TATA CHEMICALS: UK buy eases raw materials uncertainty

THE proposed acquisition of British Salt will fill a key strategic gap for Tata Chemicals. Brunner Mond, Tata Chemicals’ wholly-owned subsidiary in the UK, has signed an agreement to acquire British Salt for £93 million (. 656 crore approximately).
Brunner Mond was at risk of being hit by spurt in raw material prices after its supply contract with Ineos ends in 2016. By acquiring British Salt, it will have a captive and consistent source of raw material salt at reasonable cost.
The acquisition price that Tata Chemicals has agreed to pay for the acquisition is nearly six times the operating profits (earnings before interest, tax, depreciation and amortisation, or EBITDA) of the company. For a commodity chemicals company, this valuation is not cheap. However, the possible strategic synergies for Brunner Mond justify the pricing. The uncertainty over raw material supply at reasonable cost is eliminated for Brunner Mond’s UK operations. As British Salt starts supplying salt in a few months’ time, Brunner Mond’s raw material bill is likely to fall. Lastly, as the acquired company mines underground salt from its fields, the cavities created can be used for storing natural gas. Within five years, the new owners expect to generate gas storage business worth £45 million.
The acquisition will be funded through debt raised on the books of Brunner Mond and British Salt. British Salt’s is a high-margin business, with 45% to 50% operating profit margins and high cash generation, which will ensure easy debt servicing. Since the acquired company is profit-making, the acquisition will add to the EPS from the first year itself.
In this acquisition, Tata Chemicals has not repeated the mistake made while buying General Chemicals in the US in 2008. The pension fund liabilities in British Salt show a small surplus and there won’t be any incremental liability on this count on Tata Chemicals in future. In the case of General Chemicals, the incremental pension fund liabilities had put pressure on the company’s overall earnings for FY09 and FY10.
Tata Chemicals is back on a strong growth path after a couple of years of stagnation. Its acquisition of Rallis and foray into customised fertilisers are aimed at supplying a whole gamut of products to domestic farmers. While all these measures add to the corporate profitability, a mega-booster will come if it is able to double its urea capacity. The project continues to await firm gas allocations from the government.

Clariant Chemicals: Clariant seen on a sound footing

Co Offers A Healthy Dividend Yield

SPECIALTY chemical manufacturer Clariant Chemicals may have lost heavily as the markets tumbled during the past few weeks, but investors need not fret as the company is likely to outperform the market due to its strong business position and sound financials.
The company’s profits more than doubled in 2008 and grew by over 60% in 2009. In 2010, the growth seems to have almost stagnated. Till September 2010, the company had posted a modest 13% profit growth on a 9% growth in revenues. As a result, its operating profit margin has come under pressure. However, it has already paid a . 10 per share interim dividend in 2010 so far and is well placed to at least match its last year’s dividend of . 25 per share.
Clariant Chemicals, a 63.4% subsidiary of German specialty chemicals major, is India’s leader in colorants, dyestuff and specialty chemicals catering to industries such as textiles, leather, paper, plastics, and paints, among others.
During the past couple of years, the company shed its non-core businesses and monetised excess assets. It disposed of its flexible laminating adhesives business in 2009 and sold its diketene and intermediate business in early 2010. These two businesses contributed . 85.7 crore to its revenues in 2009 and fetched the company a profit of . 8.9 crore on sale.
In August, the company approved the sale of its land at Balkum, Thane, for . 240 crore. The sale is likely to be completed in a few months. The funds will enable the company to meet its own internal requirement
for expansions, besides raising its dividend payout.
Clariant has maintained an excellent dividend payment record. It has paid dividends for 15 consecutive years. Even though the scrip has gained over 60% in the past one year, the dividend yield works out to 3.7%.
Masterbatches, which used to be a small portion of the company’s overall business, has registered a strong growth over the past couple of years. To cater to the market potential of its product range, the company is expanding capacities and setting up a green field manufacturing facility in Ambernath. A healthy dividend yield and steady capital appreciation could be passé for investors of this company.

