Govt Ratnas Fail to Sparkle on the St

Due to undervaluation of such stocks, govt could raise only . 1.4k cr of the planned . 40k-cr, thereby derailing divestment plan

As the financial year enters the last quarter, the Indian government is struggling with its fiscal deficit. By the end of November, this had reached 94% of the FY14 target with a third of the year left. One disappointment has been asset sales. The divestment of shares in state-owned companies, from which the government had budgeted to raise . 40,000 crore, has only yielded a paltry . 1,400 crore so far in the year.
That’s not surprising considering the significant and consistent erosion in the value of the Maharatnas, Navratnas and Mini-Ratnas, designated as such because they are supposed to be the best public sector undertakings (PSUs). The Navratna title was originally conferred on nine companies that were seen as capable of becoming global leaders and were given more financial freedom than their peers to achieve this stature. The other two titles were created as more companies were identified and slotted into the categories depending on their size.
An ET Intelligence Group analysis shows that the market capitalisation of the Maharatnas – a grouping of the seven biggest government companies, all of which are listed – dropped 17% in the last one year, when the BSE Sensex gained more than 4%. The listed Navratnas, 12 in number, lost 14.5% in value while the worth of 14 listed Mini-Ratna companies plunged 56%. Over a three-year period, the underperformance is even more stark. The Maharatnas dropped 25% in the three-year period, the Navratnas were 30% cheaper and the Mini-Ratnas lost 68%, while the BSE Sensex was up more than 13%.
All the seven Maharatnas — Bharat Heavy Electricals, Steel Authority of India, Oil and Natural Gas Corp, Indian Oil Corp, GAIL, NTPC and Coal India —have lost market capitalisation in the last 12 months. GAIL lost the least (6.4%) and IndianOil the most (33.2%), which is why the petroleum ministry recently opposed plans to sell shares in the company. 
All the listed Navratnas lost value, with Power Grid Corp losing the least (less than 1%) and Mahanagar Telephone Nigam dropping the most (38.6%). Among the Mini-Ratnas, Dredging Corporation and Container Corporation of India were the only two generating positive returns for investors, each gaining more than 18% in the last one year, while ITDC and MMTC lost more than 90% of their value.
This degree of value erosion and the underperformance relative to the rest of the market are why the government has been hesitant about pursuing its divestment programme. Apart from the proposal to divest a 10% stake in IndianOil being deferred again last week, the listing of Navratna Rashtriya Ispat Nigam has been put off indefinitely.
Some of the reasons for the poor performance are business related.
“Most public sector companies operate in the domestic arena and are not export-oriented,” said Dipen Shah, head of research, private client group, Kotak Securities.
“With the domestic economy not doing well, the performance of these companies has suffered. There are various issues -- for example, oil companies are hit by subsidies, power companies by lack of fuel supply and engineering companies by projects getting delayed.”
The problem with the companies is also systemic in nature.
“The underperformance has always been a reflection that ownership and management need to be divergent,” said Gaurav Parikh, managing director of JSA Advisors, a Mumbai-based boutique investment advisory. “As long as it’s government-owned and managed, there will be corporate governance issues and government interference in the operations and toplevel appointments and paralysis in decision making,”
The government is now planning to set up an equity-traded fund (ETF) for state-owned companies to raise . 3,000 crore. This will hold shares of 11 PSUs with ONGC carrying the highest weightage. The acceptance of such a product and its success will depend on the performance outlook of each company, which doesn’t look too bright right now. “In my opinion, the underperformance will continue for the next year or two as India grapples with macroeconomic issues of high inflation, rupee depreciation and low GDP growth rate,” said JSA Advisor’s Parikh.
Shah of Kotak Securities sees most of these companies doing better once incremental reforms take place and procedural bottlenecks are removed. “PSUs definitely remain good longterm bets, but in the short-to-medium term, there is a lot of uncertainty over their performance,” he said. “Even within PSUs, those with a stronger balance sheet or high cash balance are more preferred over the rest.”

