JAIN IRRIGATION: Co has to strike a balance between growth and debt

THE results of Jain Irrigation System (JISL) for the September 2010 quarter cheered investor sentiments on Monday as the scrip gained nearly 3% in an otherwise weak market. The company reported a 46% jump in its net profit for the quarter, traditionally its leanest. The stock is trading at more than 34 times its earnings for the past 12 months.
The company had reported losses in its subsidiaries for FY10, which had dampened the scrip’s performance over the past couple of months. The June quarter numbers, although operationally strong, was weak due to to forex losses. Against this background, the September quarter’s performance provided a muchneeded boost to investor sentiments.
Out of JISL’s outstanding loans of 1,941 crore, loans worth 750 crore are in foreign currencies. With currency rates fluctuating, the company has to book a mark-to-market loss or profit on these liabilities, which are notional in nature. These numbers influence the company’s quarterly earnings to a great extent. For example, in the June quarter, it booked a forex loss of 20 crore, which resulted in a drop in net profit drop when compared with the year-ago level. On the contrary, the strong net profit growth in the September quarter was helped by a 21.6 crore forex gain due to the rupee’s appreciation.
Discounting the effect of forex fluctuations, the company’s June quarter results were actually better than the September quarter’s. The company’s operating profit had grown by 31% in the June quarter; in the September quarter it grew by just 15% y-o-y. Nevertheless, the net profit at 62 crore made the September 2010 quarter the second-best quarter historically for the company after the March 2010 quarter, when it had posted a net profit of 117 crore.
The company’s agri-input business continued to do well with a 24% growth in sales and 45% growth in preinterest-and-tax profits during the September quarter. It was mainly a volume-led growth particularly in the micro-irrigation business, which contributes almost half of the company’s total turnover. As against this, the industrial inputs division registered a dip due to discontinuation of the polycarbonate sheet business last year.
The company plans to achieve over 25% growth at the topline level in FY11. Considering that the company is likely to generate two-thirds of its business in the second half of the year, it is expected to meet the target. The company is also spending nearly 400 crore in FY11 to expand its micro-irrigation capacities. As it continues to grow, managing its debts and the borrowing levels would remain the key challenge before it.

Acting In Sync

With the market poised to touch a new high, the performance of India Inc’s subsidiaries is more in alignment with their parent firms. ET Intelligence Group’s Ramkrishna Kashelkar guides you on how to evaluate the performance of corporate subsidiaries


DEAR Sir, the EPS given in your story at 13.9 appears to be incorrect. The actual data is 5.9. If this is wrong, then your recommendation is totally false. Please check the same and answer my mail,” wrote one of our readers in response to a stock idea story in Investor’s Guide recently. We were startled. We double-checked the numbers again. The mistake was at the reader’s end. The financial numbers referred to in the article mentioned by the reader were on a consolidated basis. What he was referring to was standalone numbers.
The incident, besides reconfirming our belief that readers of Investor’s Guide analyse every statement, every number that we put out, revealed an important fact. In the complex world of companies financials and their valuations, investors often feel confused about standalone and consolidated numbers. ET Intelligence Group attempts not just to demystify these terms, but also illustrates how these concepts can be used in investment decisions.

REALITY CHECK
Standalone financial numbers indicate the financial performance of a company as a single entity, while consolidated numbers comprise the numbers of its subsidiaries. These subsidiaries could be either acquired or floated and could be wholly or partially owned. It also takes into account performance of associate companies - firms in which the parent company’s control is less than 50%.
Since consolidated financial statements present an aggregated look at the financial position of a parent and its subsidiaries, they enable one to gauge the overall health of an entire group of companies as opposed to one company’s standalone position. Naturally, while calculating price-toearnings (P/E) ratio or evaluating a company, one must always look at consolidated results after deducting minority interest and not standalone results.
Why is it important to consider consolidated results? The main reason is that a company can have a significant chunk of its earnings or liabilities hidden in a subsidiary. For example, in case of Cairn India, the consolidated net profit in FY10 stood at 1,050 crore, while on standalone basis, there was a loss of 69 crore. This happened mainly because it had most of its producing assets under subsidiaries. The company has recently taken steps to merge a few of its subsidiaries with itself, thereby rectifying this aberration to a certain extent.
There will be several such examples. In the case of leading companies such as Sterlite Industries, United Phosphorous, Jindal Steel, Hindalco, Tata Power or Grasim Industries, subsidiaries contribute substantially to their total kitty. It will be erroneous to calculate their P/E ratio or per share earnings using standalone numbers.
However, if you are an investor who gives more emphasis on the track record of dividend payment or bonus issues when investing in stocks, you need to focus on standalone numbers. This is because the annual dividends or issue of bonus shares come from the earnings of the standalone entity, and not consolidated.

