Output Ramp-up Key to Cairn’s Profitability

Company’s price-to-earnings ratio of 5.6 looks attractive for long-term investors

Exploration firm Cairn India’s performance in the quarter to December 2012 exceeded expectations marginally as the company benefited from a weak rupee, while its production remained flat from the preceding quarter. Cairn India has emerged as a cash-rich firm and is working to improve its output level steadily over the next few quarters.
Cairn India’s net profit for the quarter was . 3,345 crore, which was 48% higher than the year-ago period driven by a 21% higher production at 205,014 barrels per day (bpd). Compared to the preceding quarter, when production was almost flat, the company’s profits were up 44%, mainly due to a weak rupee.
The company has turned into a cash-generating machine with its operations generating almost $0.5 billion of cash every quarter and its free cash exceeding $2.67 billion. Ramping up production from the current level holds the key to improving the company’s profitability. For this, Cairn plans to commence production from the Aishwariya field by the end of FY13.
Similarly, it plans to apply Enhanced Oil Recovery (EOR) techniques to entire Mangala field from the June ’13 quarter. Both these measures will help extend the plateau production.
Cairn India also appears to be making progress on the long-pending 80-km pipeline section between Salaya and Bhogat. Completion of this pipeline and the Bhogat terminal in the first half of 2013 will make the company’s crude oil truly international.
In the medium-to-long-term, it has a target to reach the 300,000-bpd level at the Rajasthan block to drive its growth. In that backdrop, the government’s decision to permit exploration in the development area is a big positive. Similarly, its exploration work is progressing well in Sri Lanka. Taking into account the December quarter results, Cairn India’s net profit for the past 12 months is now . 11,679 crore compared to its valuation of . 65,000 crore, which translates into a price-to-earnings ratio of 5.6. Long-term investors are likely to find this attractive, given the visibility on the company’s future growth. 

RELIANCE INDS: Investors May Flock Back to RIL

India’s largest company by market value Reliance Industries could well see renewed interest from investors soon after a sustained period when the stock was languishing after the company cut back on its gas production and analysts were skeptical about its earnings growth. Its results for the quarter to December 2012 exceeded analysts expectations by a wide margin, powered by its refining business. At . 5,502 crore, RIL’s net profit in the third quarter was its third-best ever. That, too, when there has been an overall weakness in refining margins for the December quarter. RIL went on to post its highest-ever profits from this segment at . 3,615 crore.
The gross refining margin was an impressive $9.6 per barrel. This not only bettered its year-ago number of $6.8, which was on expected lines, but also beat its September 2012 quarter number of $9.5, when most analysts had pegged their forecasts between $8.5 and $9 for the quarter. In comparison, the performance of its two other major segments — petrochemicals and oil and gas — were dismal, just in line with market expectations. The petrochemicals segment faced margin pressure and posted a lower profit of 10% inspite of a 11% spurt in revenues. But the declining natural gas production from KG-D6 led to a 32% drop in revenues and 54% drop in profits from the oil and gas segment. The quarter was also marked by a reduced importance of other income in the overall profit of the company. From an average of 33% of pre-tax profits in the April-September 2012 period, the proportion of other income has dropped to 25%. A reduced tax provisioning at 19.7% of pre-tax profit compared to 22.6% in the year-ago period also contributed to the stellar performance.
RIL was also debt-free at end December 2012, with cash of . 80,962 crore, way higher than its . 72,266-crore debt. This despite using . 3,085 crore of cash for its share buyback programme. Analysts are not certain if this performance can be sustained. For RIL’s investors, the 24% y-o-y jump in net profit is a welcome breather after a fall in profits for the last four consecutive quarters. The December quarter show may well be the trigger for renewed investor interest in the company.