New Projects to Fire Up Mangalore Refinery’s Growth in Next Fiscal

Securing steady supply of power will help MRPL to shrug off a two-year lean patch

Mangalore Refinery & Petrochemicals (MRPL) is looking for a turnaround in the next fiscal year after a tough two-year period, with its top executives pinning their hopes on likely commissioning of some long-delayed projects to drive growth. This could also help the company’s badly-bruised stock price.
MRPL completed its third phase of refinery expansion two years ago, only to realise that a captive power plant needed to run the additional units was not ready. The new units were built to improve the company’s flexibility in processing heavier, but cheaper, crude oil that will help it improve profitability. The refinery units are awaiting the availability of uninterrupted steam and power supplies for carrying out their pre-commissioning and commissioning activities, the company said in its latest annual report released in August.
Things have gradually progressed since then. “The main reason for the delay (in commissioning the new units) was the captive power plant being built by BHEL, which is partially functional now but will take some more time to become fully operational,” said VG Joshi, director of refineries.
Getting a steady supply of power will allow MRPL to go ahead with commissioning its fluidized catalytic cracking unit, delayed coker unit and sulphur recovery unit, which will help it process high TAN and heavy crude, increase distillate yield by upgrading lowvalue naphtha and black oils, produce value-added products like propylene and upgrade its diesel output to Euro III/IV grades.
In will likely bring huge benefits for the company. “The commissioning of these units by January 2014 will add $3 a barrel to our gross refining margins,” said managing director PP Upadhya.
Besides, it will also allow commissioning of its 440,000-tonne-a-year polypropylene unit. “Once these units are up and running smoothly, we will be able to commission the polypropylene unit by around July 2014,” Joshi said. According to him, by March 2014, the units will achieve a 60% utilisation level, which will be scaled up to 100% over two-three months after that. The company also recently commissioned a single-point mooring facility, which will enable it to import crude oil in very large tankers from far off places like West Africa and Latin America.
On an expanded capacity of 15 million tonnes a year, these additional benefits could translate into significant gains on its balance sheet. A $3-a-barrel gain in refining margin would mean an incremental operating profit of . 2,000-2,300 crore on an annualised basis. The delays in project commissioning and ongoing capital expenditure had resulted in the company’s debt-equity ratio shooting up from 0.2 at the end of fiscal 2011 to 1.7 as of September 2013. Its interest burden jumped from 5% of operating profit in fiscal 2011 to 71% in fiscal 2013. Commissioning of these long-delayed projects will help ease the situation.
The stock closed trading Thursday at . 41.25 on the BSE, compared with its 52-week high of . 69.50. 

Weak Rupee Negates the Gains of a Soft Crude Oil Price Regime

As the year draws to a close, global crude oil prices appear to have remained rangebound through the year at close to the $105 per barrel-mark. There are several factors curtailing further growth in oil prices, but India has steadily witnessed a rise in under-recoveries as the rupee weakened. The quarter to December is likely to end with higher under-recoveries or sales of products at below cost by state-owned oil companies compared with the earlier three quarters of 2013.
Through 2013, crude oil prices climbed to $113 in the first quarter and then fell to $99 levels in the second quarter, while the last two quarters saw the prices move between $103 and $107 per barrel.
Rising production in the US, growing spare production capacity at OPEC and an expected slowdown in consumption on weak economic growth have all depressed oil prices. However, supply-side problems and unplanned production outages have helped oil prices stay high. Even the recent nuclear deal between Iran and six western countries did little to ease crude oil prices. Nevertheless, the impact on the Indian companies has been negative, as the under-recovery on selling fuels below cost has continued to soar.
For the October-December 2013 quarter, the domestic industry is estimated to lose at the rate of . 440 crore daily or approximately . 40,000 crore, which in the first three quarters averaged below . 32,400 crore.
The main reason for this rise in underrecovery is a sliding rupee, which averaged close to 54.8 against the dollar at the start of the year, but dropped to 62.5 in December, marking a 14% drop in value. The outlook on crude oil production is favourable in the near term as the shale revolution continues to grow in the US and countries such as Iran and Iraq are able to ramp up output. However, that doesn’t necessarily translate into a drop in oil prices ahead, particularly since a large number of old wells as well as the new deep water exploration efforts call for high prices to remain commercially viable.
The world economy is expected to grow at 3.5% in 2014 compared to just 2.9% in 2013. This has already started pushing up oil demand.
Paris-based International Energy Agency upped its estimate for global oil demand for 2013 by 130,000 barrels per day (bpd) in the last month of the year on stronger than expected demand from industrialized nations. It also noted a fourth consecutive monthly drop in OPEC production to 29.73 million barrels per day (mbpd) for November, although the group agreed in December to leave its production target unchanged at 30 mpbd.
For India, this global stability means little as the baby steps the government is taking to curtail fuel subsidies are proving futile due to a weakening rupee. The fair weather window in the global oil markets is likely to remain open in the next few years, with low oil price volatility. By 2020, India is set to become the single largest growth driver for global oil demand, when it surely won’t be able to carry on with under-recoveries like now.

