit growth has been a mere 6.5% per annum. The average annual growth in its market capitalisation was just about 4.5%. Every year, the government has taken away a chunk of its profits to pay for losses made by oil marketing companies.
The subsidy sharing mechanism and its value-destructing impact will keep weighing on investor sentiment. The government is expected to divest its stake further in the company in early July.
This could induce the government to introduce some reforms for a better price. Investors, who are otherwise living off the annual dividend payouts, may look forward to a run-up in prices if the follow-on offer materialises.

Q4 Net Best in 3 Years But Potholes Ahead

Data for 1,965 companies indicate no impact of rising interest rates, inflation on Indian Inc earnings

India Inc seems to be in the pink of health if one goes by the results of the quarter ended March. There appears to be no sign, so far, of inflation or rising interest rates biting into corporate earnings. But analysts say the future may not be as rosy.
Data compiled for 1,965 companies shows they earned higher net profits per rupee of sales during the March quarter, the best performance in almost three years. These firms exclude banking, finance and staterun petroleum companies.
The operating profit margins of these firms, too, were better than the year-ago figures, indicating that rising borrowing costs have not pinched their profits yet. Rising inflation, which is pushing up the cost of raw materials, also did not impact the profit margins, as was expected.
The proportion of raw material costs to net sales did go up to 43.4%, the highest since the quarter ended September 2008. It was 110 basis points higher than the March 2010 quarter. This means India Inc was largely able to pass on the rising cost of raw materials to customers.

In the Right Quarter
Net Profit Margins: Net profit margin at 9.3% during Q4 of FY11 is the best in almost 3 years
Interest cost: Interest costs rose 33.6% over year-ago figure. Still, at 2.34% of net sales, impact on profitability was least among 4 quarters of FY11
Effective Tax Rate: Proportion that firms pay towards tax out of pre-tax profits has hit a 2-year low of 23.5%

23.6% : Y-o-Y net sales growth. Demand was strong though firms passed on a part of cost hikes

Rising Prices didn’t Hit Demand
The year-on-year net sales growth was robust at 23.6% in the March quarter on the back of a high base. The year-ago quarter had recorded a 29.3% growth in sales. This indicates that rising prices did not dampen domestic consumption.
The companies continued to derive higher operational efficiency by cutting expenditure under other heads, such as employees, power and fuel. The expenditure under these heads showed a declining trend as a proportion to net sales. In other words, for every rupee spent on these items, Indian companies derived higher net sales. This was the reason behind their safeguarding, and even improving, operating profit margins in the tough scenario. As companies roll out their annual increments in the first or second quarters of FY12, this scenario could change.
Interest cost jumped 33.6% against the year-ago period and accounted for 2.34% of the sales revenue during the March quarter. Although higher year-on-year, this ratio was the lowest for FY11. The healthy sales growth seems to have taken the steam out of the rising interest cost burden. A steep 200-basis-point fall in the effective tax rate was another reason behind an improvement in the net profit margins in the March quarter. This is surprising given the government’s efforts at increasing the Minimum Alternate Tax rates and bringing down the number of tax exemptions in recent years.
However, this appears to be due to a combination of three factors — increase in the number of loss-making companies, MAT credits claimed by firms and a chunk of incremental profits coming from projects that still enjoy tax exemptions.
Analysts, however, say the last quarter of FY11 did not provide much of an indication of the challenges ahead.

TATA MOTORS: Cost Cut to Help, Volume Growth may be Tough

Tata Motors posted its highest-ever quarterly consolidated profits for the March 2011 quarter in line with the Street’s expectations. However, the signs of a slowdown have become visible with pressure on margin. On the other hand, the company has a significantly better balance sheet compared with a year ago, making it ready to face headwinds.
The company’s operating profit margins for the March ’11 quarter at 12.8% were the lowest in the four quarters of FY11 and the 27% growth in operating profit to . 4,545.9 crore was the slowest during any quarter of the year. The year-on-year growth in net profit was a paltry 18% for the quarter. However, it was due to inflated profits of the year-ago period, following a sale of investments.
The company ended FY11 with a significantly strengthened balance sheet thanks to the 3.6 times jump in annual profits and also the capital infusion. The company issued . 3,350 crore through qualified institutional placement in October 2010 and FCCB conversions added another 2.36 crore equity shares between November and March 2011. This has brought down the promoter group’s shareholding from 37% a year ago to 34.83% by end-March ’11.
As a result, the debt burden came down 6.6% through FY11 to . 32,791 crore. This was 1.7 times its consolidated equity, against 4.3 a year ago. However, considering the . 9,900-crore debt portfolio of its auto-finance subsidiary and its cash balance of . 10,948 crore, net debt-toequity stands at 0.69.
For the full year, the company achieved a 33% revenue growth to . 1,23,133 crore thanks mainly to the strong volume growth — 23% up in domestic and 70% jump in exports — while the price hikes remained just around 5% in both commercial as well as passenger car segments. A substantial jump in operating margins, reduction in interest cost and a benign increase in depreciation and tax expenses helped it clock a fantastic 261% jump in net profit to . 9,274 crore. The company faces many challenges going ahead. The macro-economic factors such as high inflation, rising interest rates and slower industrial growth have the potential to adversely impact demand for automobiles, while cost concerns continue with high commodity prices. The company will focus mainly on export growth in both commercial as well as passenger vehicle segments and continue expanding and improving its product portfolio. It appears difficult for the company to maintain its volume growth, but reduction in interest and other costs could see it improve profits in the coming quarters.