RALLIS INDIA New acquisition is in line with long-term plan Ramkrishna Kashelkar ET INTELLIGENCE GROUP RALLIS India’s acquisit

RALLIS India’s acquisition of a seeds company marks an important milestone in the long-term strategy of not just Rallis but also Tata Chemicals in catering to the needs of Indian farmers. This addition to the product portfolio will bring significant synergies for the group, which already has an extensive distribution network.

The acquisition is not likely to boost Rallis’ profits in the near-term; in fact, the acquired company, Metahelix Life Sciences, is just breaking even. The main benefit will be in the form of access to Metahelix’s elaborate set-up — three research facilities with systematic R&D programme and a team of 50 scientists, product-testing centres across the country, established products in rice, maize, millets and vegetable seeds and good germplasm, which is crucial to developing new seed varieties, besides a strong sales force. Metahelix is also the first Indian company to have a proprietary Bt cotton variety.

Rallis is paying about . 125 crore for a 59% stake , with the balance stake to be bought in phases by 2015. This will push back the impact of the acquisition on the balance sheet of Rallis, which is mainly paying from its existing cash reserves. The deal values Metahelix at about . 210 crore, nearly twice its expected revenue for FY11, according to the management.

In terms of future guidance, the Rallis management says the acquired business will generate cumulative revenue of . 1,000 crore over the next five years. This target translates into a cumulative annualised growth rate (CAGR) of 35% over the next five years, if the company ends FY11 with . 100 crore of revenues. How profitable the Metahelix operations will be over the next five years , however, remains to be seen. The seed industry leader, Advanta India, reported a measly 3.4% net profit margin on a consolidated basis for the 12-month period between October 2009 and September 2010. However, smaller players such as Kaveri Seed and Monsanto India enjoyed a net profit margin of 16-17% for the same period.

The future growth of Rallis India will get a boost from the new agrochemicals plant at Dahej being set up with an investment of . 150 crore. The company is expecting cumulative revenues of . 500 crore from it over first three years of operations. With Tata Chemicals launching a crop and soil specific customised fertiliser, Paras Farmoola, just a few weeks ago, the two large corporates now have a presence in the entire value chain of farm inputs. Their ability to offer a comprehensive solution will provide them with a competitive advantage.

Oil India: Aiming For A Big Leap

FROM being a small company confined to the distant north east for decades, Oil India has come a long way. The company’s chairman and managing director NM Borah says that the company’s future growth will hinge on a clear strategy and a policy and procedural framework. In an interview with ETIG’s Ramkrishna Kashelkar, Mr Borah spoke about the future of the company and and the steps taken by him to enable the state owned firm to take the next big leap. Excerpts:

How has Oil India grown in the past few years?
In the past 25-30 years, the company has primarily been producing three million tonne (MT) of crude oil per year. To grow after such a long stagnation, the first challenge was to make our own people to believe we could go higher. After much effort in the past 4-5 years, we could increase the production. At present, we are producing 3.7 MT of crude oil and now aiming for 4 MT. In fact, the September quarter production of 0.93 MT was the highest ever for the company and I am confident that we are in a position to achieve 3-5% annual growth in the coming years.
In the natural gas business, we have a lot of potential to grow. Within the past 3-4 years, the production has grown over 50% to about 6.8 million cubic metres per day. It can be expanded further also. There are not many small-scale gas-consuming industries in our vicinity, which is why we are dependent on a handful of large customers. It has happened a few times in the past that we had to cut production as customers did not lift the promised quantities of natural gas. We were predominantly a northeastern company for decades. Thanks to the new exploring licensing policy (Nelp), we became a pan-India company and subsequent policy liberalisation enabled us to expand overseas. Today more than 80% of our total acreage is either overseas or obtained under Nelp.
The expansion drive seems to have slowed down in the past one year after your IPO.
In the past one year or so, we have deliberately slowed acquisitions. This is not due to lack of opportunities or we don’t have money. As a matter of fact, there have been plenty of both. But this is a question of strategy. Thanks to our expansion of the past few years, we have enough exploration work on our platter, which is a lengthy and risky process. As part of our newly formed strategy, we decided to consolidate our existing portfolio and not to look for adding new exploration prospects overseas. On the contrary, we would like to look for discovered or producing assets. Arising out of this strategic thinking, we joined the Carabobo project in Venezuela, which is a substantially large heavy oil field. We are also actively looking for acquiring more such producing assets.