Accountants’ Battle Flares Up with Cos Act

Chartered & cost accountants lobbying to sway decision-making with Act’s provisions seemingly limiting scope for the latter

The rivalry between the two accountancy streams — cost and chartered — has escalated into a battle over what one group perceives as the machinations of the other to cut it down to size. At the heart of the dispute is the new Companies Act, the provisions of which have curtailed the scope of the cost auditors. 

Ranged on opposite sides of the dispute are two groups that share an acronym and a profession – the Institute of Chartered Accountants of India and the Institute of Cost Accountants of India.
Both are currently engaged in hectic lobbying to sway decision making, according to officials in the ministry of corporate affairs (MCA) and other stakeholders.
Suresh Chandra Mohanty, president of the cost accountants’ institute, told corporate affairs minister Sachin Pilot in a November 22 letter that the elected members of the institute may resign en masse if the ministry did nothing to protect its interests. EThas a copy of this letter.
Cost accountants say they feel betrayed by the latest turn of events. An expert panel set up by the ministry in 2008 to review the cost audit mechanism had made certain recommendations about widening the scope of such checks. To start with, only 44 specific industries and businesses — in which administered prices, subsidies, regulation and strategic public interest are involved — had been covered by cost accountants. The field was enlarged through various notifications in 2011 and 2012 as per the suggestions of the expert committee.
However, draft rules issued by the ministry in November under the newCompanies Act roll back these changes. Mohanty described the draft rules as “de-facto withdrawal of recognition” in a November 23 press release.
By definition, this branch of accounting analyses costs such as raw material, wages and marketing that a company incurs and establishes a link with the profit margin it earns. In the process, companies get better clarity on costs, making them easier to control. Cost accountants say the audit process helps authorities build authentic cost data on industries, which could be used in instances such as controlling drug prices, setting tariffs, plugging tax leakage or sniffing out fraud. Chartered accountants look at the company’s books and validate balance sheet.
Cost accountants feel that their utility won’t be realised fully if more than 96% of the corporate sector is kept out of their purview as proposed in the latest draft rules. They believe cost audits play a critical role in ensuring good fiscal behaviour. Chartered accountants, on the other hand, say cost audits are intrusive and blur the lines of accountability — to the extent that two sets of auditors look at the same data — besides making it difficult for companies to do business.
While both look at the same data, their approach is different. Statutory auditors need to give their opinion on whether the balance sheet gives a “true and fair view” of the financials, since the accounts are based on a number of assumptions. The work of cost accountants is more focused as they certify the actual cost of production of a product or service based on actual payments made.
Chartered accountants say they also uphold responsible business conduct and good governance.
“The purpose of company law is not to micro-manage business aspects. In an era where competitiveness is essential, no business appreciates intrusion, burdens or regulations which add to complexity of business without true value addition,” said a member of the chartered accountants’ institute.
Industry is mostly in favour of the new draft rules as it feels these are less onerous.
Applying the cost audit mechanism to products and services through a statutory diktat would be in direct conflict with recent growth-oriented economic policies, said Sidharth Birla, president-elect, Federation of Indian Chambers of Commerce and Industry (Ficci).
Such rules may be regarded with suspicion by the overseas investors that India has been trying to woo, he said. Added a Mumbai-based industrialist with interests in fast-moving consumer goods, “What have such regulations achieved other than to provide income to one profession?” Chartered accountants say Pakistan is the only other country that has mandated the maintenance of cost records and cost audits for business entities.
Cost accountants say the animosity of chartered accounts is of long standing.
“Way back in 1959, when the Institute of Cost and Works Accountants of India was enacted under a statute of parliament, the (Institute of Chartered Accountants) in its representation had stated that no such profession existed in India or anywhere else in the world,” said a past president of the cost accountants’ institute.
It “had then said that cost accounting was only a specialised branch of accountancy,” this person said, quoting the protest made at the time, “By a mere enactment, a profession which does not actually exist cannot be brought into existence.”
Cost records provide information that’s useful for running businesses efficiently, said PR Ramesh, chairman, Deloitte India. However, extending such audits widely may be counterproductive.
“While it is desirable that all entities maintain cost records, it would be appropriate if legislation mandated such maintenance only for businesses which operate in critical sectors or which are in receipt of subsidies from the state,” he said. “In a free-market economy, businesses should be free to determine what systems and processes they need, considering the benefits they perceive are derived from maintenance of such systems and processes.”
Cost accountants say they didn’t get a chance to represent their case when the draft rules were being drawn up.
Rakesh Singh, central council member of the institute and its president until July, told ET that no formal invite was received from the corporate affairs ministry to join the rules committee.
Singh said he wrote to the ministry in May when he came to know about what he described as misconceptions being spread about the cost audit mechanism. The institute then submitted its suggestions formally to the ministry.
“Both communications appear to have been ignored when preparing the draft rules,” Singh said. “The MCA has a specialised department on cost, but I doubt if their views were also considered at the time of finalising the draft rules.”
The committee that drew up the draft rules was made of representatives from the corporate affairs ministry, industry, the professional institutes, besides domain experts in law and capital markets, said additional secretary Mohan Joseph. 

