ADVANTA INDIA: New Products and New Markets to Bear Fruit for Co

Advanta India is making a slow, but steady comeback from a woeful time in 2010. It has closed 2011 with a profit and is looking forward to a significantly better 2012 with the introduction of new products and entry into new geographies. Although slightly risky, the company is likely to prove to be a worthwhile investment for long-term investors. 

BUSINESS Advanta is India's largest seeds company headquartered in Hyderabad. It has operations across the world. Australia contributes nearly 25% to its revenues, followed by Argentina (23%), Thailand (16%), US (15%) and India (14%) with the rest of the world making up for the remaining 7%.
In terms of products, sorghum contributes 35% of its revenues followed by corn (20%), sunflower (12%), canola (11%), vegetables (8%) and others making up for the balance 14%. The company faced a tough time in 2009 and 2010, posting a net loss of 30 crore in 2010. It turned things around with a strong spurt in net profit in the June 2011 quarter. Since then its performance has been robust. 

GROWTH DRIVERS The company has launched new products regularly. In the last 1-2 years, it has launched hybrid canola in Australia based on its proprietary technology, hybrid corn and sweet corn varieties in Indonesia, and genetically modified (GM) corn in Brazil, which will benefit it in 2012. It is also gearing up to enter the European market with sunflower seeds in 2012 apart from strengthening product portfolios in other geographies. Two of its high-profile research programmes — wheat breeding in Australia and development of high stearic, high oleic sunflower in Argentina — have recently seen the launch of its first commercial products. The company had invested nearly Rs 120 crore over the last four years in these projects. 

FINANCIALS In 2011, the company reported a net profit of 12.3 crore against a net loss last year, while the revenues were up 40% at 911.8 crore. Its December quarter ended in a net loss due to forex losses. Its debt-equity ratio stood at 1.4 at end December 2011. The debt mostly represents working capital. 

VALUATIONS Based on profits for the trailing 12 months, the company is being valued at 52.7 times. However, last year it had two loss-making quarters, which are not likely to be repeated again. Excluding these two quarters, the P/E comes to 21.6, which is reasonable for a high-growth company.

