Shiv Vani Oil: Exploring Hidden Wealth

Shiv Vani Oil seems to be an attractive choice for long-term investors considering strong visibility of earnings

INDIA’S largest service provider for onshore petroleum exploration, Shiv Vani Oil, continues to carry a fat order book, which gives great visibility to its future growth. Its flat performance in FY10 followed by a tepid June quarter has kept its stock market performance under check. However, the company is well poised to benefit from its huge capital expansion during the past couple of years. Long-term investors can bet on this stock.

BUSINESS: Shiv Vani Oil (SVOL) is India’s largest integrated service provider for onshore petroleum exploration and production. It offers services including collection and analysis of seismic data, well logging, cementing, mud engineering, directional drilling and well testing till actual extraction of petroleum and well maintenance. At present, the company has 10 seismic equipment sets, 350 shot-hole rigs and 40 drilling rigs. The company has also emerged as the leading integrated service provider for coalbed methane (CBM) development in India owning eight sets of modern directional drilling equipment. The company is executing a long-term contract in Oman for PDO and Shell, which has no expiry clause. The contract generates annual revenues of $18 million. More than 98% of the company’s domestic revenues come from national oil companies, which provide great visibility on its future earnings.

GROWTH DRIVERS:

The company currently carries an order book of 3,000 crore, which is nearly two-and-a-half times its consolidated revenue for FY10. Further, a number of more contracts has come up for bidding, which will be awarded post monsoon. The company, being a dominant player, is certain of grabbing a lion’s portion.

With all its equipment deployed on various contracts, SVOL has already started preparing for acquiring additional assets that will be required in carrying out additional contracts. It recently raised $80 million through the issue of FCCBs, which can be utilised in buying more drilling rigs. The company has historically followed the practice of buying new assets only when they have firm orders in hand.

As the company’s seismic equipment remains idle in India during monsoon, it is proposing to transfer them to Middle East for four months from next year. This will enable the company to earn additional revenues.

FINANCIALS:

The company has incurred heavy capex in line with inflow of orders, which has more than tripled its gross block in the past two years. Bond conversion and preferential allotments have resulted in 20% equity dilution since 2008. The recent FCCB issue is likely to dilute equity by another 15% when converted.

During the past five years, the company has expanded its net profit at a cumulative annualised growth rate (CAGR) of 76%, while the net sales grew at 58%. The company has consistently increased its operating profit margin from 32.4% in FY04 to 44.9% in FY10. However, the spurt in interest and depreciation burden in FY10 has resulted in a fall in the net profit margin. The company’s June 2010 quarter numbers were dull, as some of its ongoing contracts faced delays on asset relocation.

VALUATIONS:

At its current market price of 443, the scrip is valued at 9.1 times its profits for the trailing 12 months. Considering its growing asset base and the contracts in hand, SVOL is likely to end FY11 with net profit of around 282 crore. As the company continues to generate positive cashflows and retires debts, its net profit margins are likely to improve. The current market value is just 8.4 times its expected profit for FY11 on fullydiluted equity. This makes SVOL an attractive bet for investors.

Reliance Industries: FACING A HOST OF WOES

After commissioning two mega-projects, Reliance Industries has hit a few roadblocks which could affect its profitability

Although Reliance Industries (RIL) finally succeeded in commissioning its megaprojects — natural gas production from KG basin and Reliance Petroleum refinery — they both seem to have run into a stormy weather. A large chunk of the KG basin gas continues to remain embroiled in legal hassles, while the RIL-RPL merger may get delayed due to shareholder objections. The recent Union Budget carried some bad news for the company, the global outlook for its business remains weak and its other businesses — Retail and SEZ — are going nowhere. The scrip has already lost a sixth of its value over last one month, but in view of these recent developments the valuations still appear rich and long-term investors should consider buying it only on dips.

RECENT EVENTS
Over last three months, RIL has commissioned his two mega projects – RPL refinery and KG basin gas – involving investments of around $18 billion. However, since then the things have progressed adversely for the energy giant. The Mumbai High Court granted an unfavourable verdict to RIL in its row against RNRL over the supply of 28 million cubic meters per day (MCMD) of natural gas at a price 44% lower to its current price. The matter is now being debated in the Supreme Court. The company is also fighting a similar court battle against the power major NTPC over another 12 MCMD of gas. At the same time, the company’s proposed merger with Reliance Petroleum is getting delayed following objections raised by some shareholders. The Union Budget for FY2010 introduced income tax exemption on production of natural gas, however, restricted it to blocks awarded under the 8th round of NELP. This deprived all earlier blocks — including RIL’s KG-D6 block — of tax exemption. To add to the woes, the Budget also proposed an increase in the Minimum Alternative Tax (MAT) to 15% from earlier 10%. And while the company is battling these odds, the business environment for refining as well as petchem continues to weaken. RIL’s only solace is thatRNRL’s power plants are not yet ready, which would allow it to sell natural gas at current prices for next 2-3 years.