Issues with Govt Still Weigh on RIL

Index heavyweight Reliance Industries continues to underperform the broader benchmark index Nifty 50 even in FY14, continuing its subdued trend over the past four fiscals. Although brokerage houses have started revising their views in the past four months, the stock remains range-bound due to a few concerns. Investors will do well to wait and watch.
Despite a significant weightage on benchmark indices such as Nifty 50 and the BSE Sensex, Reliance Industries has gained just 1% during the past three months, against the 11.5% gain in the Nifty and 10.4% in the BSE Sensex. A Bank of America Merrill Lynch report said that RIL stock price has underperformed the BSE 30 by 98% since April 2009 due to its weak EPS growth (CAGR of 4% for FY08-13) and de-rating of its E&P. Even after its continued underperformance, analysts in brokerages have been bullish, of late.
According to data compiled from Bloomberg, just 50% of 56 brokerage analysts tracking the company had a ‘Buy’ recommendation at the start of September 2013. This has gone up to over 62% now. However, the improvement in ‘Buy’ recommendations has not been supported by any improvement in the target price. The average one-year forward target price was . 975 – or 14.3% above the then prevailing price – at the start of September, which stands at . 985 – or 13.2% above its closing price on Thursday. In other words, analysts are being bullish without really raising the target price.
This could be interpreted as an improvement in terms of visibility over future earnings, but earnings growth itself will be high. RIL has embarked upon an expansion programme and expects doubling of natural gas prices starting April 2014 and its forays in retail and telecom are close to reaching critical mass.
A Morgan Stanley report said that RIL is set to double its profits over F13-17e driven by higher gas prices and volumes and downstream expansion, with one of the most aggressive price target of . 1,156, or 33% above the current level. These bullish recommendations apart, investors are not biting owing to anumber of concerns. Concerns on implementation of the gas price increase and RIL’s dispute with the government on ‘cost recovery’, besides a weak outlook in refining margins over the next couple of years are reasons to worry. The BoAML report said that RIL’s FY15-16e GRM could be significantly lower than assumed and its gas price may not be hiked in April 2014. In that case, RIL’s FY14-16e EPS CAGR may be much lower – at 2-12% – as compared to our base case of 17%, it warns. Retail investors would be better off waiting for more clarity on these issues . 

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.