CAIRN INDIA: Going’s Good, but Stock Hit by Poor Valuation

Cairn India’s production for the March 2011 quarter dipped 7.5% on a sequential basis. Still the company was able to improve profits by 22%, thanks to higher crude oil prices. It seems well on track to ramp up its production from Rajasthan block to 175,000 barrels per day, from 125,000 barrels currently, by the second half of 2012. However, market valuation of the company suffers from the stingy valuations its owners are assigning it.
Low production levels of yearago period make y-o-y comparison irrelevant. Thanks to partial commencement of its pipeline during the year, Cairn’s average daily gross production for March 2011 quarter was 161,194 barrels, against 174,282 barrels for the December 2010 quarter and just 17,532 barrels a year ago. The net profit of . 2,457.8 crore during the March 2011 quarter was its highest ever quarterly profit.
The company is currently producing from Mangala field, while the Bhagyam and Aishwarya fields are under development. 40,000 barrels per day production from Bhagyam is expected to start in the second half of 2011, while the Aishwarya is scheduled to commence operations from mid-2012 onwards. Its enhanced oil recovery programme that started in early 2010, which is supposed to be the source of one third of its total recoverable reserves, started water injection during the December 2010 quarter.
The company has substantial funds as well as cash flows at its disposal to see through all its investment plans. It ended FY11 with a consolidated cash balance of . 4,485 crore, while the cash generated during the year stood at . 6,712 crore. This has enabled the company to reduce its debt burden.
In spite of timely execution and spurt in oil prices, the company’s share price has been stagnating. The key reason was the unattractive level at which its large shareholders are valuing it.
Cairn Energy decided to sell its controlling stake at . 405 per share, which ONGC found expensive. Malaysia’s Petronas also chose to offload its 14.9% at . 329. If these experienced petroleum companies are not willing to give any higher valuation to Cairn’s shares, it will be difficult for retail shareholders to value them any higher.

GAIL: Petrochem Boosts Nos, Subsidy Burden Weighs

India’s largest gas transporter, Gail, was at the receiving end of the government’s whims, as its March 2011 quarter subsidy burden almost tripled, pulling its profits below the year-ago level. This is unfortunate, considering the company doesn’t benefit from higher oil prices. Still the numbers were better than expected and the scrip gained 1.65% with high volumes.
Gail maintained its growth momentum in revenues with a 36% year-on-year jump for the March 2011 quarter. The petrochemical segment, which played spoilsport during the December 2010 quarter, reported a robust performance with 25% revenue growth. Similarly, revenues from natural gas trading reached a new high of . 7,153 crore. The operating profit margins fell 630 basis points to 14.5%, mainly as a result of the 2.7 times jump in subsidy burden to . 901.7 crore. A two-and-a-half times spurt in staff cost to . 275 crore was the other key reason. The natural gas trading business, which is the company’s largest revenue earner, reported a 300 basis points improvement in margins to 3.8%, which absorbed the higher costs to a certain extent. Gail’s subsidy burden for the quarter was higher compared with the average of around . 400 crore in the first three quarters. The company chose to maintain its dividend payout at . 7.5 per share, amounting to . 950-crore outgo. Gail is in the midst of . 27,000-crore expansion for which it has planned to borrow almost . 14,200 crore by FY13. The hefty cash outgoes are proving to be a drag on the company’s finances.
The company’s consolidated net profit for the year grew 20.8% to . 4,020.97 crore as its subsidiaries and JVs remain highly profitable. Revenues grew almost 30% to . 35,106.65 crore. Having fallen over 10% in the past three weeks, Gail’s scrip reacted positively to the results. The scrip now trades 13.7 times its consolidated FY11 profit, which is lower compared to its smaller peers.

India Inc’s Margins to Stay Under Pressure

Rising raw material cost, higher interest rates to make biz environment challenging, at least for the next two quarters

