GAIL INDIA: Co may have to Settle for a Higher Subsidy Share

Interpreting Numbers & Trends For gas behemoth Gail

Gail India’s earnings for the quarter to December look good, but only because of a benign subsidy burden booked on a provisional basis. 
This just adds to the growing list of uncertainties that the company has to face, including lack of visibility in gas volume growth and the government’s recent move to regulate marketing margins. It is hardly surprising to see the Gail stock drifting lower after the results were unveiled.
Gail’s 13% profit growth at . 1,091 crore was not a big surprise and is in line with its September quarter numbers. The 35% growth in net sales to . 11,294 crore proved to be the main driver. Other income dropped 89% to . 21.4 crore, while interest and depreciation grew in double-digits, while its effective tax rate rose to 31.7% from 28.1% last December.
What buoyed its performance was the subsidy of . 536.12 crore, which was accounted for on a provisional basis with the government yet to announce its share. When the government finally announces it, the amount could be substantially higher considering the government is cash-strapped. “For FY12, we model upstream subsidy share at 40% and, hence, major impact of subsidy will be in the March ’12 quarter as the actual subsidy in the first three quarters was based on a 33% upstream sharing assumption,” brokerage Motilal Oswal said in a report.
Gail is expected to complete a capex of nearly . 4,000 crore in FY12 and another . 9,000 crore in FY13. However, its natural gas volumes are unlikely to see much improvement. Increase in domestic production and imports are likely to be barely able to replace the dwindling KG-D6 volumes. This raises concern of under-utilisation of new pipelines in the medium term. Timely completion of its Dabhol terminal will be crucial for its volume growth. Most brokerages expect its FY13 volumes to average in the 119-123 mmscmd range from around 118 mmscmd for FY12. The government recently told the regulator, PNGRB, to determine marketing margins on natural gas sold by Indian players. If implemented, this will have a negative impact on Gail. The marketing margin of $0.24 per mmBtu contributed around 20% to Gail’s net income in the December quarter, according to a report from HSBC Global Research. 

KEY POINTS The subsidy booked on provisional basis is 536 cr Capex of 4,000 crore (FY12) and 9,000 crore in (FY13) unlikely to lift production much Regulator PNGRB determining the marketing margins to hit margins

CAIRN INDIA: Co Gains in Situations where Peers Struggle

Exploration company Cairn India’s December quarter numbers were better than expected as improved realisations made up for the higher royalty burden. The company’s net sales as well as production volumes stagnated compared to the year-ago period. However, higher other income, gains on rupee depreciation and fall in interest costs pushed up its profits. It is set to achieve a jump of 40% in production by March-end.
Cairn’s net realisations improved 32% to $98.4 per barrel in the December quarter, even as total production fell 1.3% to 98,969 barrels of oil equivalent per day (boepd). However, this did not help it achieve any sales growth due to the additional burden of royalty and profit petroleum. The company paid a royalty of . 628.5 crore and . 573 crore of profit petroleum towards the Rajasthan block.
Unique conditions in the December quarter, which impacted Reliance Industries’ numbers, actually helped Cairn India. The December quarter saw a price differential between heavy and light crude oil grades falling to record levels due to weak naphtha and strong fuel oil prices. This sharply pulled up RIL’s refining margins and helped Cairn price its crude a little higher. As against a typical 10-15% discount to Brent, Cairn’s oil was sold at a discount of 8.3% during the December quarter. Although flat at the revenue level, the company gained from a three-fold jump in other income to . 112.4 crore and a twothird fall in interest cost to . 24 crore. Both these factors and a forex gain of . 301 crore helped it post a 13% growth in net profit at . 2,262 crore.
The company continues to remain debt-free with an ever growing cash pile which is $1.2 billion over and above its debt. Recently, it commenced production from the Bhagyam field in the Rajasthan block, which has an approved production limit of 40,000 barrels per day. With this, the company is in a position to move significantly close to its target production of 175,000 barrels per day by March-end, which will be a gain of 40% on its current production level.
At a time when the entire Indian petroleum industry is grappling with a number of problems — under-recoveries for the oil marketing companies, subsidy burden for public sector producers and low margins for standalone refiners — Cairn India remains the only company that is benefiting from the market conditions now. The Cairn stock is already at the level of the Vedanta Group’s acquisition price of . 355 and is currently trading at a price-to-earnings multiple (P/E) of 8.4, which is comparable with its peers ONGC and Oil India. 

