Oil PSUs Don’t Make a Good Case for Investment

Although the three public sector oil marketing companies — Indian Oil, BPCL and HPCL — ended FY13 with profits, thanks to government support, their ability to create value for retail shareholders is doubtful since they face several challenges.
The three OMCs showed healthy growth in net profit for FY13, as they were well compensated by the government as well as upstream players in the last quarter. However, for the first nine months of the fiscal, the companies were sitting on huge losses, underlining their dependence on government compensation.
It is doubtful if the government’s plans to gradually deregulate diesel prices will help the companies as competition from the private sector is certain to ill eat into their dominant market share. Besides, their margins, too, can come under pressure once the market opens up.
The OMCs are also at the mercy of government decisions. The government appears to be considering export parity pricing (EPP) as the basis for calculating the subsidy burden and has set up a committee to look into it. This appears impractical, as the reduction in subsidy payouts the new model will cause will leave the OMCs grappling with losses. Also, with the prices of diesel, which took the biggest chunk of the subsidies, set to be decontrolled, there is little merit in cutting corners this way. The newsflow on this matter will keep these companies volatile on the bourses. Also, recently, the Competition Commission of India started investigating the alleged cartelisation by these oil marketing companies in fixing petrol prices. This, too, can become a cause of worry for investors going ahead. Besides, the financial health of the companies is not in great shape. All these factors have cast doubts on the ability of the three companies to create sustainable value for investors. In the last one year, these companies have gained between 0% and 12%, grossly underperforming the BSE Sensex, which rose 22%. Retail investors should stay away from them till their problems are solved. 

ONGC Past Investments to Help Pump Up Show

ONGC’s results for the March quarter were disappointing as a jump in expenses and provisioning took away all the benefit accruing from a reduced subsidy. Long-term investors may still term the company attractive, but the share price is likely to cool off a bit after the latest results. ONGC’s subsidy burden dropped 13% year-on-year to . 12,312 crore in the March quarter, enabling it to earn . 2,755 for every barrel of crude oil it produced — a whopping 23.6% growth over the year-ago period. However,the company witnessed a strong jump in almost all its expenses. Staff costs more than doubled, depreciation and amortisation jumped 77%, while other expenses were higher by 66% year-onyear. The company’s write-off towards exploration costs also rose 33% to . 4,739 crore. 
One reason for this was a . 1,850-crore provision towards the last seven years’ employer’s contribution towards employee superannuation benefits. The company also provided for . 1,585 crore towards deductions made by petroleum refineries for taxes on discounts. The resultant net profit was nearly 40% lower y-o-y. 
ONGC has long been suffering from stagnation in output. In the last five years, its production has fallen at an annualised rate of 0.9% to 46.1 million tonnes of oil equivalent in FY13. The next few years are expected to be better for the company as its investments start paying off. For long-term investors, the company may remain attractive due to the expected growth in production, likely fall in subsidies and possibility of a natural gas price hike. However,one can wait for some cool-off in its share price before investing.

Revival in Natural Gas Biz Key to GAIL’s Fortunes

GAIL reported only a 28% growth in profit for the quarter ended March despite a sharp fall in the subsidy burden. A decline in transmission volumes and precipitous fall in profitability of this key business, among other factors, impeded the growth in profit, which could have doubled with such a big fall in the subsidy burden.
For the March quarter, GAIL’s subsidy burden dropped to just . 587.2 crore, less than half of . 1,398 crore a year ago. Its natural gas transmission business, one of the biggest contributors to its bottom line, witnessed a 46% drop in revenues and 87.5% fall in profits (earnings before interest and tax, or EBIT), as transmission volumes dipped 14% to 99.5 million units per day. The depreciation for the quarter also was higher by 27% at . 273 crore. This indicates that the company’s expanding pipeline network is underutilised.
Other factors that affected the company’s profitability were a three-fold jump in staff cost and a spurt in the effective tax rate to 45.8% of its pre-tax profits.
The performance of GAIL’s petrochemicals division was commendable, lending support to the profit growth. This segment’s EBIT at . 471.6 crore turned out to be more than the EBIT for GAIL’s entire natural gas business — transmission as well as trading — for the first time ever.
Although GAIL’s quarterly numbers appear good overall, its valuations are unlikely to improve unless the natural gas business sees some revival. With domestic production dwindling and imports staying costly and fluctuating, this is not likely to improve anytime soon. 

