Cost Auditors Hit Out at New Draft Rules That Curb their Scope

ICAI says new rules will hurt company stakeholders and also jeopardise the prospects of many auditors

The latest draft rules issued by the ministry of corporate affairs related to the cost records and audit mechanism could substantially curb the scope of the cost audit profession and have outraged its practitioners, who say their implementation will hurt company shareholders.
The Institute of Cost Accountants of India, set up under an act of Parliament, has expressed deep concern and vowed to “leave no stone unturned” in seeking to make sure the draft isn’t implemented. ET had first reported on August 12 that the government was considering a reduction in the scope of cost audits due to industry pressure.
The draft rules curtail cost audits in three ways. First, the number of industries covered is reduced. “At present a company engaged in production, processing, manufacturing, or mining activities is required to maintain cost records,” said Suresh Chandra Mohanty, president, ICAI. “Moreover, all listed companies are required to maintain cost records. Cost audit is applicable to a company for which cost audit is ordered by the central government,” he said.
“The draft rules require only those companies that are operating in strategic sectors or in industries that are regulated by a sectoral regulator, or a ministry or department of central government or in some specified industries such as manufacturing of components and equipment being used by railways, minerals and ores. It also covers health care services and education services,” Mohanty said.
Secondly, the turnover and net worth threshold have been increased substantially. “The threshold has been increased from net worth of . 5 crore to . 500 crore and the threshold of turnover from the specified product is fixed at . 100 crore,” Mohanty said. Third, apart from the companies required to undergo cost audit, all others have been exempted from maintaining even cost accounting records. “Nearly 90% of the economic activity will be out of the purview of cost records and cost audit,” said Dhananjay Joshi, a leading cost accountant and past president of ICAI.
ICAI listed its opposition to the draft rules in a press release. “It is well established that managers act opportunistically and they take short-term view and benefit themselves even when the going is bad. In absence of reliable cost accounting information, independent directors will not be able to assess whether the company is achieving optimal productivity of resources,” ICAI said. “The reversal will hurt shareholders and other stakeholders.”
“It is noteworthy that when the MCA itself had appointed an expert group in 2008 and implemented its recommendations in 2011 and possibly the first audit report is filed only for the year 2012-2013 for most of the companies, MCA has taken a total Uturn,” said Joshi. 
The implementation of the draft rules could jeopardise the prospects of many who left other jobs to pursue cost accounting. Also, “the profession will not be able to attract talent and it will become weak. This will hurt all the stakeholders,” ICAI said, while terming the development as “de-facto withdrawal of recognition.”
“Cost audit is not only the audit of cost accounts, but it also reveals the utilisation of the scarce resources in the country. At a time when our economy requires efficient and costeffective resources utilisation, the new rules will defeat this purpose,” said Nachiket Vechalekar, associate dean, Indian Institute of Cost and Management Studies & Research.
The corporate affairs ministry said any changes will be based on feedback received. “The draft rules are in the public domain for comments and suggestions of stakeholders. As in case of other rules, a final call will be taken only in the light of the feedback received. In the circumstances any further comments on the issues are premature,” said Naved Masood, secretary. The ministry has asked stakeholders to send comments on the draft rules by December 6. 