RELIANCE INDUSTRIES QUARTER SHOW

Tough Days ahead, but RIL can Count on its Strong Books

Sharp fall in profit reflects a trend of slow growth for the petrochem major, signalling bad days for shareholders

After seven consecutive quarters, the quarterly profit of Reliance Industries fell below the $1-billion mark after a 13.6% drop it reported in net profit at . 4,440 crore for the quarter to December 2011.
That RIL would report disappointing numbers was a given, but what surprised the Street was the sharp slide in profits. In the near term, what may prop up the stock could be the announcement of a buyback of shares.
The numbers that the refiner had reported in earlier quarters had reflected a trend of slowing growth, with the bottomline being supported, thanks to non-business or other income. Margin pressures accentuated in the December ’11 quarter in its two main businesses — petroleum refining and petrochemicals due to moderation in demand.
The petro-refining segment was the worst performer, with gross-refining margins at $6.8 per barrel — the lowest in two years. The segment’s profit margins more than halved to 2.2% and pre-interest-and-tax profit or PBIT dropped 30.8% to . 1,685 crore.
The oil & gas segment was the second-worst performer reporting a drop of 14% in profits, but that was due to a 32.2% fall in revenues due to a decline in production and a 30% stake sale to BP.
The petrochemicals segment’s profits fell least 11.2% to . 2,157 crore. However, the fall was restricted mainly due to the 23.9% jump in revenues as margins were down 430 basis points.
Other income contributed close to 30% of RIL’s pre-tax profit in the December quarter. This marked a new high in terms of the contribution of non-business income to the company’s profits in over a decade, if one excludes occasional extraordinary gains.
Viewed against this backdrop, the buyback announcement from the company could not have come at a more appropriate time. Firstly, the company is flush with cash — . 74,539 crore at end December 2011.
Secondly, the stock has underperformed the market over the past one year and would have continued to do so in the light of the latest results. Lastly, the outlook for the coming quarters hardly appears promising.
It is one thing that RIL’s December quarter numbers were bad. But the worry is that it could also signal a below-par show in the coming quarters, which could be bad news for its shareholders.
The company benefits from its world-class scale of operations, but at its core, remains a commodity business, which is susceptible to economic cycles. The company’s extra-strong balance sheet will surely be its biggest asset as it negotiates global economic pressures.

RIL Earnings to Feel the Margin Pressure

Refiner may report a fall in Q3 profit, but interest income to support bottomline

  Reliance Industries’ December ’11 quarter numbers are likely to be dismal, following a pressure on refining and petrochemical margins and weakness in KG basin gas volumes. This will be its first time in the past two quarters to show a fall in profit. A spurt in its other income could be the only positive factor in its earnings.
RIL’s all three major business segments will face a fall in profit for the December ’11 quarter, according to analyst estimates. The petroleum refining business, which brings in over two-third of its revenues, will see gross refining between $7 and $8 per barrel — substantially lower to $10.2 of the first half of FY12.
The demand for petrochemical industry has remained under pressure due to slowing economic growth throughout the December ’11 quarter. This is likely to impact RIL’s second-largest business segment, which contributes more than a fifth of the behemoth’s topline.
The company’s gas production from KG D6 basin has been on a steady fall after briefly touching 80 MMSCMD in December 2009. The production is likely to have averaged 41-42 MMSCMD for the December ’11 quarter. Further, the 30% stake sale to BP would reduce RIL’s contribution from the gas sale.
However, this time, its sagging earnings will have support from a new fourth segment — other income. After the BP deal, RIL is sitting on a cash pile in excess of . 75,000 crore, interest income on which could prove a significant support to the bottomline.
At the aggregate level, the company’s profits are likely to be down 5-12% from the year-ago level of . 5,136 crore. Whereas, net revenues are expected to show a growth of 19-33% over . 59,789 crore of December 2010. RIL’s cash pile continues to bulge, which is a good thing for its balance sheet. However, analyst community remains concerned about its potential use. “Cash flow is greater than capex, and a significant part of incremental cash flows are being driven to non-core businesses, which in our view are return dilutive,” mentioned a Morgan Stanley research report that downgraded RIL to ‘underweight.’