BUSINESS
The company currently operates 33 million tonne per annum (MTPA) refinery at Jamnagar and has recently commissioned another 29 MTPA refinery under Reliance Petroleum. With both the refineries running concurrently, they now represent world’s largest single location petroleum refining complex. As the new refinery is set up in SEZ, the company has surrendered its status as an Export Oriented Unit (EOU) from April 2009. Over last few years RIL has entered aggressively in organized retail opening around 900 stores across 80 cities - an industry, which is witnessing entry of too many players and low profitability. The company is developing special economic zones in Haryana and Gujarat –another line of business, which has fallen out of favour.

GROWTH DRIVERS
The only hope for incremental growth comes from the company’s portfolio of E&P blocks. It is investing in exploration blocks in India as well as abroad and has also bagged a coal-bed methane (CBM) block. The potential hydrocarbon discoveries from these blocks will add value to the company. The newly constructed refinery, being more complex compared to the first refinery, will help command a better margin for the company. The company’s full integration from petrochemicals to refining to E&P will allow it to perform better in the times of uncertainty.

FINANCIALS
For the year ended Mar 09, the company reported a net profit of Rs 15607 crore marginally better than previous year afte.r removing the extraordinary items. The company’s operating profit margins weakened reflecting the weak economic conditions. The capacity utilisation at the company’s refinery too came down in the second half of the year with weakening gross refining margins. The company, which reported $15 a barrel GRM in FY08, could post only $12.2 in FY09. Similarly, the production of polymers too was 9% lower in FY09 at 3.07 million tonne.

VALUATION
At the current market price of Rs 1934, the scrip is trading at 19.4 times its earnings for the year ended March 2009. However, its per share earnings (EPS) is set to jump to Rs 130 for FY10, which discounts the current market price by 14.9 times.

Gujarat State Petronet: Growth in the Pipeline

Gujarat State Petronet is likely to emerge as a key beneficiary of rising availability of natural gas in the country. This makes it an attractive investment in the long term

GUJARAT STATE Petronet (GSPL) is India's only company that transmits natural gas for its clients without trading in it. The company's longterm contracts with Torrent Power and Reliance Industries (RIL) for transmission of natural gas are likely to become effective in the March 2009 quarter, which will boost its profits substantially.

BUSINESS:
GSPL's 1,130-km pipeline network is spread across the state of Gujarat and connects natural gas producers on the west coast of Gujarat to their clients in nearly 33 districts of Gujarat. Some of GSPL's prominent clients are Gujarat Power, Essar Steel, Essar Power, Arvind Mills, GNFC and GSFC. The company operates its pipeline network on an open access basis and is not involved in buying and selling gas.

GROWTH FACTORS:
Presently, GSPL transports about 17 million metric standard cubic metres of gas a day (MMSCMD), which will double once its contracts with RIL and Torrent Power become effective. GSPL has signed a 15-year agreement with RIL to transport 11 MMSCMD and another contract with Torrent Power to transport 4.5 MMSCMD for 20 years. Torrent Power's 1,147.5 MW Sugen power plant is scheduled to commence operations in the quarter ending March 2009. In the same quarter, RIL is also slated to start production of natural gas from the KG basin. The company is extending its pipeline network to 2,000 km by 2010 at a capex of Rs 1,900 crore. With the Petroleum and Natural Gas Regulation Board (PNGRB) now in place, the company will get competitive advantage while bidding for new projects in the adjacent areas. GSPL's return on capital is low at present. So, there is little risk that GSPL will have to reduce transport tariffs in future. GSPL also holds strategic stakes in gas distribution companies in three cities-two in Gujarat and one in Andhra Pradesh. Over the next two years, the availability of natural gas in India is expected to double. Apart from RIL's gas, Petronet LNG's project to double its regassification capacity to 10 million tonnes per annum is likely to be completed in January 2009.

FINANCIALS:
The natural gas transported by the company grew 17% from 14.6 MMSCMD in FY '07 to 17.1 MMSCMD in FY '08 but has stagnated since then. This is mainly due to the stagnation in the availability of natural gas and situation is likely to improve in the near future. The company has consistently increased its revenues per unit of gas transported. The company is currently carrying a debt of around Rs 1,200 crore at an average cost of 9.5%. The company has been consistently generating healthy cash flows from operating activities.
Being capital intensive, interest and depreciation are the most important costs for the company, which grew at a CAGR of 33.7% and 42.3%, respectively, in the last five years. During the same period its net sales grew at a CAGR of 31.4% and pre-tax profit grew at 70.3%.
GSPL currently assumes 12 years of working life, which increases the annual depreciation charged on its pipelines compared to 30 years working life assumed by India's largest gas transporter GAIL. This indicates the need to examine GSPL's cash profits rather than its book profits for its valuation. The company's cash profits have grown at a CAGR of 58.6% in last five years.

VALUATIONS:
The company is likely to post a 21% increase in its gas volumes in the second half of FY '09 to 20.6 MMSCMD. This will drive its H2 FY '09 revenues 36% up on y-o-y basis to Rs 309 crore. The net profit for the period is expected to go up 40% to Rs 91.8 crore. As a result, the company is expected to end FY '09 with an EPS of Rs 2.7 and cash EPS of Rs 5.8. The current price of Rs 34.8 translates this to a P/E of 12.7 based on book EPS and just 6, if we consider the cash EPS.

