Chennai Petroleum: The Fairest Of Them All

Chennai Petroleum’s current valuations and future prospects make it a promising investment opportunity in the domestic refining sector

PUBLIC SECTOR refinery companies are witnessing a revival in investor interest following a global trend of rising refining margins. During the recent rally, most of these companies touched their 52-week peaks. Among these, standalone refineries look more attractive than integrated companies.
Standalone refiners have petroleum-refining facilities and rely on the integrated players to market and sell their products in the domestic retail market. Integrated refiners such as IndianOil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL) have refining, as well as retail marketing channels.
Due to government regulation on retail prices of major petroleum products, integrated refiners suffer from under-recoveries arising out of sales of these products. On the other hand, standalone refiners no longer need to share these under-recoveries with their integrated counterparts and this makes them more attractive in the oil refining sector.
Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery and Petrochemicals (BRPL) are the listed players in the standalone refining space. To help readers find the right pick in this segment, IG did a comparative analysis of the three companies.
MRPL:Located on the western coast, MRPL, an ONGC subsidiary, is the largest among the three with a refining capacity of 12 million tonnes per annum (mtpa). The MRPL scrip has gained nearly 70% in the past one month alone. At the current stock price, MRPL’s enterprise value as a multiple of its operating profit (EV/EBIDTA) is much higher than that of the other two refiners. Also, its refining capacity is valued way higher (m-cap/refining capacity). The refinery is operating at high utilisation rates, recording nearly 106% throughput during the first half of FY08. For future growth, MRPL is expanding its capacity to 15 mtpa by ’10. Given a healthy operating performance and promising future ahead, the MRPL scrip has already run up substantially and the current valuations appear to be on the higher side compared to its peers.
BRPL: BRPL, the smallest in the lot, is IOC’s subsidiary. It has gained over 40% on the bourses during the past one month. At the current price, its stock attracts the lowest P/E compared to the P/Es of other two refineries.
As BRPL operates in the North-East, it enjoys excise duty exemption, which has enabled it to report consistently higher operating margins compared to the others. BRPL’s return on capital employed (RoCE) has also been substantially higher and it enjoys a de-leveraged balance sheet. Considering the last dividend of Rs 3.5 per share, the dividend yield works out to a neat 3.5% — the highest among its peers.
However, BRPL faces problems regarding sourcing crude oil and it has not been able to utilise its capacities fully. Another problem — and a major one — is that, BRPL is set to merge with IOC at an exchange ratio of four IOC shares for every 37 BRPL shares. This limits the upside in the scrip. In fact, at the current price of IOC shares, BRPL shareholders stand to lose around Rs 30 per share.
CPCL: CPCL has so far been a laggard on the bourses, gaining just around 24% during the past one month. Its fundamentals are healthy and its expansion plans will drive future growth. The company’s low equity base means that any profitability growth brings in a more than proportionate jump in its share price.
CPCL’s current valuations appear cheap on various parameters. Both the key valuation multiples — m-cap/net sales and EV/EBIDTA — are at the lower end compared to the other two refineries. Similarly, its refining capacity is valued very cheap.
The company’s performance has been robust historically and it has drawn up plans for future profit growth. Recently, the company commissioned a 17.6-mw capacity wind power project, which is eligible for carbon credits. CPCL is also expanding its refining capacity to 12 mtpa from the current 10.5 mtpa. The company has been continuously investing in improving its energy efficiency, as well as its product mix, which will help it to improve its margins, going forward. Relatively cheap valuations make this company an ideal choice of investment. Investors with a 12-month horizon can consider investing in it.

ARIES AGRO: Small Is Big

Ambitious expansion plans and aggressive marketing strategies are likely to help Aries Agro achieve future growth

COMPANY: ARIES AGRO

ISSUE SIZE: RS 54-58.5 CRORE

PRICE BAND: RS 120-130

DATE: DECEMBER 14-19, ’07

FOUNDED IN 1969 by the Mirchandani family, the Mumbai-based Aries Agro manufactures micronutrients and other nutritional products for plants and animals. The company is raising funds from the primary equity market to fund the five-fold expansion of its production capacities and to strengthen its marketing network. Investors with a 12-month horizon can consider investing in the IPO.