ESSAR OIL: Guj Sales Tax Demand of . 6,300 cr Deepens Woes

Just when things were appearing to get under control, Essar Oil’s applecart has received a rude shock. The Supreme Court upholding Gujarat State government’s demand for sales tax will necessitate the company to pay . 6,300 crore — something it can hardly afford with a stressed out balance sheet.
Essar Oil already is burdened with . 21,290 crore of debt, which is 3.1 times its equity at end-September 2011. Several years of delay — the refinery was initially planned in 1999, but became operational only in May 2008 — resulted in cost overruns. The company’s annual capex has always been higher than its cash generated from operations necessitating to borrow continuously.
However, things had started looking better for the company with its phase-I refinery expansion nearing completion and CBM block in Raniganj commencing production. Both these factors will not only boost its turnover, but also margins and improve cash generating capacity of the business.
The numbers Essar Oil published for the past three years since the refinery commissioned appeared promising. In the past four quarters, its gross-refining margin stood consistently above $7 per barrel — second best in the country to RIL.
This optimistic scenario had prompted a number of broking houses to upgrade the company. A research report from Citigroup Global Markets at end-September 2011 had mentioned, “We upgrade Essar Oil to ‘Buy’ from ‘Hold’ as its 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. Besides a nearly 30% increase in capacity, 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.”
However, the higher refinery margins — something untypical for its refinery configuration — were mainly due to its ability to collect sales tax without requiring to deposit with the government. On the other hand, interest burden and forex losses impacted the company’s bottomline in a big way.
It is not clear how the company will be able to repay . 6,300 crore. Borrowing more would be even more costly and asset sale, if any, may not materialise in a short time. Its plan to file a review petition may do little more than gaining time. Due to the inordinate delay in commissioning of its project, Essar Oil has also missed on an important commodity cycle of 2007-08 when the refinery margins had shot through the roof. Essar’s expansion will now come up at a time when the global economic growth is weakening and the refining industry globally is gearing up for a downtrend. It is going to take a while for the company to shake off the effects of these new woes. 

Payment Delays, Slowdown in Core Business Prove a Drag on Sintex

Infra entry, plan for 300-MW power plant add to working capital burden

Plastic goods maker Sintex’s December ’11 quarter results were dismal in line with market expectations. However, it wasn’t the forex loss that had impacted its September ’11 quarter numbers. The company is facing a slowdown in its core businesses while a delay in government payments has put pressure on working capital.
In the September ’11 quarter, a . 60-crore writeoff towards the forex loss had pulled the company’s profits lower. However, for the December quarter, it changed its accounting policy to amortise the forex loss over the balance period of the loan. This enabled it to write back . 13.5 crore of the amount as a one-time gain.
In spite of this extraordinary gain, the company posted a 27.6% fall in profits for the quarter that came from a slowdown in its monolithics business which saw a 24% fall in revenues and 200 bps weakness in margins.
The company’s custommoulding business also faced a lower capacity utilisation in the US and Europe due to the economic slowdown. Still, the segment was able to post a 13% growth in revenues for the quarter, but this was with reduced margins. “Custom-moulding margin in the overseas subsidiary was down by around 320 bps QoQ while the domestic business margin decreased by 150 bps QoQ,” mentioned a Nomura research report. Pre-fabricated building materials and textiles were the only segment to continue doing well. “Pre-fab business continues to be robust with a 13% YoY growth while textile revenues were steady, with margins expanding around 200 bps YoY,” said a research report by JP Morgan. The company’s entry into the infrastructure space and bagging a . 1,300-crore order to set up 300-MW power plant appear to be a diversification at a wrong time. The company’s main business is already burdened with high working capital and the additional capex needed for this project means it will have to go slow on expansions in its main business.
The company clarified that clearance delays, site allocation and receivables in government contracts were temporary. And the next quarter onwards, things will be back to normal. However,the company remains exposed to the risks of deteriorating working capital, exposure to non-related capital-intensive projects and a further slowdown in Europe, the US and even Indian markets.