GUJARAT GAS: Sept Show won’t be Sustainable

Gujarat Gas reported a 19.7% jump in profit to . 119 crore for the quarter to September. This is by far the highest quarterly profit posted by the private sector natural gas distribution company. But analysts say the company will not be able to sustain the high profit in the quarter to December. They have given a “Hold” call on the stock. Gujarat Gas, however, still holds the potential to generate value for investors. The company is focusing on improving margins and expects volumes to rise in the coming months. One of the main reasons behind the high profit growth at Gujarat Gas was its all-time high gross margins at . 9.4 per standard cubic metre. The resultant operating profit margin increased to 23.7% from 19% in the year-ago quarter. This was a result of one-time favourable developments. “We decide on pricing based on our projection of natural gas costs and volumes,” Sugata Sircar, managing director at Gujarat Gas, told ET. “During the September quarter, the availability of local gas was higher than expected, reducing the use of imported LNG to 48% against 50% in the nine months to September.” As a result, the cost of raw material for the company turned out to be lower than anticipated, which boosted its margins. The company has also managed its other operating costs well. The company’s performance over the past few quarters has underlined its focus on maintaining and improving profit margins by aggressive price hikes. The company last raised the price inOctober anticipating higher LNG prices during the winter season. Gujarat Gas also maintains that its stagnating volumes should not be seen as a long-term handicap. “Every quarter, we are signing new volumes with industrial clients while CNG and PNG customers are increasing. However, volumes would drop if clients switching over to grid power were higher,” said Sircar. The September quarter saw the situation changing as the company posted a marginal increase in natural gas volumes. An improvement in the industrial scenario and beginning of the new investment cycle should firmly reverse the declining trend in volumes. “We have bottomed out in volume terms,” Sircar said. Gujarat Gas will have a cash balance of nearly . 600 crore even after paying . 9 a share interim dividend announced by it. Considering it will generate . 350-400 crore of cash annually with capex requirements just one-third of that, its cash pile will continue to bulge. At 11 times its earnings for trailing 12 months, the company’s stock appears attractively valued for long-term investors.

Receivables Flow Changes Fortunes

Output, Subsidy Woes to Worry ONGC

The depreciation of the rupee helped ONGC, India’s biggest oil and gas explorer, post better-than-expected results in the September. quarte. The state-run explorer, however, continues to suffer from ad hoc subsidy sharing and stagnating production. Net profit at ONGC rose 2.8% yearon-year to . 6,064 crore, despite a 12% spurt in the subsidy burden to . 13,796 crore. This was made possible mainly by the more than 12% year-on-year depreciation in rupee during the quarter.
For every barrel of oil that ONGC sold, it recovered . 2,786 even after offering a $64.2 per barrel discount to oil marketing companies under a government diktat. This was 7.9% higher compared with the year-ago quarter. Being the biggest oil company, ONGC has to share the maximum subsidy burden.
While ONGC gave a subsidy of $64.2 per barrel during the quarter, Oil India offered $56 per barrel. It was also higher than the $62.9 per barrel discount it extended to downstream oil marketing companies in FY13 and $62.7 per barrel discount it offered in the quarter to June.
Although production has been lagging ONGC’s own expectations for some time, the September quarter did see some improvement in output. While crude production was stable at 5.1 million tonne, natural gas output was up 1.4% to 5.9 billion cubic metre.
The company’s depletion and depreciation expenses rose nearly 47% to . 2,427 crore, but a slow rise in rest of the costs led to a muted 11% growth in total expenditure. However, markets are likely to cheer the company’s ability to post a more than 50% growth in profits over the previous quarter. The positive sentiment, though, is likely to be short lived as the worry over ad hoc subsidy sharing still persists.