What are the kind of assets that you are seeking to acquire?
This is also a question of long-term strategy, which took a lot of time for us to formulate.
But the time was worth spending because now we have developed not only the structured logic to decide on acquisition matters, but also the entire background policy framework.
The process has also identified more criteria for our prospects. In terms of oil or gas, we are comfortable with both. We have a lot of expertise in onshore, but we won’t mind offshore as we are building our capabilities there. In terms of size, we will be comfortable with asset with production potential of 10,000-20,000 barrels per day, which will be around 0.5-1 MTPA. However, we could look at smaller projects as well to gain an entry point in a particular geography. In terms of specific geographies, we would primarily wish to expand in those areas, where we are already operating. Apart from that, we have identified certain regions of South East Asia, Australia, Latin America and Canada as areas of our interest. We are also considering acquiring a company with niche technical expertise to fill up certain technology gaps within Oil India.
To spot the opportunities that match our appetite from the numerous proposals we get, we have created a parameter checklist. Only when a proposal meets this parameter, we take it up for further study. We also have identified a few financial institutions to facilitate in getting such proposals and have also laid out a transparent procedure to decide their fees etc. With this entire set up ready, we are very comfortable in going ahead with our acquisition strategy. In the calendar year 2011, we plan to make minimum two such acquisitions.

What will be your strategy for diversification?
While we would like to stick to our core competence in E&P and long distance oil & gas pipelines, we have a strategy for ‘selective diversification’. However, these diversifications will be related to the petroleum value chain such as refinery or petrochemicals. Apart from the a 26% stake in Numaligarh refinery, Oil India has also bought 10% in the Brahmaputra Cracker & Petrochemicals, which is scheduled to go on stream in 2013. Similarly, the company has tied up with BPCL, Gail and ONGC apart from Indian Oil to participate in bidding for the city gas distribution business. We also have a 45,000 TPA plant to produce LPG, which we sell to Indian Oil. An earlier idea of petro-product retailing was dropped due to under-recoveries.
In gas transportation, we can extend our upcoming Duliajan-Numaligarh pipeline to Guwahati and further to Barauni as we already have the right-of-way, thanks to our existing pipeline. We have also done survey on market potential and anchor customers on this route. We are also looking for certain opportunities in Bangladesh in pipeline business. In non-conventional energy, we are readying ourselves for the bidding rounds for shale gas that the government is planning for.

These are all strategies for the long-term growth that you have outlined. What will drive the company’s earnings in the near term?
Today, 100% of our oil and 95% of gas comes from the northeast. While the exploration and development work progress in our other fields, our majority production in the next few years will continue to flow from the northeast fields. And we feel that a lot more can be done to increase production — induction of better technology to arrest decline in old fields and improving operational efficiency to reduce the time in bringing new discoveries to production. In the next 1-2 years, we would aim to increase our oil production to 4 MTPA level.
Our natural gas volumes would grow once the pipeline supplying 1 mmscmd to Numaligarh refinery commences operations in February 2011. Oil India also holds 23% in the pipeline with Assam Gas Company and Numaligarh Refinery holding the rest. The next big jump in gas volumes would come in 2013, when the Brahmaputra Cracker project commences operations. We will be the largest gas supplier at 1.35 mmscmd to the project.
In other exploration blocks through Nelp, we have two highly prospective onshore blocks — one in KG basin and another in Mizoram. We are trying to bring them to drilling phase as fast as possible.