RETURN TO PROFITS
The performance of India Inc’s subsidiaries has started improving, of late, which till a year ago, proved to be a burden. Indian companies’ overseas acquisition drive over the past few years had created a number of subsidiaries which underperformed in 2008 and 2009 as the going got tough due to a slowdown. However, we see a turnaround in FY10 and beyond.
In the sample of BSE 500 companies, we found 217 companies providing annual consolidated and standalone numbers for the past five consecutive years. These companies were showing consolidated performance slightly ahead of their standalone numbers in FY07 and FY08. The scene changed in FY09 with consolidated numbers falling more than the standalone ones.
In FY10, the group’s aggregate consolidated profits grew 23% y-o-y as against 19.7% growth at the standalone level indicating a revival. This revival in subsidiaries was accompanied by an improvement in the operating profit margins, with stagnated interest cost.
Two companies, NDTV and 3i Infotech, reported net losses on standalone basis, while profits from subsidiaries helped them post positive numbers. In the case of Suzlon, the profits in subsidiaries were not sufficient to make up for the loss on a standalone basis. As many as 74 companies, or a third of our sample size, still had a net loss in subsidiaries during FY10 - the largest being that of Tata Steel. Its subsidiaries, which include European steelmaker Corus, incurred a loss of 7,056 crore in FY10 as against the company’s standalone profit of 5,046 crore.

WRITING ON THE WALL
Going by the quarterly numbers, one can find the companies where the performance of subsidiaries has started improving, of late. For example, Tata Steel’s losses from subsidiaries turned into profit since the March 2010 quarter. Its results for the September 2010 quarter, which will be announced later this month, will be substantially superior on a y-o-y basis, considering the 3,610 crore of loss its subsidiaries had booked last September.
The problem is that several companies do not publish their consolidated numbers on a quarterly basis. For example, India’s leading electrical equipment manufacturer, Havell’s India, announced a turnaround of its important subsidiary, Sylvania Europe, in the September quarter, which was in the red earlier. The company’s press release mentioned that for the quarter, a consolidated loss of 14 crore last year turned into a net profit of 71 crore. However, the company had stopped publishing quarterly consolidated numbers after FY09. Together They Unlock Value
IN OUR sample size, quarterly consolidated numbers are available for nearly 150 companies. Tata Motors is a leading example of how a turnaround in subsidiaries is boosting its earnings. The turnaround of Jaguar Land Rover (JLR), over the past couple of quarters, has led to the subsidiaries contributing nearly 80% of its quarterly profit. Similar is the case with Dr Reddy’s Lab. After posting an operating loss in the December 2009 quarter, it has reported a gradual improvement at the operating level in the subsequent quarters. In the September 2010 quarter, it reported a healthy operating margin of 22.7%, thanks to improvement in its subsidiaries. Lupin, Mercator Lines, United Phosphorous are similar such examples of firms that have seen turnarounds in their subsidiaries in the past few quarters.

VALUE UNLOCKING
Sometimes subsidiaries are also like hidden gems as the value in them can be unlocked in due course and can give a booster to the parent company’s valuation. For example, a recent IPO of Orient Green Power (OGPL) might have lost money for its investors, but boosted the valuations of its parent Shriram EPC. The company’s market capitalisation gained 50% within a span of just two months on OGPL filing the draft prospectus in April 2010.
There are several other companies planning to unlock value in their subsidiaries at an opportune moment. The engineering behemoth L&T has long been planning to list its various subsidiaries, particularly the IT and finance ones, to unlock value. Other companies, such as Ballarpur Industries, GE Shipping and Glenmark, have plans for listing their subsidiaries.
This analysis takes us to a method of choosing the future winners. Companies - particularly those which publish consolidated numbers only once a year - are likely to be undervalued if fortunes of their subsidiaries have changed. Investors should, therefore, do well to know the businesses and geographies of the key subsidiaries of companies and track their performances consistently to make investment decisions. Remember that investors of Tata Steel, when it had posted its largest consolidated quarterly loss in the March 2009 quarter, would have tripled their money by today.