Subsidy Flow, Poll Season to Leave a Mark on OMCs

The three state-owned oil marketing companies (OMCs) appear to be in better health today, with the government having raised its subsidy payout in the quarter to September. This combined with steadily rising diesel prices and the government’s resolve to cut subsidy on diesel have prompted a few analysts to project a little more optimistic picture of the sector. Yet, the lack of flexibility on the fiscal front makes future subsidy payments uncertain, while any sharp rise in diesel prices will not be an option with national polls next year. This will mean a subdued outlook for the sector in the near term. For the September quarter, the government agreed to share over half of the under-recoveries estimated at . 35,150 crore.
This was substantially better when compared to the quarter to June this year, when the government chose to pay only 32% of the . 25,050 crore under-recoveries. This is certainly a good sign.
The three OMCs – IndianOil, BPCL and HPCL – also appear to have improved their balance sheets over the last one year.
Their combined net debt at the end of September this year was . 107,165 crore, 13.5% lower compared with a year ago. Net debt represents the total of long-term and short-term debt by deducting current investments, cash and bank balance as on date.
The government’s improved payment schedules during 2013 and steadily rising diesel price, which at one point limited under-recoveries on this largest consumed fuel to below . 4 per litre, helped these three companies in cutting down their working capital loans and improve balance sheets.
The oil marketing companies have not done anything spectacular over the last one year on the bourses. IOC and HPCL have lost between 23% and 28% in the last 12 months, while BPCL gained 4.5%. As a result, IOC and HPCL are now trading at 0.6-0.7 times their book value. BPCL commands a premium valuation thanks to its highly successful exploration portfolio, which is expected to bring in more profits than its traditional business from 2018 onwards.
A few market analysts are taking a view that these improvements signal light at the end of the tunnel and in view of very low valuations, are suggesting that investors should buy into these stocks for decent returns in the near term.
This view appears to be a bit premature. First, the government agreeing to compensate the OMCs does not necessarily mean timely disbursal of cash. In fact, the government has already exhausted its budgeted funding for petroleum subsidies in FY14, as close to . 40,000 crore of payments for FY13 were made this year. In view of the need to cut fiscal deficit to 4.8% of GDP in FY14 to ensure that the sovereign rating is not downgraded, there is a possibility that it will again postpone a chunk of current year’s subsidies to next year’s budget. This will mean that the oil marketing companies will report profits, but will need to again borrow heavily this time just like last year. The other way out will be to raise diesel prices sharply as suggested recently by the by Kirit Parikh committee and several others in the past. However, this appears unlikely in view of the general elections in mid-2014.
It is more likely status quo will be maintained for these OMCs, which will continue to report annual profits adequate enough to keep their heads above water, but will have to live on borrowed funds. This will put off long-term investors although there could be shortterm trading opportunities.

India to Drive Global Oil Demand by 2020

By 2035, India will consume more oil than Japan, Australia and Korea combined, says IEA chief economist

India is set to become the biggest driver of global oil demand by year 2020,” claimed International Energy Agency’s chief economist Fatih Birol while speaking to ET on Tuesday. “Year 2020 is like tomorrow, from the oil industry’s point of view,” he said, underlining the urgency in his message on the sidelines of the publication of IEA’s World Energy Outlook 2013. 

The Paris-based International Energy Agency (IEA) came out with its annual take on the energy industry’s outlook on Tuesday. Set up by the Organisation for Economic Cooperation and Development (OECD) as a response to the oil shock of 1973-74, IEA advises its 24 member countries on issues related to energy security. IEA’s well-researched monthly as well as annual reports on the energy industry are regarded as unbiased and referred by policy makers, industry as well as academia.
IEA’s World Energy Outlook 2013 predicts the global oil demand to reach 101 million barrels per day (mbpd) by year 2035 from today’s around 87 mbpd. This is a significantly modest projection compared with 108.5 mbpd predicted by the Organisation of Petroleum Exporting Countries (Opec) in its World Oil Outlook published last week.
“There are various estimates available for future global demand, which differ based on the assumptions made,” Birol said. “One reason our estimate is lower maybe because we take into account the effect of current and likely energy efficiency policies by the governments, which will slow down consumption growth,” he reasoned.
The World Energy Outlook 2013 projects global coal consumption to grow 17% by year 2035 while the oil consumption is expected to grow nearly 16% from current levels. Natural gas consumption is expected to grow fastest mainly due to sharp growth in emerging economies such as China. While the high-paced growth in the shale gas and oil output will continue to transform the industry globally, conventional oil production is expected to stagnate to 65 mbpd.
“This does not mean the world is on the cusp of a new era of oil abundance,” cautions the report, which predicts a $128 per barrel price for crude oil till 2035, excluding any impact of inflation. Major oil industry investments during next 20 years will go in trying to maintain the output from existing oil fields. By 2035, transportation and petrochemicals will remain the only two demand drivers for oil. The size of India’s economy and growing population means the country will need more and more energy to continue its growth. Around a quarter of incremental oil demand globally will start coming from India alone post 2020. Similarly, by that time India will be world’s single largest importer of coal, according to IEA’s World Energy Outlook 2013.
“India’s oil consumption will exceed 8 mbpd by 2035, which is more than current consumption of Japan, Korea and Australia combined,” explained Birol.
India faces the challenge of ensuring access to affordable energy in the long-term while minimising the environmental impact.
“For a country like India, policies to improve energy efficiency are most necessary in transportation or electrical ppliances etc,” he added. According to him, India’s coal-based power plants have one of the lowest efficiencies in the world. “Making use of renewables, wherever economically feasible and increasing the share of natural gas,” were the two other measures he suggested. For a country like India, which has grossly neglected the health of its energy sector, thanks to unsustainable subsidies, this report should come as a wake up call. To sustain its economic growth and well being of the ever growing population, bold reforms are called for in the energy sector. 