Turnaround Hopes Take Roots

Be Wary of Economy, Rates and the ‘Other’

Profit margins of India’s top companies have improved in the quarter ended March 2013, hitting a seven-quarter high on easing raw material costs and interest rates. However, what is worrying is that there are early indications of a bumpy ride ahead as revenue growth slows due to faltering economic growth

First the good news. An ETIG analysis of the March quarter results of over 826 companies, excluding banks and fi nancial institutions, shows that their operating profi t margins have improved, thanks to easing raw material costs. Net profit margins, too, are now at a seven-quarter high of 8.6% aided by lower interest rates.
But there are worry lines. Indian corporates are now battling a severe slowdown in sales with aggregate revenues of companies, featured in the analysis, rising just 5% year-on-year — the slowest in at least 10 quarters. 
The other sobering fact is that India Inc’s net profit growth has largely been due to a spurt in other income, which at 27.7% of pre-tax profit was the highest in at least eight quarters.
What also contributed to net profi t growth was the drop in effective tax rate, or tax expense as a percentage to pre-tax profit. At 22.8 %, this was at an eight quarter low. In other words, much of the profi t margin growth is coming from nonoperational areas.
Over 1,200 companies are on course to announce their March ’13 quarter results by the end of this month, which may well influence or alter these fi ndings. Still, the declining sales growth ought to worry Indian companies, unless the trend reverses this fi scal. Source: ETIG Database

Huge Debt Pile a Big Burden for Essar Oil

Essar Oil’s results for the quarter to March were almost similar to those of the preceding couple of quarters. The company has stabilised its operations and the key booster to earnings will come from dollarisation of its debts, which should take three to six months. Investors need to wait for deleveraging of its balance sheet and strong bottom line growth. Essar Oil’s net profit for the March quarter at . 200 crore was better than in the quarter to December, when it reported a profit of . 32 crore.
Since the company is operating a much bigger and better refinery now than a year ago, comparing the sequential numbers will provide a better picture, instead of the normal year-on-year comparison. On the key variable of gross refining margin at current prices (GRM), Essar Oil posted a marginally lower number at $9.06 per barrel against $9.75 in the December quarter. The gross refining margin is the differential between crude oil cost and price of refined products and represents the main source of income for a refinery.
Essar Oil also saw its interest costs inch up to . 920 crore, 4.3% higher than . 882 crore in the December 2012 quarter. In addition, the company’s exit from CDR necessitated a one-time write off of . 111 crore. The company ended the whole FY13 in loss and, hence, had no tax liability. That the company was still able to show an improvement in net profit in the March quarter was owing mainly to the foreign exchange gain of . 25 crore against a loss of . 345 crore in the December 2012 quarter. “It was one of the rarest quarters since we had neither the forex losses nor inventory losses,” said Suresh Jain, chief financial officer of the company. With its major capex over, the main goal for the company remains paring of its huge debt, which is still more than seven times its equity. It sucked out . 3,424 crore from its operating profits as interest cost in FY13. The company’s aim to replace its rupee loans with external commercial borrowings (ECB) to the tune of $2.27 billion would save it nearly . 1,000 crore in annual interest costs.
The company also reported operating profits (EBIDTA) of . 3,966 crore in the latest three quarters, when the refinery expansion was completed.
“We are in a position to generate $1 billion at EBIDTA level every year,” said LK Gupta, managing director of the company. Ultimately, it is these earnings that would help it lower its debt pile.
The company has indicated it will take 3-6 months to raise the necessary foreign borrowings, which will lower interest costs. Still, it should take 2-3 years to fully de-leverage its balance sheet. The current share price mostly discounts these factors and investors will need to wait to see any significant appreciation from the current levels.

PETRONET LNG: Raw Material Costs Wipe Out Higher Revenue Gains

Petronet LNG’s March quarter results reflected a pronounced stagnation, as the net profit was flat at Rs 245.1 crore compared with the year-ago period despite a 33% jump in revenues at Rs 8,465.6 crore. The scrip has lost over 20% in three months and the valuations are attractive, but the company needs to decisively overcome its stagnation woes to attract investor fancy. Rise in raw material costs wiped out all the gains from increased revenues. The volumes remained stagnant at 122 trillion British thermal units (TBTUs), as high prices discouraged spot purchases.
The company’s new five-million-tonne-perannum LNG import terminal at Kochi is likely to remain under-utilised in FY14 as the long distance pipeline connecting the terminal to potential buyers is not ready. The company had earlier planned to commission the plant in December 2012, but it now has postponed the commissioning to June. The terminal won’t generate much revenues initially, but the company will have to book depreciation and interest costs towards the $840-million investment, impacting the profitability.
The company has many plans to grow in the medium to long-term. A new berth at Dahej will enable handling of more vessels at the terminal. Power generation plants are being planned near Dahej and Kochi terminals, while a greenfield unit is being planned in Andhra Pradesh. The company has also signed supply contracts with various LNG producers to ensure steady flows. The company’s utility business with stable regassification charges and long-term contracts with low regulatory risks make it an attractive investment at the current price-to-earnings ratio of 9.1. Nevertheless, investors are unlikely to favour the scrip until the company is able to sail through its stagnant phase over the next 2-3 quarters.