Budget Analysis: Follow-up Action on Cess to Decide Oil Industry’s Fate

The 2012-13 Budget has brought some bad news and also hope for some good news for India’s petroleum industry. The provision to raise cess on oil producers is clearly a negative for the industry. But the Budget does raise hopes of some long-term solution to the problem of under-recoveries and subsidies. How the government follows this up with firm action will decide the industry’s fate in 2012-13.
The increase in cess on oil produced from . 2,500 per tonne ($6.8 per barrel) to . 4,500 ($12.3 per barrel) is a body blow to the oil producers like ONGC, Oil India and Cairn India. ONGC, which alone produces 24.5 million tonnes of oil annually, is going to see its annual cess expenditure go up by . 4,600 crore. Oil India, which is nearing 4 million tonnes in annual crude oil production, will take a hit of . 700 crore. The Cairn-ONGC joint venture, which has been producing around 6.4 million tonnes per annum from the Rajasthan block, targets to reach 9-MTPA level by end-March. The increase in cess will add a burden of . 1,700 crore for the JV.
ONGC expects its crude oil production to move up from the current 27.3 million tonnes to 28.75 million tonnes in FY13 and 32 million tonnes in FY14. The Cairn-ONGC JV is expecting the production to touch 12.3 MTPA by end-2013. Higher cess payments will reduce the attractiveness of these production jumps. A number of brokerage houses have gone ahead and de-rated these companies. “We believe the increase in cess (keeping all the other variables constant) is likely to impact the upstream companies significantly with downward revision of over 10% in earnings for FY13E and FY14E,” mentioned a report by Centrum Capital, adding further, “We thus downgrade ONGC, OIL and Cairn from ‘Buy’ to ‘Hold’.”
“Driven by a significant impact on EPS due to cess revision, we are downgrading Cairn India from ‘Hold’ to ‘Reduce’. we are downgrading ONGC to ‘Hold’ from ‘Accumulate’. Similarly, we are revising our target price downwards for Oil India to . 1,218 per share from . 1,325, maintaining ‘Hold’ rating,” wrote IDBI Capital.
The Budget has also been gung-ho about cutting subsidy burden and reigning in fiscal deficit. The oil subsidy provision for FY13 at . 43,580 crore is 36% below the FY12 number. However, a major chunk of this provision will be used for the January-March 2012 quarter, leaving little for the next year.
“We note that in the Budget for FY12, the government had budgeted . 23,000 crore for oil subsidy, of which . 20,000 crore was a carry forward of its share for Q4FY11. Similarly, of the . 43,580 crore budgeted for FY13, we expect . 40,000 crore to be compensation for government’s share carried forward into FY13,” mentioned a report by Edelweiss.
Considering the . 45,000 crore already borne by the government for the first three quarters, this means the government’s share to touch . 85,000 crore for the whole FY12. When the total under-recoveries are expected to cross . 138,000 crore, the government’s total share will amount to 62% of the total. This will restrict the upstream companies’ burden at . 50,000-55,000 crore and that of retailing companies to a negligible level. Also, this will be necessary to ensure none of the oil marketing companies end the year in losses. This is a good news for companies for the year ending March 2012 which, however, will leave little subsidy provision for FY13. Lack of provisioning will imply a price hike.
“Based on our estimates, the budgeted oil subsidy of . 43,580 crore assumes increase in retail prices during FY13. If prices are not increased, it assumes international oil prices averaging $97 per barrel,” mentioned BRICS Securities in its Budget impact update report.
The oil marketing companies are losing around . 13.1 per litre on diesel sale, . 28.7 per litre on kerosene and . 439.50 per cylinder of LPG apart from over . 5.1 per litre on petrol. The total daily losses for the OMCs have risen to . 486 crore. If the industry was not investorfriendly pre-Budget, the situation has worsened post-Budget. While there is a visible negative impact on oil producers, the positive, if any, for retailers will take time to emerge as the government continues to seek support for fuel price hike. The economic fortunes of the entire industry continues to depend on the political mathematics in New Delhi.

BHARAT PETROLEUM: Govt’s Subsidy Policy Hits Fuel Retailing Major

With its profits at the mercy of the government, one cannot really evaluate BPCL on earnings. But the growing value of its assets highlights the success of its exploration portfolio. Long-term investors would do well to buy in

    Bharat Petroleum has lost control over its quarterly and annual profits, which are solely at the discretion of the government’s subsidy policy. However, the value of its assets is growing thanks to its successful portfolio of exploration assets. Long-term investors can ignore the current fluctuations in BPCL’s profitability and buy the scrip. 

CURRENT SCENARIO BPCL’s primary business of fuel retailing has been suffering from the government’s subsidy policies. It has to sell petro products below cost, but the extent and timing of reimbursement of the under-recoveries remain uncertain.
As a result it no longer has control over its quarterly and annual profits, which go up suddenly in one period and plunge in another. Secondly, its working capital needs have gone up necessitating heavy borrowings that impact its balance sheet health and put an additional burden on its profits.
While the government has been tinkering with its fuel subsidy policies from time to time, it has largely avoided any structured solution to the problem for years and we don’t expect it to change in the near future. 

