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.