ESSAR OIL: Debt Remains a Worry Despite Improved Show

Essar Oil’s search for solace isn’t likely to end soon as its huge pile of debt continues to prove a drag on financial performance, even as the company is doing better operationally. September quarter numbers show a little improvement, but it needs to be seen whether this can be sustained. In other words, investors will need to be patient. With interest payments eroding earnings, what Essar Oil requires is either a sustainable spurt in operating cash flows or a restructuring of its debt burden. The company has been working on both these aspects for several months but it is taking much longer than earlier anticipated. Total net debt at the end of September was almost the same as it was six months before, but net worth — shareholders’ funds — stands eroded. Plans to raise dollar-denominated debt to repay that denominated in rupees to lower interest costs and extend the tenure also didn’t make much progress during the quarter. It converted loans worth just $50 million; it needs to raise an additional $1.4 billion. Nevertheless, the company’s ability to generate free cash flows could be improving, as it has put up a strong operating profit show, while interest costs appear to have softened. On a sequential basis, operating profit was up almost 45% to . 1,595 crore, while interest costs dipped 19% to . 766 crore. These two key trends need to be sustained. Foreign exchange losses of . 773 crore saw the company post another net loss in the September quarter. Gross refining margin (GRM), the differential between the price of refined products sold and the cost of crude oil needed to produce them, slipped to $6.93 per barrel from $7.86 in the year ago. The company is betting on improving GRM in coming months to ease its cash flow position further, while continuing to push for the conversion of rupee debt to dollar debt. The global outlook for the refining industry doesn’t appear rosy with capacities getting added while demand growth is muted. Essar Oil, therefore, needs to achieve the debt conversion goal at the earliest to relieve some of the pressure on earnings. Investors will have to wait till the company starts making sustainable profit.

CAIRN INDIA: Lower Realisations, Worries Over Output Growth to Weigh

Exploration firm Cairn India’s earnings in the quarter to September failed to impress investors despite a 46% growth in net profit. That is because the company reported an unexpected drop in realisations, while output growth was muted. Cairn India’s ability to achieve production growth will hinge on timely regulatory approvals. Cairn’s production from its Rajasthan fields averages 174,245 barrels of oil (bopd) daily, which is just 1% above the April-June ’13 quarter. However, this is much lower than the 180,000 bopd rate the company reported in July, when it announced its Q1 FY14 results. This has stoked concerns relating to further production growth, inspite of the company maintaining its year-end production guidance of above 200,000 bopd. A note from India Infoline said that despite Cairn India bringing 26 new wells into production, volumes in Rajasthan were stagnant QoQ. The wells — Mangala and Aishwarya — produced 152 thousand barrels per day (kbpd), indicating a decline in Mangala at around 145 kbpd, while Bhagyam produced 23.5 kbpd, short of the approved 40 kbpd plateau, the note said. Apart from concerns about the natural decline at the biggest field – Mangala, there are worries about the second largest field Bhagyam as well. A report from Nomura points out that over the last one year, Cairn drilled 13 additional wells in the Bhagyam field, but without any increase in production volumes. The report says that while 79 of FDP-approved 81 wells are drilled, production is well below FDP-approved rate of 40 kbpd. The Field Development Plan, or FDP, is the government-approved plan of action with specified deliverables and costs. Another negative was the lower realisations for Cairn’s crude oil. The Rajasthan realisation stood at $96 per barrel, implying a discount to Brent at around 13% as against 8.3% in the April-June period and 11% in FY13, due to a weakness in fuel oil prices. The company’s progress in ramping up production will depend on timely approvals from its JV partner ONGC as well as the government. It has received approvals for drilling 48 infill wells in Mangala and 18 in the Bhagyam field, while it awaits approval to launch an Enhanced Oil Recovery programme in Mangala and FDP to develop Barmer Hill reservoir. Cairn also continues to explore in the Rajasthan block for incremental resources. Investors will keenly watch progress on these fronts to raise production.