GROWTH DRIVERS BPCL has stakes in 27 petroleum exploration blocks — 9 in India and 18 overseas — through its wholly owned subsidiary Bharat Petro Resources. Over the last few years BPCL has been very successful in its exploration with 13 discoveries — 3 in Brazil, 9 in Mozambique and one in Indonesia.
The nine discoveries in the Rovuma block in Mozambique hold an estimated 15-30 trillion cubic feet of recoverable natural gas reserves and have substantially increased the value of this asset. This was validated in the ongoing acquisition deal of London-listed Cove Energy, which holds 8.5% stake in the block. Royal Dutch Shell valued the firm at above $1.6 billion. With this benchmark, BPCL’s 10% stake in the same block alone is worth onethird of BPCL’s current market capitalisation of 24,240 crore.
The testing and certification processes are under way, still the consortium developing the field has already planned an LNG export plant to commence sales by 2017. BPCL’s exploration assets in Brazil also hold great promise. The Wahoo discoveries in the Campos basin hold estimated recoverable oil reserves of 150-200 million barrels. First production is expected in 2017.
Bharat Oman Refinery (BORL), a joint venture of BPCL and the Oman Oil Company with a refining capacity of 6 million tonne per annum, was commissioned in June 2011. BPCL holds a 49% stake in the company with Oman Oil holding 26%. The BPCL management has mentioned several times its intent to float a public issue for BORL. 

FINANCIALS In the first three quarters of FY12, BPCL has made a net loss of 2,651.6 crore against a small profit in same period of last year. Delayed reimbursements from the government have necessitated heavy borrowings, which have resulted in a debt-to-equity ratio of 1.6 at the end of September 2011. In the first three quarters, the interest cost jumped 66% to 1,305.5 crore. 

VALUATIONS BPCL needs to be valued on its assets rather than earnings, which are not under its control. The scrip is currently trading at 1.6 times its book value at the end of September 2011. However, this doesn’t capture the market value of its assets. With the Mozambique stake worth onethird BPCL’s market-cap and its investments in other listed companies making up another 14%, its core business and other assets are valued at a price-to-book value of just 0.8. This undemanding valuation means the downside is protected and gains can be expected in line with the progress in the overseas exploration projects. 

Vital STATISTICS 1-Year Return (%) 17.12 Price to Book Value 1.72 Market Cap ( Cr) 24,121.95 Dividend Yield (%) 2.1

PETROLEUM REFINING: Costlier Crude, Weak Demand to Trim Margins

Indian petroleum refiners have mostly underperformed the broader market in 2012 so far — which may continue for some time as well — since the global refining industry outlook continues to be poor. Persistent weak demand for petro products, while crude oil prices move up, is squeezing the margins of the refining industry globally.
“Product market sentiment turned bearish in February, following disappointing demand for middle distillates due to weak economy and mild winter in the northern hemisphere. The continued recovery at the top of the barrel was outweighed by the increase in crude prices, causing refinery margins to fall,” mentioned OPEC’s monthly report of March 2012.
The widely tracked Singapore GRM had gained in January mainly on the news of Europe’s largest standalone refiner PetroPlus filing for bankruptcy and closing several of its units. It crossed $10 per barrel mark in early February, but fell to $6 per barrel owing to weakness in fuel oil, diesel and gasoline spreads. The situation is likely to worsen from hereon as more refining capacity is getting added globally. India Infoline wrote refining margins will continue to remain weak throughout 2012 “owing to incremental capacity additions in a scenario of weak demand, leading to supply-demand mismatch by a significant margin”. China and OECD are expected to add 0.6 mbpd and 0.8 mbpd of refining capcities, respectively, in 2012.
In India the 9 million-tonne HPCL-Mittal Energy refinery is nearing completion. BPCL-Oman Oil’s 6 milliontonne refinery was completed in June 2011. Essar Oil is also expanding its capacity from 14 million tonne to 18 million tonne.
This scenario will keep the earnings growth of India’s petroleum refiners under check. This will most prominently reflect in the performance of Reliance Industries. “…RIL’s FY13 earnings growth may be weak if its refining margins (GRM) do not improve,” concluded a recent report by BofAML. Its GRM had dipped to $6.8 per barrel in the December quarter, which the brokerage expects to fall to $5.4 - 6.7 per barrel in the March 2012 quarter. 