You spoke about shale gas. Has Oil India done any work on this front ?
Our geological perception is that the northeast in general is a rich source of shale gas, although it is not possible to give a definite figure. The problem we are facing today is too much of data. In over 50 years of operations in the north east, we have gathered a lot of geological data. When we were drilling for our target reservoirs, the wells have passed through the shale ranges at different depths. However, the data was generated without any specific perspective on shale gas.
Compiling all this data, processing it and taking a fresh look at it from the shale gas perspective is a time-consuming process. We have set up a small team within the company for this purpose. Within the next 4-6 months, we will be in a position to complete the study to find the resource potential. And once we have this information, we can tie-up with someone, who has actual shale gas drilling experience to help us identify the best locations to drill. Secondly, we would also like to go to acquire a shale gas asset overseas to gain hands-on experience. Since it will be a producing asset, the cost will be high. Hence, we have taken steps for a strategic tie-up with suitable domestic partners.

REFINING : Q3 to ride high, but margins likely to soften

THE last couple of months have been good for the refining industry globally, with margins improving due a spike in demand amid stagnant supply. This may boost the industry’s December quarter numbers. However, the buoyancy appears temporary.
During the September quarter and so far in the December quarter, demand for oil rose in the 34 economically advanced countries that are part of the Organisation of Economic Cooperation and Development (OECD). On the other hand, the global refinery throughput actually came down due to maintenance shutdowns, production cuts induced by low margins, and the industrial unrest in France. A strike in the Fos and Lavera oil terminals in France for most of October forced the temporary shutdown of more than 1 million barrel per day (mbpd) of refining capacity. This reduced the OECD refinery throughputs from 37 mbpd
in September to 34.6 mbpd in October. The global refining throughput fell by 2.3 mbpd in this period. These problems had resulted in supply stagnation in Europe, and as a result refiners all across the world witnessed improvement in their margins.
“In October, due to the tight situation of products in Europe, gasoline and distillate stocks dropped, causing a recovery of the gasoline crack in the US, which, in combination with stronger distillate demand on both sides of the Atlantic, allowed the US to protect its refining margins,” an OPEC report said. Cracks represent individual product’s profitability over the crude oil, while the gross refining margins (GRMs) represent the differential between the cost of a barrel of crude oil and revenues from sale of all petroleum products produced from it.
In its December 2010 report on the Indian oil sector, Edelweiss said there was a sustained improvement in the refining margins of domestic firms in November.
These higher GRMs are likely to witness pressure in the coming months as the fundamental demand-supply imbalance will prevail. The outlook on global oil demand recovery in 2011 remains mixed with the large economies of US, Europe and Japan stagnating. Also, an estimated 6 mbpd refining capacity will be added steadily through 2015. In a webcast with investors earlier this week, the refinery head of petroleum major LyondellBasell, Kevin Brown, said that the refining margins are likely to remain flat “over next several years”. This may not be strictly true for Indian refiners, but investors should be wary of the global economic recovery in the coming quarters before investing in this industry.

CRUDE OIL: Energy agency warns of a price bubble

AFTER staying range-bound for over a year, global crude oil prices appear to have broken a key resistance level and headed northwards. Several factors are at play. Among the key factors that have boosted oil prices is a sustained increase in demand, especially from the OECD countries, during the last few months. Global oil demand in the September 2010 quarter was higher by 3.1 mbpd y-o-y, continuing the acceleration since the beginning of 2010 — 2 mbpd y-o-y growth in the March 2010 quarter and 2.8 mbpd growth in the June 2010 quarter. On a sequential basis, the demand in the third quarter at 87.5 mbpd was nearly 1.5 mbpd more than in the second quarter of 2010. This made the International Energy Agency (IEA) revise upwards its earlier demand growth estimates for 2010 by 0.2 mbpd. The latest estimates peg the world’s oil demand to average 87.3 mbpd in 2010 — 2.3 mbpd or 2.8% higher against 2009. OPEC countries increased production, but non-OPEC countries registered a sequential fall in output during the September quarter. This resulted in a reduction in oil inventories the world over. In the US, for which weekly inventory numbers are available, oil stocks have fallen by 37.5 million barrels from the beginning of September till end-November. In Europe, the inventories fell substantially in September and continue to remain below the year-ago level in spite of a marginal growth in October.