For a country like India policies to improve energy efficiency are most necessary in transportation or electrical appliances, etc. I also suggest making use of renewables, wherever economically feasible and increasing the share of natural gas 

DR FATIH BIROL
Chief Economist, International Energy Agency

Oil India Likely to Gain if Gas Prices Rise Next Fiscal

Oil India’s financial performance in the quarter to September did not throw much of a surprise as a higher subsidy burden and an increase in depreciation and depletion cost eroded any benefits derived out of rupee depreciation. Profit, however, was better than in the preceding quarter, which boosted the company’s share price. Dry wells and depletion costs are key to any exploration and production firm, since other costs do not fluctuate much. For Oil India, this cost nearly doubled over the year-ago quarter to . 465 crore, its highest level so far. Similarly, subsidy burden for the quarter was 7.5% higher YoY to . 2,234 crore. The company’s oil and gas output has for long suffered stagnation because of agitations in the northeastern states, where it has most of its operations. Its oil production fell 4.6% to 0.92 million tonne while natural gas production declined 3.5% to 0.67 billion cubic meters during the quarter. Rupee depreciation, however, helped Oil India maintain its profitability at a decent level. The company’s average realisation at . 62.25 per US dollar in the quarter was nearly 12.7% better than the exchange rate of 55.2 in the year-ago period. This helped it achieve a net realisation price of . 3,257 per barrel of oil, which was 12% higher than the previous year. This aided Oil India in restricting the fall in its profit to just 5.3% year-onyear to . 903.6 crore.
The company is set to gain from the likely hike in gas prices in the next fiscal. However, there is also a possibility of a hike in its subsidy burden. Oil India is being valued at a priceto-earnings ratio of 8.6 with a dividend yield of 6.4%.

Debt, Local Gas Price Hike Loom Over Gail

The 7% drop in Gail’s September quarter net profit was along expected lines. The slowdown in business and likely increase in natural gas prices from April next year remain key concerns for the transporter of thefuel,butthe government appears to be actively considering a move to exempt it from having to participate in the subsidy-sharing mechanism, which will help re-rate the stock despite current woes.
State-run Gail is required to pay a share of the subsidy that the government incurs on selling fuels at below cost.
The company has been trying to cope with the dwindling domestic availability of natural gas, which persisted in the September quarter, with volume dipping to 95.2 mmscmd (million standard cubic metres per day), down 4% from thepreceding quarter and 9.9% lower than in the year earlier.
However, this didn’t impact operating profit as EBIDTA, or earnings before interest, taxes, depreciation and amortisation, grew5% to . 1,463 crore, thanks to take-orpay arrangements with customers. This means that a contracted buyer needs to pick up supplies or pay a penalty.
The company has been investing heavily over the last few years in the expansion of its pipeline network, which has necessitated borrowings. Net debt shot up 47% at the end of September from a year ago, which resulted in a four-fold spurt in interest costs to . 108.2 crore in the quarter. This could prove another drag on earnings, since there may be a lag in capacity utilisation. The other hurdle it faces is the rise in prices of domestically-produced natural gas starting April 2014, which could dent margins in the petrochemicals and LPGbusinesses. It isestimated that the company’s overall costswould goup by around. 1,350-1,400 crore annually on this count. Gail’s subsidy-sharing burden may be limited to what it has paid out so far in the fiscal year — . 1,400 crore. This means earnings may rise in the second half, then slide once gas prices goup in April. Ifthe governmentexemptsthecompany permanently from sharing in the subsidy, Gail could be in for a rerating — not because of any substantial jump in FY15 earnings, but due to reduced uncertainty.