CRUDE OIL: Tension over Strait of Hormuz to Hurt India

Tensions over Iran have started escalating of late, which prop up global crude oil prices in an otherwise weak economic scenario, globally. As sanctions over OPEC’s second-largest oil exporter Iran tighten, how the Islamic Republic reacts will have a great impact on oil prices in 2012.
Annoyed over Iran’s continuing defiance in pursuit of its nuclear ambitions, the US had imposed growing number of economic sanctions on Iran. And more countries are following suit.
The US raised the sanctions one notch higher end-December by passing a law that would ban any institutions that deal with Iran’s central bank to do business with the US financial system. Since Iran’s central bank processes all oil payments, this measure will make it impossible for any country to buy crude oil from Iran. However, as the buyers of Iranian crude oil include the European Union, India, China and Japan, the US is going slow on the implementation of the law. However, the US demand that the buyers should progressively reduce their imports. The EU, which buys nearly onefifth of Iranian crude oil, is also working on imposing an oil embargo on the country. The foreign ministers of EU countries will be meeting on January 23 to discuss this. EU may further adopt the US stance to block any dealings with Iran’s central bank.
Last week, Japan also officially agreed to reduce its imports from Iran in a phased manner. Japan makes for around 13% of Iran’s oil exports. Chinese imports data revealed that its imports from Iran would halve for the first two months of 2012. The country is also exploring tie-ups with Saudi Arabia, which are seen as its efforts at diversifying oil imports. India, which is exploring ways of routing its payments to Iran, is unlikely to join the bandwagon unless the UN approves of the sanctions. The noose is tightening and Iran is bound to feel the pinch sooner or later. Crude oil makes up for over 80% of Iran’s exports and over one-fifth of its GDP. How it chooses to react will be a crucial question for global energy markets. Iran’s control over the narrow strip of water connecting the Persian Gulf with the Arabian Sea, known as the Strait of Hormuz, puts it in a dangerous situation.
Nearly one-fifth of global oil and one-third of LNG trade pass through the Strait, which makes it strategically important. Iran has, time and again, threatened to block this waterway in a bid to counter the US sanctions. Iran gets more and more isolated, it may very well be tempted to act upon its rhetoric. Although experts have called such an eventuality as ‘economic suicide for Iran’, it will have dangerous repercussions for global energy markets — oil prices could shoot past $200 per barrel. Iran may be in no position to face US navy positioned to protect the passage, but it’s very much capable of carrying out a sabotage. Admiral Habibollah Sayari, the head of Iran’s navy, recently boasted that closing the Strait would be “as easy as drinking a glass of water.”
India remains a mere spectator in this high-profile sabre-rattling. However, it could end up paying a particularly high price — with its heavy dependency on imported oil, huge petroleum subsidies and a widening trade deficit — if the tensions were to escalate. 

Lead Story: SEIZE THE OPPORTUNITY

The New Year has not given retail investors much to cheer about. A bouncy pitch to bat on coupled with a cloudy climate have made life difficult for most. Worse, things are unlikely to improve in a hurry. It makes sense therefore to play with a straight bat and preserve your wicket. And if you hang in, the boundary balls will come. In the current stock market scenario, delisting offers are those boundary balls you need to cash in on to keep the returns flowing, says the ET Intelligence Group

etail equity investors are in a difficult situation. The Indian stock market, in a downtrend for more than a year, has lost over 25% and figures among the world’s worst performers. The bad news is far from over though. Apart from macroeconomic troubles like the slowing economic growth and mounting budget deficit, a sharp depreciation in the rupee over last three months has opened up another avenue of woes for Corporate India. Analysts are already sceptical about India Inc’s performance in the second half of FY12.
These uncertain times call for retail investors to adopt defensive strategies. It is important to focus more on avoiding capital erosion now, rather than looking at spectacular returns. Investors should look for potential delisting candidates - fundamentally strong scrips that won’t fall too much in a weak market, but offer potential for opportunistic gains. Some recent examples demonstrate how investors stand to gain even in times of economic uncertainty when companies decide to buy back their own shares in a bid to voluntarily delist. UTV Software, Alfa Laval, Carol Info, Patni Computers and Ineos ABS have all generated hefty returns for longterm investors defying the overall market weakness in the second half of 2011. 

IS IT POSSIBLE TO PREDICT DELISTING CANDIDATES? Delisting shares from the stock exchanges is a unique decision in a company’s life. And it is almost impossible to forecast. These decisions depend greatly on the owners and management and their way of thinking. At least, one can’t predict the timing of a delisting offer.
We at the ET Intelligence Group have therefore put together a group of companies with certain common parameters that make them more likely to opt for delisting than others. These are MNC associates with parent companies operating overseas. Secondly, and most importantly, the promoters hold more than 80% in the Indian arms. Thirdly, they don’t need to raise capital in India. Or, in other words, being listed in India doesn’t serve them much purpose.
With market regulator Sebi or the Securities and Exchange Board of India mandating that all listed companies have to increase public shareholding to a minimum 25% by June 2013, these companies have to take a conscious call sooner or later on whether to reduce promoter holding or go for delisting. 