BUSINESS: The company markets a comprehensive portfolio of micronutrients under 41 different brands to nearly seven million farmers through a network of around 6,000 dealers. Micronutrients are elements such as iron, boron, manganese and molybdenum required for the growth of agricultural plants. The company imports certain products such as water-soluble nitrogen, phosphorus and potassium (NPK) fertilisers and markets them in India under its own brand name. It tries to provide maximum customisation in its products to suit the specific geographical and crop needs. Aries Agro has a 21,600 tonnes per annum (tpa) manufacturing capacity at four plants. This is expected to increase to nearly 1,00,000 tpa after it sets up four new plants. The company will also invest in its UAEbased subsidiary, Golden Harvest, to set up another manufacturing plant. It operates in a seasonal industry and clocks over 65% of its annual turnover from July to December, compared to the rest of the year.

GROWTH FACTORS: Aries Agro’s new plants will commence production one by one between February ’08 and September ’08. Domestic demand for micronutrients is currently estimated at 2.5 lakh tonnes, with a growth rate of over 8% per annum. It plans to purchase 100 trucks to market its products, which will improve its geographical footprint. The company focuses on R&D to bring out new products. It has established brands and strong distribution capabilities. The company also has long-term plans to enter the seeds and farm equipment businesses and has established two subsidiaries for the purpose.
FINANCIALS: Its net profit spurted multi-fold to Rs 8.7 crore in FY07 from Rs 1.1 crore in FY05. Sales during this period witnessed a CAGR of 37% to Rs 72.7 crore during FY07. It has demonstrated improved profitability over the years. Operating margin grew from 20.9% in FY06 to 23.1% in FY07. It further rose to 27.2% during the four months ended July ’07. The weakening dollar fares well for the company since it imports nearly 30% of its raw materials.

VALUATIONS: At the higher end of the price band, the P/E works out to 16.8 based on annualised EPS during the four-month period ended July ’07. Aries Agro does not have any direct peer with a comparable business profile. However, it can be broadly classified under specialty chemicals or fertilisers segment. Comparable peers under these categories, such as Ciba Specialty and Rallis India, are currently trading at an EPS of Rs 19.2 and 11.7, respectively. Considering its strong growth prospects, Aries Agro’s valuation appears reasonable. RISKS: The company has reported negative cash flows from operating activities in four of the past five years. Its business is directly linked with Indian agriculture. This exposes the business to the risk of longer credit periods. Thus, the company’s working capital will increase along with its expansion. This may accentuate the problem of negative cash flows.

Chennai Petroleum: The Fairest Of Them All

Chennai Petroleum’s current valuations and future prospects make it a promising investment opportunity in the domestic refining sector

PUBLIC SECTOR refinery companies are witnessing a revival in investor interest following a global trend of rising refining margins. During the recent rally, most of these companies touched their 52-week peaks. Among these, standalone refineries look more attractive than integrated companies.

Standalone refiners have petroleum-refining facilities and rely on the integrated players to market and sell their products in the domestic retail market. Integrated refiners such as IndianOil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL) have refining, as well as retail marketing channels.

Due to government regulation on retail prices of major petroleum products, integrated refiners suffer from under-recoveries arising out of sales of these products. On the other hand, standalone refiners no longer need to share these under-recoveries with their integrated counterparts and this makes them more attractive in the oil refining sector.

Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery and Petrochemicals (BRPL) are the listed players in the standalone refining space. To help readers find the right pick in this segment, IG did a comparative analysis of the three companies.
MRPL:Located on the western coast, MRPL, an ONGC subsidiary, is the largest among the three with a refining capacity of 12 million tonnes per annum (mtpa). The MRPL scrip has gained nearly 70% in the past one month alone. At the current stock price, MRPL’s enterprise value as a multiple of its operating profit (EV/EBIDTA) is much higher than that of the other two refiners. Also, its refining capacity is valued way higher (m-cap/refining capacity). The refinery is operating at high utilisation rates, recording nearly 106% throughput during the first half of FY08. For future growth, MRPL is expanding its capacity to 15 mtpa by ’10. Given a healthy operating performance and promising future ahead, the MRPL scrip has already run up substantially and the current valuations appear to be on the higher side compared to its peers.
BRPL: BRPL, the smallest in the lot, is IOC’s subsidiary. It has gained over 40% on the bourses during the past one month. At the current price, its stock attracts the lowest P/E compared to the P/Es of other two refineries.

As BRPL operates in the North-East, it enjoys excise duty exemption, which has enabled it to report consistently higher operating margins compared to the others. BRPL’s return on capital employed (RoCE) has also been substantially higher and it enjoys a de-leveraged balance sheet. Considering the last dividend of Rs 3.5 per share, the dividend yield works out to a neat 3.5% — the highest among its peers.

However, BRPL faces problems regarding sourcing crude oil and it has not been able to utilise its capacities fully. Another problem — and a major one — is that, BRPL is set to merge with IOC at an exchange ratio of four IOC shares for every 37 BRPL shares. This limits the upside in the scrip. In fact, at the current price of IOC shares, BRPL shareholders stand to lose around Rs 30 per share. CPCL: CPCL has so far been a laggard on the bourses, gaining just around 24% during the past one month. Its fundamentals are healthy and its expansion plans will drive future growth. The company’s low equity base means that any profitability growth brings in a more than proportionate jump in its share price.

CPCL’s current valuations appear cheap on various parameters. Both the key valuation multiples — m-cap/net sales and EV/EBIDTA — are at the lower end compared to the other two refineries. Similarly, its refining capacity is valued very cheap.
The company’s performance has been robust historically and it has drawn up plans for future profit growth. Recently, the company commissioned a 17.6-mw capacity wind power project, which is eligible for carbon credits. CPCL is also expanding its refining capacity to 12 mtpa from the current 10.5 mtpa. The company has been continuously investing in improving its energy efficiency, as well as its product mix, which will help it to improve its margins, going forward. Relatively cheap valuations make this company an ideal choice of investment. Investors with a 12-month horizon can consider investing in it.

Interview- MRPL: Eye On The Future

Although refinery margins are on an upswing currently, the risk of a downturn in the long term remains, says LK Gupta, director-finance, MRPL

How is the current gross refining margins (GRMs) situation? Given that several new refinery projects have been launched globally, how will the global benchmark GRMs behave in future?
Mangalore Refinery and Petrochemicals’ GRMs have been fluctuating between $4 and $8 per barrel during the last couple of quarters. We generally track the benchmark Singapore GRMs unless the gasoline cracks are very high, as Singapore refineries produce higher gasoline in their product mix.
Given the current global refining capacity of above 4,000 million tonnes per annum (mtpa), new additions of 200-250 mtpa in the next few years are not expected to have much negative impact on refining margins. Hence, going forward, I think the GRMs are likely to remain high compared to what they used to be in the past.

At what GRM levels will investment in a new refinery be justifiable?
In the past, refineries could work with GRMs at $2-3 per barrel levels. Over the past year or so, the cost of setting up a refinery has gone up substantially with a number of new refinery projects coming up globally. Today, to set up a 15-mtpa refinery, the capital cost will be around $5 billion, taking a conservative estimate. Assuming just 10% return on investment and 5% depreciation, it should generate at least $750 million at the EBIDTA level annually. This translates into refining margins of $6.8 per barrel. Hence, I feel that if in future, the GRMs fall below these levels, no new capacity addition will be feasible. Reliance Industries (RIL) commenced its refinery project just before this spurt in capital costs, which helped it to keep the cost low.