Exploring Growth Avenues

11th October 2010

Exploring Growth Avenues

From $6 billion in 2006 to $14 billion today, Cairn India’s valuation has gone up strongly. But the road had been full of hurdles. The company’s Executive Director & CFO Indrajit Banerjee talks about the company’s future growth plans and the challenges of the past in a telephonic interview with ETIG’s Ramkrishna Kashelkar. Excerpts:

What were the key challenges involved in executing the Rajasthan project?

Developing the Rajasthan field in the middle of desert was an enormous task. In 2007, it was one of largest onshore developments globally. And implementing it, while balancing out various uncertainties, was a huge challenge for the management. We had several key regulatory issues that lacked clarity. There was total uncertainty on evacuation of oil. On top of it, the project cost started soaring. Then there was the economic turmoil, credit crunch and crash in oil prices that created hurdles for fund raising. All this had to be considered while devising the best exploration and development methods. A lot of efforts went into tackling these issues. We spent a lot of time explaining the necessity to set up evacuation pipeline to the Gujarat coast and include its cost in field development plan to the government. With our JV partner ONGC firmly by our side, we managed to get the permission. We could have decided to wait for full clarity on all these issues before risking our capital. However, it was a conscious decision to go ahead. Importantly, we kept all our stakeholders informed of what we were doing. Finally, the efforts paid off.

How were your experiences in arrangement of funding?

The IPO had left us with cash of around $600 million, while there was $850 million debt facility contracted before the IPO. However, further funding became necessary as our project cost went up. Firstly, the global spurt in oil exploration increased the cost of commodities and oilfield services. And subsequently, the scope of the project increased to include the 690-km pre-heated pipeline to evacuate crude oil. By the time we felt the need for further funding, the world had entered the financial crunch and global banks were unwilling to lend. Indian banks, which were used to security-based lending, were not accustomed that time to fund the development of E&P assets. Even interest rates were going up. And this was the time our project was progressing at a ferocious speed and the pipeline had to be built up. The first thing we did was to relook at the financing options. In April 2008, we got an opportunity to raise $625 million by placing equity with a couple of long-term investors — a Singapore-based fund and Malaysia’s Petronas. This gave us a breather. At the same time, we optimized our capex plans to prioritise only that capex, which was absolutely essential to commence oil production. The priority was to aim for oil production at the earliest and meet our 2009 target. For example, rather than building all our processing trains simultaneously, we focused on building the first 30,000 bpd processing train, which was small but cheaper and quicker. We started selling oil since August 2009 by trucking even at high cost. This opened the tap of cashflows. By May 2010, when our pipeline partially commenced operations, we had sold nearly 6 million barrels of oil.

What hurdles did you face while raising debt from domestic banks?

It was a rare occasion of reserve based lending of such a large scale was being tied up. The main asset we have was oil in the ground. However, Indian banks then were not ready to accept that as security. We had to create a security, which was acceptable to them. Finally, a consortium of banks led by SBI took an extremely proactive view and accepted our participating interest in Rajasthan field as security. At that time, this was a novel thing in India. We raised 4,000 crore of debt from the consortium and another $750 million loan from Standard Chartered Bank in October 2009. We replaced earlier loan arrangement with this.

What has been Cairn’s capex on Rajasthan project so far? What is the planned capex for the next couple of years?

We have already spent nearly $3 billion on Rajasthan fields so far and plan to spend another $2 billion in 2010 and 2011 together. This will take care of our entire planned development work at the Rajasthan field to reach the plateau production level of 175,000 bpd. The capex, thereafter, will depend on lot many factors such as success of our EOR pilot, further exploratory successes and the government’s nods. Considering the growing cashflows from oil sales, we are well funded to see us through our current capex cycle. In fact, we may not need the entire $1.6-billion debt line arranged last October. These funding arrangements were done in times of uncertainty and with crude oil assumptions at much lower level than what they are now.

What are the challenges before the company in future? Where will the future growth come from?

Immediate challenges for us are reaching the plateau of 175,000 bpd production as early as possible. We are already at 125,000 bpd and Bhagyam and Aishwarya fields need to be operationalised. We have a vision to reach a production level of 240,000 bpd from the Rajasthan field. This will involve implementing enhanced oil recovery (EOR) techniques, exploiting oil reserves in the Barmer Hill formation and developing other smaller discoveries. We are taking all stakeholders with us to meet this vision.Similarly, we have all along maintained ourselves as low-cost efficient producer. At Ravva and Cambay offshore fields, the direct production cost is around $2-2.5 per barrel, which is comparable to most efficient producers in the world. For Rajasthan field also, we need to achieve this distinction. During the quarter ended June 2010, this stood around $4 against our desired target of $3.5. With the production increasing, the average cost should come down.Future growth of the company will come from our ability to make the most out of Rajasthan field, where further exploration work is continuing. Our other exploration blocks will also provide another growth avenue. For example, we had a discovery in our KG basin block recently. Exploratory drilling in other couple of blocks is set to begin soon.