Interest Cost Cut to Help Sustain High Valuations

Essar Oil’s results were lukewarm for the quarter ended December 2012. The earnings report was marked by a net profit of . 32 crore, despite the oil refiner’s highest ever gross refining margins at $9.75 per barrel.
The company management has blamed foreign exchange fluctuations for pulling down profits, while interest costs ate away over twothirds of its operating profit.
In a conference call with analysts, Essar Oil’s chief financial officer, Suresh Jain said that the EBIDTA and PAT would have been higher by . 260 crore in Q3 if not for the forex gain accounted in the previous quarter, which showed up as lower sales realisation during the quarter.
While interest costs shaved off . 882 crore or nearly 71% of its . 1,242 crore of operating profits, or EBIDTA, this proportion was substantially higher compared with 63% in the September 2012 quarter. The company maintained its operational efficiency from the preceding year running the refinery at full utilisation while bettering the previous record margins posted in the last quarter.
Its current price gross refining margins (CPGRM) was at a record high of $9.8 per barrel compared with $7.9 in the September 2012 quarter. It also maintained 84% diet of heavy and ultra-heavy crude oils, with 85% of the product slate in the profitable light- and middle-distillate categories.
As the refining company has completed all its major capital expenditure, its quarterly earnings will remain linked to the capacityutilisation level and margins it can bring home. It is attempting now to pare its interest costs and is in the process of arranging foreign borrowings. Essar Oil, according to the CFO, has secured a higher limit for its foreign borrowings — from $1.5 billion to $2.2 billion — which is a large chunk of the $2.8-billion loans it currently has on its books and could lead to a saving of $140-150 million annually on interest cost. Essar Oil has gained over 32% on the bourses over the last six months on hopes of a turnaround. Its enterprise value is currently nearly 13.5 times its EBITDA for last 12 months. The company’s efforts to bring down its interest cost may help sustain the valuations at the current high level. 

Concerns over Equity Dilution Mar Sintex’s December Show

Sintex Industries reported a strong operational performance for the quarter to December 2012, improving sales as well as margins. The weak bottom line performance was because of the foreign exchange losses due to a weak rupee. By managing to finance the repayment of its foreign currency convertible bonds, or FCCBs, its near term concerns have been addressed.
The company posted a 23% topline growth at . 1,427 crore with a 130 basis points improvement in operating profit margins to 15.4% at the consolidated level. This boosted pre-tax profits by 45% to . 140.3 crore. Sintex also bookeda notional forex loss of . 45 crore on revaluing its long-term liabilities, while its tax outgo jumped substantially, leading to a 35% drop in bottomline at . 53.3 crore.
Although the scrip lost 2.5% on Thursday, when the results were declared during market hours, it rebounded strongly on Friday, surging 3.2%, in spite of the overall weakness in the markets.
The key concern for investors now is about the equity dilution the company had to settle for while re-financing the FCCBs falling due in March 2013.
On a fully-diluted basis the company’s per share earnings or EPS works out to . 2.1, excluding the impact of forex losses, for the quarter and . 5.3 for the 9-month period ended December 2012. Annualising these earnings, the scrip is currently valued at a price-to-earnings multiple of slightly below 10.
A number of equity analysts are terming these valuations as inexpensive. However, investors will look for a reduction in the company’s debt and improving return on capital.

PETROLEUM: Slipping Margins Spell Trouble for Some but Key Govt Decisions Benefit Others

The petroleum sector’s results for the quarter to December 2012 is expected to be lacklustre with a few exceptions, as margins in the refining as well as petrochemicals industries stagnated and the performance of state-run firms will hinge on the government’s ability to compensate their losses. The investment outlook for the sector could improve if the government implements a few key policy decisions, especially on pricing of products.
Refining margins — the differential between the cost of a barrel of crude oil and revenues from selling refined products — in the Singapore region, considered the benchmark for Indian shores, have dipped in the December quarter from the previous quarter.
Even the petrochemical business may see subdued margins. The market expects the industry to report under-recoveries ranging from . 39,000 crore to . 42,300 crore in the December quarter, compared with . 37,775 crore in the September quarter. However, subsidy sharing continues to remain ad hoc. The share of upstream companies is expected to go up in the total under-recovery bill. Brokerage Nirmal Bang says it expects upstream companies to bear 40% of under-recoveries in FY13E.
The results of Essar Oil and Cairn India are expected to be better than the rest of the industry. Essar Oil will benefit from the commissioning of its coal-fired power plant mid-November, while a weak rupee through the quarter bodes well for Cairn India. The sector, which under-performed the broader benchmarks in 2012, could see some vibrancy with the government perceived to be working on important policy decisions. The recommendations of the Rangarajan committee are beneficial for exploration and production companies, while the petroleum ministry’s proposal to raise diesel and kerosene prices gradually is good news for retailers. These decisions could improve the industry’s outlook going ahead.