CASTROL INDIA: Volume Growth Poses a Challenge

Castrol India surprised the Street with a strong 21.9% spurt in net profit in the July-September period despite the rupee and oil price volatility during the quarter. However, the company faces challenges with volume and revenue growth remaining stagnant. Operating profit rose 23.4%, thanks to margins widening by a dramatic 3.9 percentage points. The company’s fortunes have traditionally been tied to that of the commercial vehicles segment which, in turn, has been doing poorly because of the economic slump. Nearly 75% of Castrol’s 200-million litre volume is accounted for by commercial vehicles. On the other hand, in the personal mobility segment – two-wheelers and passenger cars – volume is growing at 10%. The wider margin is ascribed to this segment share shifting. “The stagnation in turnover is not abig concern, since it is not due to Castrol losing market share or its customer base,” managing director Ravi Kirpalani told ET. “We are improving our market share in passenger vehicles. Our rural initiative has added 9,000 new customers and 3 million litres of volumes of incremental sales in the last one year.” The company cut costs in areas such as advertising and promotion during the quarter, which also helped expand its margins. Castrol introduced RX Super Max Fuel Saver during the quarter, promoting it as the world’s first diesel engine oil recommended for fuel efficiency by a vehicle maker -- Tata Motors. “This engine oil is designed to increase fuel efficiency of Tata trucks by 1.5%. This means for a truck running 100,000 km per annum, it will save 375 litres of diesel, or 20,000 in running expenses,” Kirpalani said. The market’s reaction to the earnings was muted, given the likelihood of margin pressure on December quarter numbers as rupee and oil price fluctuations in August are likely to have a delayed impact on results.

PETRONET LNG: Underutilised Kochi Terminal, Pipeline Issues are Big Worries

The drop in profits of Petronet LNG in the quarter to September has already been discounted by analysts considering that the company had capitalised its underutilised Kochi terminal during the quarter. But the performance in the last quarter indicates that some of its operating challenges will not be easy to surmount in the near term and the stock is likely to underperform over the next three to six months.
Petronet LNG, which imports and sells liquefied natural gas (LNG) to local firms and has two terminals, encountered multiple headwinds during the quarter. A bout of rupee volatility resulted in a lower demand for imported natural gas leading to a 9% y-o-y drop in volumes to 123 trillion British thermal units (tBtu). Its long-term volumes were up 9% to 98 tBtu, but tolling and spot volumes were down 31% and 55% at 12 and 12.5tBtu, respectively. This translated into a 30% drop in operating profit at . 363.9 crore.
The company also commissioned its new 5-million tonne import terminal at Kochi during the quarter, which boosted its depreciation charge by 27.7% and interest burden by 22% from the year-ago levels. This led to a 40% drop in profit before tax and close to 42% at the net profit level, thanks to a rise in the effective tax rate.
The capacity utilisation at the new Kochi import terminal is going to be a big worry for the company due to the lack of adequate pipeline connectivity. The expected commissioning of the Kochi-Mangalore pipeline has been pushed to October 2014, compared to May 2014 earlier. There is no clarity on the Mangalore-Bangalore pipeline too. Until these pipelines become functional, the Kochi terminal’s capacity utilisation will remain below 10%. This will depress corporate earnings due to higher depreciation and interest costs. During the July-September ’13 period, the Kochi terminal incurred a loss of . 32 crore before tax, even though the terminal has been recognised as an asset in the books of accounts only from September 10, 2013. From the quarter to December this year, as interest and depreciation on this asset will be booked for the full quarter, it will put greater pressure on the company’s profitability.
Petronet LNG plans to add one more jetty at its Dahej terminal by May ’14, which would enable it to import 1.25 million tonne more annually. Similarly, its project to expand the Dahej terminal’s capacity by adding two more storage tanks will take 36 months to operationalise.
Most brokerage houses, including Kotak Securities, Motilal Oswal, Karvy Broking and Religare, remain bullish on the company’s future prospects with target prices ranging from . 142 to . 165 due to low valuations and on expectations that the domestic shortage of natural gas will favour Petronet LNG. Another brokerage Centrum Capital took a contrarian view recommending a ‘Sell’ on the stock with a target price of . 110 as the company “faces multiple headwinds which would lead to earnings pressure.” Investors should be cautious since the stock lacks any near-term positive trigger, while facing the challenge of pressure on profits. 

BPCL: Is it a Refining Stock or an Exploration Play?