CRUDE OIL: Rising Prices to Put More Pressure on Economy

The cost of imported crude has been steadily going up of late, touching a historic high of . 6,186.8 per barrel this month. Both rising global crude prices and a falling rupee have contributed to the spike in import costs. Add to this the oil industry’s daily losses of over . 465 crore since the beginning of February, it is bad news for the country’s economy.
In December 2011, when the rupee stood at around 53 to the dollar and crude traded at $110, India’s oil import costs exceeded the previous high set in July 2008. The rupee’s steady recovery in 2012 was expected to ease the problem, but oil prices continued to rise, gradually crossing the $125 per barrel mark — nearly a three-and-a-half-year high — on tensions in Iran, Syria and Sudan.
On the other hand, the rupee, that had recovered to 48.6 against the dollar in February, again started weakening, breaching the 50 mark recently. As a result, the price India pays for its crude oil imports consistently stayed above . 6,100 per barrel in March 2012 — a historic high. Considering that India imports three-fourths of its oil requirement and retail fuel prices remain heavily subsidised, this is indeed bad news. According to the petroleum ministry, the daily losses of three state-owned oil marketing companies (OMCs) have exceeded . 465 crore since the start of February. This is 70% higher than the losses in October 2011.
Assuming that the industry’s losses from the first half of March 2012 remain unchanged in the second half as well, its total under-recoveries for the January-March quarter could be . 40,200 crore. This will take the country’s total under-recoveries for FY12 to close to . 138,000 crore.
Unfortunately, this data only reflects the industry’s losses on diesel, kerosene and LPG, and ignores the losses on petrol, which the OMCs have been selling below cost due to elections in five states. The industry is currently losing . 12.04 per litre on diesel, . 28.54 per litre on kerosene and . 439 per LPG cylinder, apart from . 5.1 per litre on petrol.
At a time when economists all over the world are imagining scenarios where oil prices could top $150 per barrel and ratings firm S&P warning India on a credit downgrade for fiscal profligacy, this doesn’t bode well. Increasing retail fuel prices are not only politically unpalatable, but also can stoke inflation making it difficult for RBI to reduce rates.
And any indication that the rate cycle would take time to reverse is likely to make equity markets nervous, prompting FIIs to sell and weakening the rupee further. As the finance minister presents Budget 2012-13 later this week, he will face a tough task managing all these variables while dealing with fuel subsidies.

RELIANCE INDUSTRIES: Co Needs to Show that it Can Cash In on New Openings

Once the darling of stock markets, RIL seems to be out of favour now. Plagued by a host of issues, the company has found the going tough in the recent past. But it is trying to break free with a foray into new businesses

    Even after underperforming the broader markets for three years in a row, Reliance Industries does not appear attractive for retail investors. The company has achieved a massive size without compromising on balance sheet health. However, there is little clarity on where its incremental profits would come from. There is still time before its investments in diverse businesses start making their presence felt and in the immediate future all its existing businesses appear to be under pressure. 

CURRENT SCENARIO Reliance Industries (RIL) is currently facing problems in all its key business verticals. Natural gas output from its KG-D6 block has been on the decline for more than a year, and is likely to continue falling well into FY13 and FY14. The company's latest status report to the petroleum ministry mentioned that the production is likely to fall from 35 mmscmd now to 27.6 mmscmd in FY13 and 22.6 mmscmd in FY14.
Its refining business is witnessing a margin squeeze as an economic slowdown lowers demand for fuels. The company’s December 2011 quarter saw its gross refining margins dip to a two-year low of $6.8 per barrel. Similarly, a slowdown in demand for petrochemicals and polymers is having an adverse impact on RIL's third important business segment. The margin pressure is likely to continue, at least, for another year until the global economy improves. Besides business problems, the company has other woes. For more than two years, RIL has been trying to get a reprieve in two of its cases with market regulator Sebi — one over the breach of insider trading norms in 2007, and another over the breach of creeping acquisition norms in 2000. At the same time, its production-sharing contract for the prized KG-D6 block has come under criticism by the country's audit watchdog CAG, which recommended its immediate review. RIL's capital expenditure for the KG-D6 block is also being reassessed.
RIL’s recent disclosure of its stake in several ETV channels surprised investors and prompted Sebi to launch an examination to ascertain whether the company had made proper disclosures in the past. 