WHY MNCS ARE MORE LIKELY TO DELIST Compared to domestic companies MNC associates in India are more likely to choose to delist when faced with the dilemma of whether to dilute promoter stake to meet local regulations or delist. Most of these companies were listed in India not due to a need to raise capital, but more to meet the then prevailing FDI norms. For such companies complying with the cumbersome and timeconsuming rules and regulations of Sebi and the stock exchanges makes little sense. Be it fund raising or M&As, any major decision takes substantial time for a listed company compared to an unlisted one. Finally, the current depressed market conditions offer an ideal opportunity to delist.
This is not to say MNCs are the only delisting candidates. In fact, over a period of time a number of unexpected Indian companies such as Nirma and Binani Cements have gone ahead with delisting processes. In a number of cases, acquisition by a foreign player has proved a prelude to delisting. For example, Sparsh BPO. However, MNCs are the more predictable candidates. 

ONGOING OFFERS A number of companies have already begun the process of voluntarily delisting their shares from Indian stock exchanges. In most cases ETIG analysts recommend that the shareholders should avail of the attractive prices and tender their shares in the open offer. After all, a retail shareholder won’t have much use for shares in a company once it delists. At the same time, the profits booked here can be invested in other avenues.
If one does not already hold shares in these companies, buying right now, however, may not be a correct strategy. It is true that the shares can still generate some 5-10% return by the time delisting takes place. However, the risks involved that don’t justify buying now. If the delisting offer fails due to any reason, the stocks could correct heavily. 

How does a delisting offer work? The process of voluntary delisting begins when promoters of a company inform it of their intention to buy all outstanding shares and delist the company. The board of directors approve the same and inform the stock exchanges. Subsequently, the shareholders, excluding the promoters, have to approve the delisting process with a two-third majority. Once the approvals are in place, the delisting process takes place in a reverse book building format. Under this the shareholders convey the price at which they are willing to sell their shares to the company. For this purpose, the company sets a ‘floor price’ in accordance with Sebi rules, above which the bidding takes place. In a number of cases, companies voluntarily offer a higher price to draw investor interest. This is called ‘indicative offer price’. However, the shareholders are free to bid at whatever price is reasonable according to them. To successfully delist the shares, the promoters need to acquire at least 50% of the outstanding shares and take their holding beyond 90% of the paidup capital. Once the shareholders submit their bids, the company finds the price point at which the requisite number of shares can be acquired. This is called the ‘discovered price’. Finally, it is the prerogative of the promoters whether to accept the discovered price. There have been instances where aggressive bidding by retail shareholders has taken the discovered price beyond the promoters’ acceptance limit. As a result the delisting failed. It is impossible to predict what the promoters will accept finally. In several cases, the promoters have given a substantial premium over the floor price to make the delisting offer successful. If the promoters accept the ‘discovered price’, or the delisting offer succeeds, the same price becomes applicable to all shareholders tendering their shares. This is followed by cessation of trading for the scrip on bourses. The company has to offer the same price to any shares tendered to it up to one year after the delisting date.