While private sector companies are known to take that extra risk, diversify into newer areas even at the risk of inviting investors’ wrath, stateowned companies are happy in their comfort zone, anchored in their traditional businesses despite holding the biggest chunk of idle cash in the corporate world.
It’s in this context that state owned Bharat Petroleum’s gradual but successful move into the exploration & production (E&P) space needs to be looked at. After all, E&P business is vastly different from refining and marketing, although they form the same value chain.
In the next five years, the company will start earning much higher profits from its E&P business than the government-sponsored profits it can earn from its traditional business.
In 2010 huge natural gas deposits were discovered in a Mozambique offshore block. BPCL’s 10% stake in it is already worth over $2.2 billion, or half of the company’s value today. 
BPCL also holds between 10% and 20% stake in 10 blocks in Brazil, which have seen some exciting oil discoveries over the years. Although not certified yet, they are likely to be significant going by the technical details available.
By 2018, both these mega projects begin production, BPCL is likely to have a bigger source of profits than its conventional businesses.
Experts are already valuing the E&P portfolio steeply. In fact, most brokerage houses prefer BPCL as an investment candidate for its E&P success.
“BPCL remains our top pick,” mentioned a Barclays report in May 2013 attributing the preference to its undervalued E&P portfolio.
The oil reserves in Brazil will be known in the first half of 2014, according to a Motilal Oswal report. “Assuming the recoverable reserves at 500 mmboe, it is likely to add around 50 to BPCL’s share value,” it mentioned.
As more details trickle in, this changing face of BPCL will turn it into a winner for investors.

SINTEX INDUSTRIES: Lower Debt Key to Help Sustain Dramatic Rebound

The stock of Gujaratbased plastic goods m a k e r Si n te x Industries apears to be rebounding after hitting an all-time low of 16 last month – down more than 70% from a year ago. Over the past one month, the stock has reversed its direction, and its recent results appear encouraging.
    A key growth driver earlier, the company’s business contrac ted consistently over the past three years owing to delayed payments. This grew 8.7% to 263.3 crore during the quarter to September, which was cheered by investors. The other businesses — prefabricated structures, customs moulding and textile are doing reasonably well.
    Yet, the company needs to do a lot more. Its debt-equity ratio has not improved during the past six months. In fact, its net debt has gone up marginally while its interest cost for the quarter to September at 47 crore was the highest ever it paid in a quarter.
    If the euphoric run-up in the scrip has to continue, Sintex will need to improve on these parameters.

RIL’s Q2 Other Income Falls, But Still Too High

Changes in balance sheet or asset creation seen as more relevant to driving the company’s future growth

The earnings of Reliance Industries in the quarter to September were in line with analyst expectations and devoid of any surprise. As India’s second most valuable company maintains stability in its quarterly earnings, the changes in its balance sheet or asset creation will be more relevant to drive future growth. 

RIL has once again embarked upon an aggressive capital expenditure programme after it had added assets worth nearly . 25,000 crore in FY08-09. In the six-month period to September 2013, the company has already incurred a capital expenditure of . 20,154 crore, overshooting its FY13 capex of . 19,041 crore.
The higher capex has led to the company’s debt rising 16% from . 72,427 crore in March 2013 to . 83,982 crore at the end of September this year. The company continues to retain its cash-rich status However, the excess of cash over debt has dropped from . 10,548 crore at the end of March 2013 to 6,558 crore at the end of September this year.
In the September quarter, RIL reported a weaker performance in the refining segment with lower refining margins, while the petrochemicals division posted a robust performance, negating the impact of the lower refining margins. Other income, or income from sources other than the core business, at 2,060 crore were substantially lower compared to 2,535 crore in the quarter to June. This means the non-operating income now contributes just 30% of the company’s pre-tax profits as compared to 38% of previous quarter. This may be considered good for the company since the proportion of operating businesses in overall profitability has gone up. However, other income’s influence on profitability is still too high.
The company reported a sharp drop in polymer demand growth in India to just 1% year-on-year in the July-Sept quarter from 15% of April – June 2013. Growth was subdued and the anticipated festive season demand did not materialise fully, said a company release. Such a subdued demand growth, if it persists, could stoke concern, especially in view of capacity additions which the company is planning.
The results are unlikely to provide any direction to the company’s stock price, since they met most analyst estimates. “There was no surprise in RIL’s numbers. The markets have already factored in the results,” said Dhananjay Sinha, head of research with Emkay Global Securities. However, any updates the company’s management shares with brokerage analysts about its capex plans and timelines in a late evening meeting could influence the performance of the stock in the near term.