KEY RISKS:
The company is currently conducting a postal ballot seeking shareholders' view to contribute 30% of pre-tax profits for social development as requested by the chief minister of Gujarat. Presently, 50.2% of the company's equity capital is held by five companies, which are controlled by the Gujarat State government. The company's EPS will erode proportionately, if its shareholders accept the resolution.

Gail: Lots In The Pipeline

Gail is a low-risk investment option with immediate growth triggers. Its current valuations are attractive for long-term investors

EVEN AMIDST the current market uncertainty and financial turmoil, Gas Authority of India (Gail) stands out as a low-risk investment option with immediate growth triggers. We had recommended this stock in our edition dated March 17, ’08. Although the scrip has not lost much in the recent meltdown — declining around 10% since our recommendation, against a 32.6% fall in the Bombay Stock Exchange (BSE) Sensex — its current valuations are attractive for longterm investors. Gail enjoys a monopoly status and an inherent pricing power in cross-country natural gas transmission, as it owns India’s largest gas pipeline network. The fact that it is a government-owned, diversified and cash-rich company improves its risk profile. Reliance Industries’ (RIL) natural gas, which is expected to start flowing from the fourth quarter of FY09, will benefit Gail to a great extent. Natural gas is a cheaper and better alternative to liquid fuels and there is a huge unmet demand in India. As a result, the company will enjoy the twin benefits of sustainable growth, while keeping risks low, even in times of a global financial turmoil and economic slowdown.

BUSINESS:
Gail’s business model is well-diversified as it operates in the entire natural gas value chain from processing, transporting and marketing, to producing liquid hydrocarbons and downstream petrochemicals. It is going in for the last step in backward integration of producing natural gas and has invested in 29 exploration blocks and three coal bed methane (CBM) blocks.
As part of its diversification in natural gas-related businesses, it has invested in liquefied natural gas (LNG), gas-based power plants and gas retailing through city gas distribution (CGD) projects. Its wholly owned subsidiary, Gail Gas, is setting up a compressed natural gas (CNG) corridor on the country’s national highways.
The company is already connected with all the natural gas supply points — Dahej and Hazira in Gujarat, Uran in Maharashtra and now Kakinada in Andhra Pradesh. This makes it a natural transport partner for any large producer or consumer of natural gas. Gail is now laying pipelines on the west coast, which will connect future LNG terminals at Dabhol and Kochi to the national gas grid. In a bid to diversify geographically, the company has gone to countries like China and Mongolia to implement CGD projects. Gail produces liquefied petroleum gas (LPG) — one of the heavily subsidised petroleum products in India — and has to suffer a portion of the under-recovery. However, over the past couple of quarters, Gail’s subsidy burden has remained flat, despite the spurt in global oil prices, which is directly helping its liquid hydrocarbons business. We expect that even in future, Gail’s subsidy burden will remain at present levels, which will allow the company to post decent profit growth.

GROWTH DRIVERS:
At present, the company transports over 82 million metric standard cubic metres per day (mmscmd) of natural gas, produces 1.3 million tonnes (mt) of liquid hydrocarbons, including LPG, and nearly 4 lakh tonnes of polyethylene. The company has recently expanded its polyethylene capacity by 25% to 5 lakh tonnes, which will be gradually scaled up to 8 lakh tonnes.
Gail has embarked on an ambitious plan to invest over Rs 28,800 crore by ’12 to expand capacities in areas such as pipelines, exploration & production (E&P), petrochemicals, city gas projects, LNG etc. This entails doubling the natural gas transmission capacity, covering over 200 cities under CGD, 60% expansion of petrochemicals capacity and expanding LNG terminals.

FINANCIALS:
Since FY05, Gail’s net profit has witnessed a compound annual growth rate (CAGR) of 11.2%, while its sales grew 10.7%. In the quarter ended June ’08, the company posted 31% profit growth to Rs 897 crore, on the back of a 35% jump in sales to Rs 5,731 crore. The company’s LPG and liquid hydrocarbons business, which was making losses in FY07, has witnessed substantially superior profit margins in FY08; in the first quarter of this year, its profit margin touched nearly 40%. Similarly, the natural gas transmission business is showing a steady increase in profit margins. The company recently issued bonus shares in the ratio of 1:2. If the company maintains a 100% dividend policy, as in the past three consecutive years, its dividend yield will be a decent 4% at the current market price (CMP).

VALUATIONS:
At the CMP of Rs 243.65, the scrip is trading at a P/E multiple of 11. We expect the company to close FY09 with an earning per share (EPS) of Rs 26.1 and FY10 with an EPS of Rs 32.3. The CMP is 9.3 times the expected FY09 EPS and 7.5 times the expected FY10 earnings. At the same time, nearly 30% of Gail’s market capitalisation is represented by the value of its investments and cash. Hence, its core business is available at even cheaper valuations. Existing investors are advised to stay invested in the stock.