Refining is often termed as a cyclical industry. Currently, where does the global refining industry stand with regard to business cycles?
Currently, we are on an upswing in refinery GRMs. During ’00-03, the global refining industry was going through bad times. No investments were being made in this industry. At times, even the cost of crude oil and processing was not recovered from the selling price of petroleum products. Though the scene has improved in the past three years, the risk of a downturn in the long term remains.

How is MRPL’s capacity utilisation currently? Going forward, what will be the sustainable level of capacity utilisation?
Our nameplate capacity is 9.69 mtpa, but we are operating at around 12.5 mtpa currently. However, in running our refinery at higher capacity, at times, energy efficiency and product slate is not at the most optimal levels. Under the current expansion and upgradation plan, we will increase the sustainable capacity to 15 mtpa by ’10. Then we will benefit not only from higher production, but also from better yields and improved product mix.

What are MRPL’s current capex plans? How does the company plan to expand its refining capacity?
We have planned a capex of around Rs 8,000 crore for our refinery upgradationcum-expansion project, which will be financed through Rs 5,300 crore of debt and Rs 2,700 crore of internal accruals. The project includes an increase in the refining capacity from the existing 9.69 mtpa to 15 mtpa to be completed by ’10. The upgradation will increase the distillate yield by about 10%, eliminating the low-value black oils, and enable processing of higher quantities of cheaper sour and heavy crude oils. Once this upgradation project is completed, MRPL’s refinery complexity and refining margins will be comparable with the best refineries.

What is the current status of your plans to build refineries in Rajasthan and Kakinada?
For the Rajasthan refinery, we have conducted feasibility studies which reveal that without fiscal incentives, it won’t be economically sustainable. If we build this refinery, it will have to be primarily for exports. This is mainly due to the fact that no oil marketing company will buy from us, as their own refineries already exist in nearby states. Discussions with the state government are continuing. As regards the crude oil to be produced by Cairn, we are in discussions with Cairn for finalising the pricing. We understand that a pipeline is being set up to evacuate that crude oil to a western port location by Cairn and ONGC. As of now, MRPL is the government’s nominee for processing this crude. We are also talking to other PSU refineries. A detailed feasibility report (DFR) for a 15-mtpa refinery at Kakinada is being prepared by Engineers India. We will take a decision on implementation after receipt of the DFR.

What are the company’s plans with regard to expanding into the petrochemicals space?
The aromatic complex to produce valueadded products like paraxylene and benzene from surplus naphtha from MRPL is being set up by ONGC Mangalore Petrochemicals (OMPL), a separate special purpose vehicle company of ONGC and MRPL at Mangalore SEZ, with an estimated project cost of Rs 4,852 crore. ONGC will hold 46% of the equity, MRPL will hold 3% of the equity, while the balance 51% will be raised through IPO/strategic investments/product offtake. This project is expected to be completed by December ’10. We are also examining the feasibility of setting up an olefins complex at Mangalore.

How does the depreciating dollar affect your business? What is your take on the rupee-dollar exchange rate over the next two years?
We are a totally dollar-based company, i.e. crude purchases and product sales, both domestic or from/to international markets, are based on the US dollar. Hence, the depreciating dollar affects us mainly to the extent of our GRMs. Due to a depreciating dollar, our margins get impacted adversely when converted into rupees. Going forward, I don’t see the rupee depreciating against the dollar. From the macroeconomic perspective, the country is currently facing a trade deficit mainly due to petroleum imports. However, India’s dependence on import of petroleum products is expected to go down in the long term, given the inclusion of new oil and gas capacities. Gas production by RIL is scheduled to start in ’08, which is equivalent to almost 25 mtpa of crude oil. Similarly, Cairn India/ONGC’s Rajasthan field production of about 7.5 mtpa is likely to start in ’09. India’s exports of petroleum products will also move up significantly due to addition of fresh refining capacity in the next couple of years. A few sectors such as textiles are facing a decline in exports in the current scenario, but this may not pose a major challenge for the strengthening rupee. On the whole, the fundamentals indicate a strong rupee.