Falling Output, Subsidy Squeeze on Capex Weigh Heavy on ONGC

In spite of being the largest profitmaking listed company in India and always staying in the top three by market capitalization, ONGC hardly participated in the market’s rally through 2012. When the BSE Sensex gained 26% through the year, ONGC remained flat. Its subsidy sharing woes were no doubt the main reason, but the falling production is another concern for investors.
The monthly production data published by the petroleum ministry shows that ONGC’s oil production has been on a steady decline through the first half of FY13. During the April-November 2012 period, ONGC’s production, at 15 million tones, was 7.3% below its target and 5.9% below its production in the corresponding period in the previous year. Production from the Mumbai High offshore field, which is the biggest contributor to the company’s total production, was 8.8% below target.
The company had acknowledged its production woes in its interaction with the analyst community. “Due to deferment in the commissioning of marginal assets and natural decline, ONGC has reduced its FY13 production guidance to 23.6 million metric tonnes (MMT) from 27.5 MMT and for FY14 to 25.8MMT from 28.2MMT,” mentioned Religare’s report on the company in November 2012.
The company has been blaming less-than-anticipated success on various fronts as the major cause of missing production targets. The petroleum ministry has enumerated a few reasons, including lessthan-anticipated oil production from side track and development wells in the Mumbai High and similar problems in the Vasai East well. Project delays too have contributed to the shortfall.
However, ONGC missing out on its production targets is not a recent phenomenon. The company’s production through the 11th Five Year Plan too was less than expected. According to the 12th plan documents, production target for ONGC was 140 million tonnes during the 11th plan, while actual production stood at 124.3 million tonnes, translating into an 11.2% shortfall.
According to the 12th plan, ONGC’s production is expected to be 25.05 million tonnes in FY13, which will rise to 28.27 million tonnes in FY14 before falling to 25.5 million tonnes in FY17. However, these targets appear difficult to meet under the current circumstances. 
To be fair, the Bombay High is an old field and is subject to natural decline in reserves. The company has been battling the decline with an array of special projects designed to extract more oil from the reserves. The planned investment for these projects is . 40,363 crore, out of which it had spent . 28,420 crore till FY12. The company has also been expanding its reserve base with incremental discoveries.
At a time when ONGC is facing a funds crunch for capital expenditure and acquisitions abroad — both necessary to keep its production stable and growing — due to the ever-growing subsidy burden, the decline in domestic production is an additional cause of concern.

Supply Pacts, Foreign Asset Buys Only Way to Beat Energy Crisis

Although policy makers and industry professionals have been talking about long-term energy security for quite some time now, with a few steps having been taken, given the economic slowdown and weak oil demand which has kept oil prices depressed, the next couple of years offer a good window for India to acquire overseas assets and to link long-term supply contracts.
Afailure to do so may force the country to import high-cost energy which can slow down economic growth. Predicting oil prices is no doubt a hazardous game, but still economists try their hand at figuring out at least the broad patterns. The recently published ‘Annual Energy Outlook 2013’ by the US Department of Energy makes a case for the benchmark Brent crude oil prices to trade around $96 per barrel by 2015 compared to an average of $111 in 2012. Post that oil prices will resume their upward trajectory to reach $269 by 2040. The expected weakness over the next three years is mainly the result of the economic slowdown in the West, growing unconventional production of oil such as shale oil or oil sands, natural gas replacing oil demand and increasing use of energy-efficient technologies in western countries. Nevertheless, the growing oil consumption from Asia, Middle East and the African nations apart from the dwindling production from ageing fields will at some point reverse the downward trend in oil prices. It is imperative for India to make the best of this phase, since its energy consumption is growing very fast. “The primary energy consumption of the world is expected to grow 1.6% annually from 2008 to 2035; whereas India’s primary energy consumption is expected to increase at 3.2%,” according to a PwC recent knowledge paper.
Vikram Dhawan, director, Equentis Capital — a UK-headquartered analytics and research firm put things in perspective. “Population in Japan is almost 1/10th that of India; however Japan consumes 30% more oil than India. This is despite the fact that oil consumption in Japan has declined by around 20% in past decade. If the current trend continues then India should overtake Japan in terms of oil consumption within the next decade .”
On the other hand, the global scenario in the petroleum industry is changing fast. US, the world’s biggest consumer, is seeing its petroleum consumption inching lower while its production through shale oil is slated for a rapid
    growth. The country’s
    energy production growth rate has outstripped the consumption growth rate.
China is emerging as the new influencer on the global energy economics front. It has long been making concerted efforts at securing its long-term energy future, furthered its reach as state-owned petroleum behemoth CNOOC recently acquired Canada’s Nexen for a stunning $15.1 billion. Back home India doesn’t have too much of its own hydrocarbon reserves. The proven oil reserves in the world at the end of 2011 were 234 billion tonnes, which are sufficient to meet 54.2 years of global production. On the other hand, India has oil reserves to meet its demand only for 18.2 years. Similarly, the domestic proven natural gas reserves are worth only 27 years of production, according to the PwC report. This means the country’s long-term energy security will depend on imports in the foreseeable future.