NEW INITIATIVES RIL has long been taking initiatives to enter a variety of different industries. It has been present in the organised retail business for over five years and has invested $3.15 billion in shale gas assets in the US. Over the last one year, the company has formed several joint ventures for entering new businesses. It joined hands with DE Shaw Group for a financial services foray and launched a JV with Siemens for homeland security solutions. Recently, it floated India Gas Solutions —a joint venture with BP to import LNG to India and another one with SIBUR for butyl rubber. In addition, the company has bought strategic stakes in various companies — the most recent being the acquisition of an undisclosed stake in the TV18 Group and a 14.8% stake in East India Hotels. 

FINANCIALS RIL became debt-free at the net level by the end of December 2011 as its cash balance of 74,539 crore exceeded the debt on its books. For the first nine months of FY12, its net profit grew 6% to 15,804 crore, while net sales jumped 39.4%. Its operating and net profit margins have been consistently under pressure and dipped to multi-year low levels in the Dec ember quarter.
The company’s share buyback programme is currently under way to buy up to 12 crore shares for a maximum price of 870. 

VALUATION The RIL scrip is currently trading at a price-to-earnings multiple of 12.3 and price-to-book value of 1.8. These are low when compared to the company's historical valuation levels. However, in view of the problems ahead for the company they don’t appear attractive for a retail investor.

OMKAR SPECIALTY: Co's Capacity Addition to Boost Earnings

Omkar Specialty Chemicals (OSCL) is expanding capacity fast. With high capacity utilisation and strong margins, these additional capacities stand to boost its profits in the coming quarters. Retail investors would do well to buy the scrip with a longterm horizon. 

BUSINESS OSCL makes niche value-added organic as well as inorganic chemicals, which are derivatives of iodine, molybdenum, selenium, cobalt and tartaric acid. It primarily caters to the pharmaceutical industry apart from chemicals, glass, cosmetics, pigments and ceramics sectors.
OSCL has a wide portfolio of products to which it continues to add regularly through its R&D. It imports almost all its raw materials, but predominantly sells in India. The supply contracts with customers are linked to raw material prices and exchange rates, which safeguard OSCL’s margins even in volatile times.
The company had floated an IPO in January 2011 to fund the expansion of its production capacity from 750 tonne to 3,650 tonne by September 12. 

GROWTH DRIVERS: OSCL has already added nearly 1,000 tonne of capacity. It also recently acquired a company in Ratnagiri with an installed capacity of 2,800 tonne per annum. This capacity will begin commercial operations from April 2012 onwards and is expected to generate 40-45 crore of turnover in FY13. It is also on track to add another 1,800 tonne of capacity at its Badlapur units in the next 6-8 months. 

FINANCIALS: In the first 9 months of FY12, OSCL's revenues jumped 66.6% to 126 crore, while net profit grew 63% to 11.7 crore. Its interest cost was up 93% at 6.2 crore, while depreciation more than doubled to 3.1 crore. The company has consistently maintained its operating profit margins at above 20% and net profit margins above 9%. Its debt-equity ratio stood at 0.7 at the end of September 2011. Between June and December 2011 the promoters' stake has gone up by 0.38% to 59.11% 

VALUATIONS: OSCL is currently trading at a priceto-earnings multiple (P/E) of 8.3 based on profits for the trailing 12 months, which is in line with its peers. The company's capacity addition plans are set to boost its earnings in the coming quarters.