The Reserve Bank of India (RBI) has recently allowed domestic refiners to hedge the value of their inventories. How does that help?
RBI has recently come out with guidelines allowing oil companies to hedge their inventories against any substantial fall in prices. The industry operates on $5-7 per barrel margins and if crude oil prices fall suddenly in the global markets, oil companies’ profitability may take a severe hit if they’re stuck with a high-cost inventory. Oil companies can now hedge up to 50% of their average inventory of the previous quarter, which will help them to safeguard the value of their inventories.

RENAISSANCE JEWELLERY: Still Shining Bright

Considering Renaissance Jewellery’s steady growth prospects, investors with a 12-month horizon can remain invested in the scrip

COMPANY: RENAISSANCE JEWELLERY

OFFER PRICE: Rs 150

LISTING PRICE: Rs 190

CURRENT PRICE: Rs 164.55

CURRENT P/E: 10.5

MUMBAI-BASED jewellery manufacturer, Renaissance Jewellery, had issued 53.24 lakh equity shares and 26.6 lakh warrants through an IPO in November ’07 to raise Rs 80 crore. The scrip was listed on the stock exchanges on December 12, ’07 at Rs 190 — a 27% increase over the offer price and closed at Rs 165. The warrants issued by the company were separately listed, which closed at Rs 24.5.
The company plans to use the IPO proceeds to expand its production facilities in SEEPZ and Bhavnagar. The company is also setting up a subsidiary in the US to market its products to medium and smallsized retailers.
Despite the US economy facing risks of a recession, weakening of the dollar and gold prices ruling around historic highs, Renaissance continues with its US-centric approach. Sumit Shah, the company’s managing director, is determined to prevail over these challenges. “The environment is challenging, but we view it as the best time to consolidate our position in the world’s largest consumer country for studded jewellery,” he says. The share of non-US sales, which stood at just 5% last year, are expected to rise above 15% during FY08.
However, the management is taking steps to de-risk the business model. “We have recently entered the bridal jewellery business, the demand for which is relatively inelastic. Similarly, we are also increasing our non-US revenues,” says Mr Shah. The company, which derived around 9% of its sales from bridal jewellery, expects this share to go up to 15% in FY08. The management hopes to maintain over 25% annual profit growth rate for FY08 and FY09.The warrants issued by the company will be convertible at Rs 187.5 into equity shares between April and June ’09. The company expects to collect Rs 50 crore from full exercise of the warrants. According to Mr Shah, “There will be three main avenues for deployment of these funds, viz our retail business in India, the US business and the non-US business. We may float another subsidiary in some non-US markets such as Europe, Middle East or South-East Asia, depending on the growth prospects.”Considering the company’s steady growth prospects, investors with a 12-month horizon are advised to remain invested in the scrip.

Investors in listed PSUs may be in for a windfall

Guidelines state that PSUs having reserves in excess of three times their paid-up capital should consider issuance of bonus shares