How do you view the proposed change in the promoter group of the company?

As this was a decision at the shareowners’ level, Cairn India had no role to play in this deal whatsoever. However, we believe this is a positive development particularly for retail shareholders. Vedanta’s willingness to acquire Cairn India and the price they are paying for it, are actually a great endorsement to the quality of our assets, the management capabilities and future growth prospects. As for the management, we are as focused on the company’s growth and committed to value creation as we ever were.

ramkrishna.kashelkar@timesgroup.com

CASTROL INDIA - Co holds its own, but raw material costs are a worry

14th October 2010

CASTROL INDIA

Co holds its own, but raw material costs are a worry

CASTROL India, the leader in the lubricants business, has reported a healthy 22.3% growth in its September 2010 quarter’s net profits, which stood at 16.9 crore, as its revenue growth was aided by improved operating margins, reduced depreciation charge and a lower effective tax rate. This, however, failed to meet the market expectations; the scrip fell by 0.6% on Wednesday, in an otherwise buoyant market when Sensex jumped 2.4%.

Castrol’s September quarter numbers saw sales growing 13.5% to 643 crore with a 100 basis points improvement in operating profit margin to 26.4%. The margin improvement came despite rising raw material costs, as the company aggressively reined in its other expenditures such as staff cost and selling & admin costs. The company’s raw material cost to net sales ratio jumped to 52.4% this quarter, from 47.5% in last September. In fact, it was the highest in the last six quarters. The company achieved an absolute reduction of 11% in its expenditure on staff, selling & administration and manufacturing in spite of the rising turnover.

An 11% fall in its depreciation provisions and reduced effective tax rate at 31.2%, further helped the bottomline in achieving a higher growth rate.

For the company, brand-building and consumer-connect initiatives remain the key to its success besides developing novel products. In this regard, the company launched extensive marketing campaign with the punchline “instant protection from the moment you turn on the key”. It also launched Castrol Safe2GO programme to promote importance of vehicle safety. Sanjeevani, a rural-outreach programme for tractor owners, achieved a milestone by reaching two million tractor owners within a year of its launch.

In the last couple of quarters, the company has seen an upward trend in raw material costs, denting its margins. Its efforts to maintain and even grow its profit margins so far have proved effective. However, it could become difficult going forward, if the trend in raw material costs continues. Its future volumes growth will also depend on the performance of the automobile industry.

The company has outperformed the markets over the last one year, nearly doubling in value, while Sensex gained a little over 21%. It continues to remain a stable cash-generating company with little debt and healthy dividends.

GAIL: Expansion plan, gas availability to benefit co

THE September 2010 quarter results of natural gas major Gail India were in line with the Street’s estimates as it benefited from the marketing margin on APM gas and y-o-y reduction in the subsidy burden. But, there was a noticeable fall in volumes as a couple of its plants underwent maintenance shutdowns and a shutdown at Panna Mukta Tapti fields reduced gas availability.
Gail’s subsidy burden for the quarter came down 24% y-o-y to . 346 crore, which boosted performance of its LPG business. The PBIT from the LPG and liquid hydrocarbons business stood at . 175 crore, as against a loss of . 73 crore in the year-ago period. However, production was 10.6% lower at 337,000 tonnes as its Vijaypur plant was shut down for maintenance.
The company’s natural gas sales volumes were 2.5% lower at 79.04 million metric standard cubic meter per day (mmscmd) during the September 2010 quarter as supply from the Panna Mukta and Tapti fields was down for most of the quarter due to technical problems. For the quarter, the company reported a 30% growth in net sales to . 8,128 crore. Although its operating margin improved y-o-y by 130 bps to 17.9%, it was the weakest in the last four quarters. Between the December 2009 and June 2010 quarters, the company had maintained its operating profit margin above 20%. The company’s y-o-y growth rate at the PBDIT level was 35%, which increased to 40% at the pre-tax level thanks to a fall in the interest cost and slower growth in depreciation. However, the company’s deferred tax provisions soared disproportionately, bringing down the growth at the net profit level to 29%. The jump in deferred tax provision was mainly on account of the tax exemption enjoyed on the cross-country new pipelines, which became available to the company during the quarter for the first time. A high level of deferred tax is likely to become a regular feature for the company as more and more pipelines commence operations.
In the petrochemicals business, the company had to shut down its Pata plant for scheduled maintenance as well as debottlenecking. This brought down volumes by 9% to 93,000 tonnes and was partially responsible for the pressure on the margin, bringing down profits when compared with the year-ago period.
The company has embarked upon an ambitious expansion project, which will triple its gross block in the next four years. Being the largest player in its field, it is also a natural beneficiary of the increasing gas volumes in the country. With the government planning to introduce some formula to apportion oil industry’s under-recoveries, Gail stands to benefit from a better visibility on its earnings.