Akzo Nobel will Find it Difficult to Settle for a Palatable Deal

Serious issues of corp governance seen linked to merger deal

The stock of paint maker Akzo Nobel gained 10% on Thursday on news that opposition by minority shareholders could stall the proposed merger of the listed firm with three unlisted group companies. The rise has also been fuelled by indications that Akzo Nobel was planning to mop up shares from the market through a creeping acquisition. The stock had earlier fallen nearly 15% on the earnings dilutive merger proposal.
The Netherlands-based paint and specialty chemicals company has had a presence in India through its several unlisted subsidiaries. However, its acquisition of ICI in 2007-08 led to it controlling the promoter’s stake in the listed entity in India.
Even for someone who is not a finance whiz, it is clear that the acquisition of the three unlisted companies was being proposed at an unfairly high valuation. Since the aggregate net profit of these three companies was just Rs 24.7 crore, it worked out to a price-toearnings multiple of between 30 and 40 — which even the listed company has never commanded. Also, the consolidated net profit margin of the unlisted companies was merely 4.4% in FY11 compared to 14% for the listed company.
At the time of announcing this merger, the company also agreed to pay a royalty to the parent company at 1% of net sales, which will go up to 3% in the future. This would be a charge of close to 5-15% on the pre-tax profits of the company in the next few years. However, the exact benefits of this arrangement are not known. Both these developments raise serious concerns relating to corporate governance standards of the company.
Akzo Nobel has grown through a series of acquisitions over the past 3-4 years in various parts of the world. Last week, it completed the acquisition of a Chinese company — Boxing Oleochemicals — and then announced that it was acquiring the residual shares of Italian company Metlac, in which it owned a stake through ICI’s acquisition.
Whether the company will unveil an offer to buyback shares or delist its Indian arm is a matter of speculation. However, that may not be easy.
For one, a large chunk — 23.8% of the equity — is controlled by local institutional investors who appear to be in no mood to accept such an arrangement.
Secondly, its rival Asian Paints holds nearly 5.5% of this. It will be a tough task negotiating with these investors to settle for a deal that is palatable to everyone.

AGROCHEMICAL INDUSTRY: Firms with Overseas Exposure to Do Well as High Costs Hit Local Cos

The decline in food grain prices over the past three months has impacted agri input demand negatively and is likely to put pressure on the December 2011 quarter results of India’s agrochemical companies.
With the rupee weakening over 20% during the quarter, the cost pressure on India-focused firms is expected to be higher. Companies with an overseas exposure will, however, continue to do well.
Prices of a number of agrocommodities have fallen considerably in the past three months of 2011. Prices of vegetables, tomatoes, onions and potatoes fell between 23% and 63%, as reflected in their wholesale price index numbers.
This fall in prices comes at a time when the weather conditions have turned unfavourable and pest pressures are low. As a result, the profitability of farmers during the Rabi season was impacted, reducing demand for agri inputs.
In the past four years, the domestic agrochemicals industry has witnessed a healthy and steady growth, posting a compounded annual growth rate (CAGR) of 12.4% in topline and 19.1% in bottomline, driven by improved farmer profitability. This in turn has lead to strong agrochemicals demand.
For local agrochemical firms, the high cost of crude oil and the recent weakening of rupee have further added to cost pressures. In a low demand scenario, companies are reluctant to raise prices to pass on the burden. All these factors are set to dampen the performance of agrochemical companies in the quarter to December 2011.
The markets have taken a note of all this with most local agrochemical companies — Bayer CropScience, Dhanuka Agritech, Excel Crop Care, Meghmani Organics, Nagarjuna Agrichem, PI Industries and Rallis India — losing between 11% and 30% of their worth in the past three months, while the BSE Sensex lost 4.5% and BSE Mid Cap Index lost 11.7%. Insecticides India and United Phosphorous were the exceptions, gaining close to 2-3% each.
While domestic market conditions remain challenging, Indian agrochemical companies with an overseas exposure like United Phosphorus are expected to continue to do well. United Phosphorus draws more than half of its overall revenues from the overseas markets. For the past five years, the company traded at an average price-toearnings ratio of 17.3. However, it is now trading at 12.4. 

ONGC: Co’s Capex Plans, Dividend Yield Support Stock

ONGC’s inexpensive valuations, a likely improvement in earnings from rupee depreciation and reduced royalty burden in the Rajasthan block make it an ideal candidate for investment