Indian corporates will have to weather pressure on margins for at least another couple of quarters with raw material cost, which represents the single-largest cost component, rising to a level not seen in the last three years.
Half-way through the earnings season with over 1,150 listed firms having released their quarter to March 2011 numbers, data show that 43.7 % of India Inc’s March quarter revenue was spent on buying raw material. That is higher than what local firms were spending on raw materials even at the height of the commodity cycle in the quarter to September 2008.
Interest costs, now under control, could also worry companies and investors as it could squeeze margins further. The Reserve Bank of India, which raised key policy rates over a week ago by 50 basis points, is widely expected to raise rates further to cool headline inflation, which is close to 9 %. Indian corporates will have to weather pressures on margins for at least another couple of quarters with spurt in raw material costs.
Results announced so far show that despite inflationary pressures, Indian companies have fared well during the March quarter.
The aggregate results of 1,150 companies, which exclude banks and nonbanking finance companies, indicate that operating profit margins have actually improved in the March quarter over the preceding two quarters. This is no mean feat considering the rise in raw material costs.
What is also interesting to note is that Indian companies have focused on improving efficiencies relating to other factors of production.
Broadly, they have successfully curtailed the growth in staff and other costs, which fell to their lowest level of FY11 in the March quarter, when compared to net sales.
For Indian companies — the effective rate of tax — tax as a percentage to pretax profit — dipped to a two-year low of 23% during the March quarter.
At a time when the minimum alternate tax, or MAT — the rate at which exempted businesses have to pay tax on their book profits — has gone up, this indicates that a groswing number of companies are slipping into the red. From our sample of 1,150 companies, 319 companies, or almost 28%, posted net loss in the March quarter, which was the highest for FY11.
A full picture will emerge only after the numbers of many other large companies are unveiled. The operating environment for local firms is likely to be more challenging in the next few quarters with high inflation, which could dampen consumption demand and spending, besides higher raw material and interest costs. What this means is that investors may have to gear up for margin pressures ahead.

Full Report

• Data show that 43.7 % of India Inc’s
March quarter revenue was spent on buying raw material

• Results announced so far show that despite inflationary pressures, Indian cos have fared well during the March quarter

• From our sample of 1,150 cos, 319 posted net loss in the qtr

5 Vital Signs of India Inc

ESSAR OIL: Back in Contention

Essar Oil’s earnings are likely to tick higher on completion of refinery expansion and coal-bed methane projects in FY12. For long-term investors, the party may just begin with stronger cashflows

ESSAR OIL made robust profits in fiscal 2010-11, after years of losses. Its refinery expansion programme, scheduled to be completed by end of this year, will improve margins. Output from Raniganj coal bed methane block will start a steady stream of cash flow. Long-term investors will find value growth in Essar Oil.
BUSINESS: The company runs a 14 million tonne per annum ( mtpa) petroleum refinery at Vadinar in Gujarat. It has 12 petroleum exploration blocks and five coal-bed methane blocks with estimated 10 trillion cubic feet (tcf) reserves. It runs 1,635 retail outlets and focuses on liquefied petroleum gas and compressed natural gas, besides non-fuel business. It has 50% controlling stake in a refinery in Kenya.
Essar Oil sells about 60% of its output to domestic oil marketing companies -- Indian Oil, BPCL and HPCL. It exports one-third output and sells the rest to retail consumers. The company is eligible for sales tax deferral benefit worth $1.8 billion by August 2020 and a 7-year income tax holiday under section 80-IB. The ability to collect sales tax without requiring to deposit with the government has enabled the company to post higher refining margins than the one that would be typical for its current configuration. GROWTH DRIVERS: The company's refinery expansion will be complete by end of this year. Expansion will increase capacity to 18 mtpa and raise complexity to 11.8 from 6.1. Post expansion, the company will be able to process high sulphur, heavier types of crude oil, which is cheaper, and produce euro IV/V grades of fuels that command premium. It will boost gross refining margins. The company will further raise the capacity to 20 mtpa through debottlenecking by September 2012.
The company's CBM block at Raniganj will soon begin natural gas production. Currently, at 0.35 million standard cubic metres per day (mmscmd), production is expected to rise to 3.5 mmscmd by FY14-end. The government approved a price of $5.25 per mmbtu plus a $1 per mmbtu as transportation charge for this block. At the current production level, this translates into an annualised turnover of around Rs 130 crore.Gross refining margins cycle has grown steadily after hitting a bottom in December 2009 quarter. During FY12, the GRM is expected to remain steady, if not improve. High oil prices and sales tax benefit that it enjoys will keep its GRM buoyant. Exploratory successes at its E&P blocks could be an added benefit.
FINANCIALS: Essar Oil posted a net profit of 654 crore in FY11, which was a multi-fold jump from FY10. Prior to that, the company had been making heavy losses and had to undergo the pains of debt restructuring in FY05. Weakness in refining margins cycle meant that the company had to wait for a couple of years after its refinery was commissioned to show a respectable profit figure. The company ended FY11 with debt burden of 13,472 crore, which was more than twice its net worth. However, this debt-to-equity ratio is lowest in the last 10 years. The company paid 1,214 crore -- or nearly twice net profit --as interest cost in FY11.
VALUATION: The scrip is trading at price-toearnings multiple of 30 based on profits for trailing 12 months, which is significantly higher than peers. However, Essar Oil is in a rampingup phase while all its peers are mature steady players. Essar Oil is expected to report a net profit of about 950 crore for FY12, which discounts the current market price by around 21 times. Considering the rise in profitability, thanks to expansion from FY13 onwards, the premium valuations appear justified. Long-term investors willing to wait for a couple of years will see further value growth in the scrip.
CONCERNS: The company has time and again witnessed delays in its major projects, which could be a great cause of concern.