Atul picks up growth momentum

After A Poor FY08 And FY09, Co’s FY10 Net Profit Jumped 50% Y-o-Y

THE scrip of the Gujarat-based specialty chemicals company, Atul, gained more than 16% on Monday to close at its lifetime high of . 200.3. The stock has gone up almost three times in the past one year, against the 25% growth of BSE’s Sensex.
Atul’s results for the September 2010 quarter were hardly exciting. The company posted a 20.6% profit growth on a 41.4% growth in net sales. The company’s operating margins weakened and a fall in other income restricted its growth numbers.
The rise in the stock price had more to do with the growth momentum the company has picked up over the past one year, and the momentum is likely to continue.
After stagnating in FY08 and FY09, the company picked up growth momentum in FY10. Its FY10 net profit jumped 50% compared with the previous fiscal. In the first half of FY11, the company’s net profit at . 50 crore is almost 90% of what it clocked in the whole of FY10.
This is mainly due to an overall improvement in business climate in most of the industries it operates in. The company operates in several verticals related to the chemicals industry with a 40 MW captive power plant. It is a world leader in the production of some chemicals like p-Cresol and p-AA.
The company is increasing its focus on branded goods. It recently acquired Polygrip, an established brand in rubber and polyurethane-based adhesive. It has obtained the exclusive marketing rights of multi-purpose product WD40 in India. It is also expanding its emphasis on branded products in its agrochemicals division.
The company is gearing up for a stable growth. It is planning to introduce more value-added products while maintaining the cost and volume leadership in its existing products. In the colours division, which is the single-largest segment for the company with a 25% share in total revenues, it is planning to increase the product range and also move into finished products that can be directly sold to the textile industry.
The company is growing its capacities mainly through de-bottlenecking wherever necessary. This includes resorcinol, pharma intermediates, epoxy resins as well as agrochemicals. Its deleveraged balance sheet — current debt-to-equity at 0.6 — and strong cash flows from operations means this can be easily funded.
The company’s current market capitalisation is . 594 crore, of which 30% is the market value of its investments in several listed companies such as Wyeth, Novartis and Arvind Mills.
The company’s profits for the trailing 12-month discount the current valuation 8.4 times, which doesn’t appear too high despite the latest run-up in the scrip.

RIL: Base effect likely to dent co’s double-digit profit growth

RIL reported healthy earnings for the September quarter, which were more or less on expected lines. The fully-integrated business model enables the company to expand margins in one business, even if others suffer. However, with its price-toearnings valuation at 19.4, which discounts most of the existing positives, the share price may not react much to the results on Monday.
Since the company’s two mega-projects — SEZ refinery and KG basin gas — were being ramped up in the corresponding period last year, its double-digit profit growth on a year-on-year (y-o-y) basis for the past few quarters was well expected. However, this is likely to taper off, going forward, as base effect comes into play. Thus, considering just y-o-y growth numbers in analysing the performance could paint a misleading picture, and a view of sequential growth patterns becomes necessary.
The September quarter shows stagnation on a sequential basis, which could be a cause of concern for investors. Compared to the June 2010 quarter, the company’s operating profit and net profit were almost flat. Also, the paltry 1.5% qo-q growth in bottomline came mainly from reduction in depreciation charge.
The company continues to run its refineries significantly over their nameplate capacities to make the production more costefficient. During the first half, the capacity utilisation rate stood at 109%, substantially higher than the global averages during the same period. At the same time, the rising differential between light and heavy crude oils helped the company earn higher margins.
Although the company holds a few triggers for long-term earnings growth, it could stagnate in coming quarters. Its petrochemicals business will continue to face pressure — particularly polyethylene and polypropylene — due to higher production from the Middle East. The oil & gas business faces growth uncertainties as the next phase of ramp up of KG gas production to 80 mmscmd is delayed. Refining industry’s growth remains greatly dependent on the continuing global economic growth, while inventory levels remain quite high.