 ONGC continues to remain a healthy investment candidate for the long-term given its inexpensive valuation and likely improvement in earnings from rupee depreciation and reduced royalty burden in Rajasthan block. If the first half of FY12 was any indication, the company’s subsidy burden, is likely to remain low. Its heavy capex plans, besides the dividend yield of 3.4%, protect its stock price from downside risks. ONGC’s subsidy burden, which stayed at 27-28% of the total industry’s under-recoveries, spiked suddenly to 31.5% in FY11. However, in the first half of FY12, the burden has again fallen to 27.3%. This has allowed the company to earn a part of the benefit of rising oil prices. The company’s net realised price of crude oil stood at $66.52 a barrel for the first half of FY12, around 19.4% higher than corresponding period of last year, making it one of the best periods for ONGC.
The production from Mangala field in Rajasthan has enabled ONGC to show a marginal improvement in its domestic crude oil production after years of stagnation. The oil production for the first half of FY12 was up 1.1% at 13.6 million tonne (MT). The production had come down from 27.94 MT in FY08 to 26.58 MT in FY10, which inched up to 27.26 MT in FY11.
The production of ONGC’s wholly-owned subsidiary ONGC Videsh (OVL) is also scaling up in spite of the problems faced by its subsidiary Imperial Energy in Russia. OVL has nine producing assets apart from three development blocks, two discovery blocks and 18 exploration blocks across seven countries. Its production grew 6.5% in FY11 to 9.44 MT of oil equivalent. Its net profit too jumped 29% to 2,691 crore for FY11. Three more blocks — A1 and A3 in Myanmar and Carabobo in Venezuela — are expected to start production in 2013. ONGC is implementing a number of projects to improve oil production from its current fields that will be completed in 2012 and 2013. In addition, it is also working on a number of new blocks. Its capex plan envisages spending 31,150 crore on revamping and modernising existing fields and infrastructure, with additional 24,500 crore on developing new fields.
In the past five years the company has consistently maintained a reserve replacement ratio above 1. In other words, its recoverable reserves are growing faster than its current production level. This gives visibility to its future growth.
ONGC’s joint ventures are set to complete two mega-projects in downstream industries in 2012 - aromatics complex at Mangalore and a 725 MW gas-based power plant at Tripura. In 2013, its 1.4 million tonne petrochemical complex in Dahej under ONGC Petro-additions (OPaL) will be commissioned. 

FINANCIALS In the first half of FY12, ONGC’s net profit grew 40.7% to 12,737 crore on a benign subsidy burden. The company remains cash rich with bank balance exceeding 27,440 crore by end September 2011. Although reducing over the past few years, ONGC’s return on employed capital (RoCE) remained above 25% for FY11. 

VALUATIONS ONGC is currently trading at a P/E around 10 on a standalone basis. Adjusting for OVL’s numbers, the valuation stands at 8.6. Its peers Cairn India and Oil India are trading at P/E of 6.5 and 8.1, respectively. Still, ONGC’s dividend yield is highest among the lot at 3.4%. 

CONCERNS Rising under-recoveries in the petroleum sector poses a risk to ONGC’s burden of subsidy particularly because the government continues to defer from making this a formula-based transparent system. The company’s long-awaited FPO also has had a lasting depressing impact on the scrip’s movement. This may continue to linger on for a while.

The company’s recoverable reserves are growing faster than its current production level. This gives visibility to its future growth

PETROLEUM: Upstream Oil Producers to Gain, OMCs may Reel

For India’s petroleum industry, the performance in the quarter to December could well be a mixed bag. Upstream oil producers will benefit from high crude oil prices coupled with a weak rupee.
Pressure on refining margins will spoil the show for midstream refiners. The performance of downstream marketers will hinge on whether and how much the government compensates them for selling fuel below cost. The natural gas industry is expected to continue its steady pace as domestic availability of gas remains tight.
The upstream oil majors — ONGC, Oil India and Cairn India — will see higher realisations as the average rupee-dollar rate was 50.88 for the December 2011 quarter, down 13.5% compared with the yearago period. ONGC and Oil India will have to face uncertainties related to subsidy sharing, but are still likely to emerge as winners. The one-time income of . 2,500 crore on recovery of royalty on the Rajasthan fields will also boost ONGC’s numbers.
The performance of standalone refiners such as MRPL and Chennai Petroleum, including private sector players such as Reliance Industries and Essar Oil, will be under pressure due to lower gross refining margins, or GRM. During the December 2011 quarter, Reuters’ Singapore benchmark GRM dipped to its lowest in FY12 at $7.9 per barrel. Reliance Industries, in particular, is likely to see a sizeable margin erosion due to a fall in the light-heavy crude price differential. Essar Oil is expected to post another quarterly loss on adverse foreign exchange movement.
As retail prices remain below cost, the three oil marketing companies — Indian Oil, BPCL and HPCL — are likely to post under-recoveries in excess of . 30,000 crore for the December 2011 quarter. In view of the state of government finances, we expect only the minimum compensation to be given in FY12. This may, however, prop up OMCs’ earnings in Q3.
India’s natural gas industry is unlikely to see any significant positives with gas volumes staying more or less stagnant. Gail’s performance will depend on its ability to combat margin pressure in the petrochemicals business, as well as its subsidy burden. Petronet LNG is expected to do better compared to transporters such as Gujarat Gas, GSPL or Indraprastha Gas.