IF PUBLIC sector undertakings (PSUs) decide to abide by the guidelines of the department of public enterprises (DPE), then investors in more than half of the listed PSUs could be in for a windfall. DPE guidelines state that PSUs having reserves in excess of three times their paid-up capital should consider issuance of bonus shares. On December 8, ET had reported that the government had instructed IndianOil (IOC) to consider a bonus issue on this parameter. During FY’07, IOC’s reserves were 28 times its paid-up capital. According to a study by ET Intelligence Group, more than half of the actively-traded PSUs meet this requirement.
To put it in perspective, out of the 83 listed PSUs, 52 companies have reported accumulated reserves and surplus that were more than three times their respective paid-up capital during FY’07. This, viewed in the backdrop of the DPE guidelines and the government’s instructions to IOC, may hint at a possibility of bonus announcement by these PSUs.
The list includes PSUs from various sectors including banking, petroleum production and refining, metals and engineering. On the top of the list is the lignite producer Gujarat Mineral Development Corporation. The reserves of this Rs 600 crore mining company were 126 times more than its paid-up capital by the end of FY’07. It is followed by Tide Water Oil Company, a Rs 421-crore oil and greases manufacturer and State Bank of India, the largest bank in the country, which had earned over Rs 39,000 crore in interest income during FY’07.
It needs to be noted that DPE has issued only a guideline. “The DPE guideline need to be looked more as a directive than a mandatory rule. What the guideline means is that on a face value of Rs 10, the PSUs having book value of more than Rs 40 per share may consider giving a bonus issue,” says SP Tulsian, an investment advisor. This means PSUs may still observe their discretion while taking a decision in this regard.
Another point to be noted is that a bonus issue may not be advisable for companies which have been witnessing a decline in their net profits or those companies where earnings visibility is low. In such cases, a bonus issue may reduce the dividend per share paid by the company. This is particularly relevant for oil marketing companies (OMCs). Profits of OMCs are reeling under the burden of fuel subsidies. “Currently there is no certainty about future profitability of oil companies. Unless the situation improves and gives us some confidence of servicing the increased equity capital, it will be imprudent to consider any bonus issue,” says SK Joshi, finance director, BPCL.
Experts think that the directive would not serve much purpose as it mainly results into a mere adjustment in the books of account of the companies. Mr Tulsian says, “A bonus issue would increase the paid-up capital by reducing the reserves of a company. This means there is no change in the net worth of the company. Further, such a decision would not increase the free floating shares of the company in the market.” Free float for some of the PSUs including NMDC, National Fertiliser and RCF is below 10% of the total number of paid-up shares as the government holding in these companies is very high. Some of these stocks have seen a huge jump in prices on the bourses in recent times. Mr Tulsian thinks that splitting the number of shares would lead to improved free float of the shares of such companies instead of giving bonus shares and may curtail speculative movements in share prices

SEAMEC: Docked vessels may take a toll on Seamec topline - 12th December 2007

SEAMEC, which provides offshore support to petroleum exploration and production companies, is likely to see a dip in its performance during the December 2007 quarter. The Rs 200-crore company has been unable to deploy two of its vessels during the current quarter, leading to substantial loss of revenue. The vessels, which are currently in shipyards undergoing repairs and upgradation work, have faced delays in work completion.

Seamec currently owns and operates three multisupport vessels (MSVs) required in the offshore petroleum production industry and had acquired a fourth vessel in mid-2006 to ramp up its fleet. The charter rates for MSVs have moved up substantially over the past couple of years, in line with the industry trends, to around $50,000 per day currently.
Seamec’s fourth vessel, Seamec Princess, scheduled to commence business by June 2007, has already spent six extra months in shipyard for upgradation and is still to commence business. One of its working MSVs — Seamec II — while undergoing periodic dry-docking in September 2007, suffered an accident, thus putting it out of business for the entire quarter.
With both these vessels spending their time in the docks, the company could operate only two of its vessels during the current quarter. The company, which follows December year-end, is likely to report a fall in its quarterly revenue on a y-o-y basis. Since the company is also likely to book the dry-docking expenses in the current quarter itself, its profitability also would take a hit. However, the future does appear bright for the company, which expects to engage all four of its MSVs throughout 2008 resulting in higher revenues and improved profits. During the past one year, Seamec’s shares have moved up from Rs 155 level to cross Rs 255 in July 2007. However, the scrip has witnessed a decline since then. It has remained range-bound around Rs 200-220. The company, which appears to tread cautiously with regard to investing in the business despite the booming offshore industry, commands the lowest P/E among its peers.