VIDEOCON INDUSTRIES: Stagnant Sales Hurt Co, But Gas may Fire it Up

Videocon Industries’ results for the December 2011 quarter were dismal as profit almost halved from the yearago period on flat sales. The company has ended its financial year with an 8.4% dip in net profit, prolonging its stagnation since FY06. However, the company has not published the consolidated figures, which means investors and analysts only have half the picture.
Videocon’s Q4 net profit fell 47% to . 86.4 crore as sales dipped 2%, operating margins contracted by 240 bps and interest cost rose 54% to . 299 crore. Its main business of consumer electronics and home appliances saw a 5% drop in revenues and 20% drop in profits. On the other hand, the oil & gas business, which contributes 12% to its turnover, performed well with a 20% jump in revenues and 23.6% growth in profits. Net profit for the year fell 8.4% to . 545.6 crore while sales rose 10% to . 12,919.5 crore. The company had nearly doubled its profit in 2006 to . 818.8 crore, but it has been stagnating ever since. The company has been having cash-flow problems with its debt mounting over the past few years. The company had a debt-equity ratio of 1.6 as of December 31, 2010. On a standalone basis, the ratio stood at 1.4 on June 30, 2011. The company spent nearly . 977.8 crore on interest cost in 2011 on a standalone basis. Since the telecom business and most of the petroleum exploration assets are held in subsidiaries, the consolidated debt and interest cost are bound to be higher.
The Supreme Court ruling to quash all 2G telecom licences issued after January 10, 2008 will hit the company hard, since all its 21 licences will be impacted by the order. However, a deal in the making in London is having a positive rub-off on Videocon. London-listed Cove Energy has attracted valuations above $1.6 billion, thanks to its 8.5% stake in Rovuma offshore block in Mozambique. Videocon holds 10% stake in the block through one of its wholly-owned subsidiaries. Going by Cove’s valuation, Videocon’s stake is worth over . 9,000 crore. 

KEY POINTS Videocon’s Q4 net profit
fell 47% to . 86.4 crore as sales fell 2%
Consumer electronics and home appliances saw a 5% drop in revenues and 20% drop in profits

ONGC: Co Gets Auction Boost, but Subsidy Still Weighs

The government’s decision to finally sell 5% of its stake in ONGC through the auction mechanism has boosted the scrip to a 9-month high. The oil exploration company’s stock has been under pressure over the past one-and-ahalf years on talks of a follow-on public offer or FPO. A successful auction could help ONGC’s market valuation in the near term, although concerns over subsidy-sharing remains.
Since the December 2010 quarter, the government has been toying with the idea of divesting part of its shareholding in ONGC through a follow-on public offer. The offering got postponed a few times, but whenever talks of an FPO started doing the rounds, the share price would stagnate. This was because a typical FPO would be offered at a discount to the prevailing market price with a further discount to retail shareholders.
Investor interest in the company dwindled due to the FPO hangover. Since May 2011, the average monthly turnover in ONGC stock has steadily declined till January 2012, when it was just 35% of what it was in May 2011. In contrast, February has seen a sudden jump in average turnover, which was over 2.5 times that of January 2012 — as it became clear the government would choose the auction route for divestment.
The FPO hangover also meant that in the past one year the scrip didn’t react to developments which otherwise would have had a sizeable positive impact on the stock — bonus issue and stock split in February 2011 and a favourable resolution of the royalty payment issue for the Rajasthan block.
Even though the news of auction has boosted ONGC share price, the scrip remains substantially undervalued. The key reason is the ad hoc nature of subsidies, which makes it impossible to forecast ONGC’s profits.
For example, in the first two quarters of FY12, the company’s subsidy burden was set at around 30% of the industry’s overall under-recoveries. However, for the December 2011 quarter the method was suddenly changed and ONGC’s subsidy burden was calculated at $56 per barrel of oil sold for the entire nine month period, April – December 2011. This meant a steep rise in the burden in a single quarter.
Unfortunately, there is no assurance that the method wouldn’t change again.
ONGC is hoping to increase crude oil production to 28.75 million tonnes in FY13 and to 32 million tonnes in FY14 from the current 27.3 million tonnes. Another positive about the auction process is the setting of a floor price. For a long-term investor the floor price of Rs 290 is surely attractive and there is a possibility that the bidding could take it even higher. A higher price in the auction will boost ONGC scrip in the secondary market.