Traders remain bullish on crude oil, since the US dollar is likely to remain weak thanks to ‘quantitative easing’. The revised demand forecasts by institutions such as IEA as well as OPEC mean that the signals appear to be more bullish than bearish.
These developments do not bode well for India, whose oil import bill and budget deficit will swell if oil prices continue to rise. Similarly, under-recoveries for state-run oil companies will start moving up. According to a research report by brokerage firm Edelweiss, under-recoveries on the sale of diesel averaged . 3.3 per litre in November 2010 from . 2.3 in October. “Based on crude and product prices as on November 30, 2010, gasoline and diesel under-recoveries are at . 1.3 per litre and . 4.9 per litre, respectively,” says the report.
Rising oil prices would spell bad news also for economies struggling to recover after the economic turmoil during the last few years. The IEA has warned of a renewed price bubble, built from a perception that there could be tightening in the oil markets in the near term. “This points to the possibility of weaker 2011 GDP growth, and, thus, the oil demand,” the report says. If that is the case, high oil prices may not be sustained in 2011.

Jindal Drilling & Industries (JDIL): Debt-free, cash-rich JDIL looks attractive

Co Insulated From Rig Charter Rate Fluctuation

THE shares of Jindal Drilling & Industries (JDIL) have underperformed the markets almost throughout the past one year, losing 10% while Sensex gained 15%. However, it had more to do with the company’s internal instability rather than its financial performance. The company’s board recently removed its managing director unceremoniously “having concluded that they have lost confidence in him” to be re-placed by one of the promoters. It has also put its earlier restructuring ideas on the backburner.
Jindal Drilling (JDIL) is in the business of hiring jack-up drilling rigs and deploying them on ONGC contracts, besides offering support services such as mud-logging and directional drilling. These two support services represent around 10% of the company’s total revenue.
For the first half of FY11, the company reported a 34% profit growth to . 49.9 crore, although revenues dipped 21.5% Y-o-Y to . 526.3 crore. This was mainly on account of a substantial cut in its single
largest cost item of drilling operation charges. In effect, the company is now paying around 80% of revenues as charter hire charges to rig owners – down from 87% last year. The numbers were slightly affected due to dry-docking of one of the rigs between the contract renewal phase.
The company currently has five jack-up drilling rigs on hire — three from Noble and one each from two joint ventures, Discovery Drilling and Virtue Drilling, where the company owns 49% stake. All these rigs are working with ONGC on long-term charters of three or five years and the next renewal is due only in October 2011.
The company’s share in these two JVs resulted in a net profit of . 91.5 crore during FY10 — more than its standalone profit of . 84 crore. However, the return on capital is substantially higher in the standalone business.
Despite being in the offshore drilling services business, the company is virtually insulated from the fluctuations in the rig charter rates. This is mainly because it doesn’t own any rig on its own and earns its income as a differential between what it gets from ONGC and what it pays to the rig owner. Typically, both these contracts are back-to-back, with 80% of revenues being paid to the rig owner.
Being asset-light, the company has emerged a debt-free and cash-rich company with strong operating cashflows. Its joint venture companies, which had raised loans to buy rigs, are also repaying their loans rapidly. During FY10 alone, the outstanding loan in JVs fell by . 235 crore or 30%.
While focusing on repayment of debts in the JVs, the company is also looking to charter few more rigs for the Indian market. JDIL is currently trading at 12.1 times its standalone earnings for trailing 12 months. Considering the profits on a consolidated basis, the valuation would appear even more attractive.