Weak Gives India a Crude Shock

Despite the easing of global oil prices, the cost to India has been rising due to fall in rupee

    The steep depreciation in rupee in the past couple of months is worsening the problem of high crude oil prices for the Indian economy. Although, the global oil prices have somewhat eased recently, the cost to India has been going up. At a time when India is battling several woes such as high inflation, rising deficits and slowing growth, a combination of weak rupee and high crude prices could further complicate matters. 

After reaching a peak in April 2011, the global crude oil prices have eased subsequently. Accordingly, the average price for India’s crude oil basket at $106.9 in September and October was 4% below the average in the April-August 2011 period. However, in rupee terms, India’s net import cost in the past couple of months at almost . 5,200 per barrel turned out to be nearly 4% higher than the preceding four months.
It is not that the current global oil prices are at their historic peak or the rupee is at its historic low. Brent oil prices touched $143 in July 2008, while the rupee-dollar exchange rate had touched 52 in March 2009. FY09 witnessed India’s fuel under-recovery zoom above . 1,00,000 crore. The government then could afford to plug the hole with a huge heap of oil bonds. Things are different this time as both the perils — weak rupee and high oil prices — have come back to haunt the economy and the government lacks the firepower it had three years ago. It is already seen falling behind its revenue targets and overshooting expenditure targets and hence looking at a wider fiscal deficit. India imports around 80% of the crude oil it needs. Although, the country is a net exporter of finished petroleum products, the domestic consumption has been growing at a high pace. Since FY07, India’s consumption grew at a cumulative average growth rate of 4.1% to 142 million tonne in FY11 and is expected to grow 4.6% in FY12 to 148.3 million tonne, according to the petroleum ministry. This is more than twice the global growth in oil demand during this period. 
Rising global prices, apart from growing domestic consumption, have also created a huge fiscal burden on India as the costs are not fully passed on. According to the petroleum ministry’s estimates, India’s total petroleum under-recoveries for FY12 will be . 1,21,571 crore, if Indian crude basket averages at $110 per barrel for the whole year. However, these estimations were made in June 2011 when rupee-dollar exchange rate was . 44.85. The currency has weakened 10% since then. The industry lost . 64,900 crore in the first half of FY12 and . 272 crore daily in the first fortnight of October 2011. The rupee depreciation could necessitate an upward revision to the overall under-recovery numbers in the near future.
The composition of the Indian basket of crude is based on total industry processing of sour and sweet crude, including domestic output of crude. With Indian refiners improving their ability to process more and more sour crude oil — or crude oil with high sulfur content — the Oman — Dubai grades have gained weightage in the composition of Indian basket over the years. From 58% weightage in overall basket in FY06, the sour grades represented by Oman & Dubai grades now account for 67.6% since April 1, 2010. Naturally, the proportion of Brent crude in the Indian basket has fallen to 32.4%, from 42%, in this period.
Risk appetite returned to the markets in the past few trading sessions due to the Eurozone’s plans to bail out the Greek economy, while the rupee appreciated with FII money flowing in. On the other hand, this also boosted the international oil prices.
Looking at the fundamental picture, over the next 6-12 months, the oil prices could stagnate particularly with moderate global economic growth and rising oil production from the Gaddafi-less Libya and Iraq. The rupee’s fate will depend on how India is able to contain foreign investors’ worries about widening budget deficit and slowing economic growth. In this regard, what the government does with its mountain of fuel subsidy is something the world will be watching for. 

Digging Deep 
• In rupee terms, India’s net import cost in the past couple of months at almost . 5,200 per barrel turned out to be nearly 4% higher than the preceding four months

• Since FY07, India’s consumption grew at a cumulative average growth rate of 4.1% to 142 MT in FY11 and is expected to grow 4.6% in FY12 to 148.3 MT

• India imports around 80% of the crude oil it needs

Lead Story: SMALL & STARRY-EYED

Every investor dreams to have a future Infosys or Titan Industries in her portfolio. But choosing the right gems out of over 5,000 listed companies is no mean task. Take heart, ET Intelligence Group has done the job for you. Here’s a list of 100 Fastest Growing Small Companies that could be future giants.

The phrase “nothing succeeds like success” might be a cliché, but when it comes to demonstrating the success nothing quite succeeds like growth. It is the growth in revenues and profitability that validates the correctness of a business strategy or a robust business model. Better still, if this is achieved consistently over a period of time. Both large corporates and the smaller ones have their own set of growth stories. Still the limelight is never the same. Bigger companies are always the ones that are talked of more and corner the bigger share of attention. After all, their growth into biggies has already confirmed their success. However, as they say, ‘the great thing in the world is not so much where we stand, as in what direction we are moving.’ Going by this logic, we feel it is important to celebrate the growth stories even of smaller companies. They may be standing low on the ladder, if size were a criteria, but their consistent growth indicates that they are moving in the right direction. They hold the potential to become India Inc’s poster boys in years to come.
While the ubiquitous disclaimer about future’s uncertainties is definitely in order here, we recommend investors cherry pick companies from our list based on their individual research. Such investments
could prove immensely fruitful over next the few years. 

THE STREET SHOW Last one year has been bad for the stock market and in times like this small and mid-cap companies tend to suffer the most. However, that was not the case with our last year’s list of 100 Fastest Growing Small Companies. Between last and this October BSE Small Cap lost 36%, BSE MidCap fell 27% and BSE Sensex slipped over 15%. However, three in every four companies from the 2010 list of Fastest Growing Small Companies have outperformed the BSE Midcap Index in this period, while 52 companies have performed better than the BSE Sensex itself. One in every three companies gave a positive return during this period. It is worth noting that this performance is calculated based on monthly average prices and not point-to-point comparison. 

THE STAR CAST OF 2011 The list of Fastest Growing Small Companies remains, as usual, a representation of varied sectors from auto ancillaries, pharma & FMCG, chemicals to packaging and mining. Only about half the contenders of last year could make it to the list this time. In a few cases this was on account of the company’s inability to continue to perform well. However, quite a few had to lose their rankings due to the raised bar. The list this year is topped by Ester Industries, maker of polyester film, which made a dashing entry into the list, thanks to the runaway prices of its final product. Zydus Wellness, our last year’s topper maintained its momentum to secure the second place. While National Peroxide and Mayur Uniquoters improved their last year’s rankings to take third and fourth places, respectively. A brief analysis of our 10 toppers follows the main story for readers’ easy reference. 

ACTION & DIRECTION One of the key challenges in compiling this list was to weed out unsound and potentially dubious candidates. This is important because one can’t worship growth just for the sake of it.
We tried to achieve this by putting strict parameters for companies vying to enter the list. Only companies qualifying on all these accounts were considered for ranking. As such, making it to the ranking is itself quite an achievement.
The first thing considered was the debt-equity ratio — the gauge of leverage. Any company with a reading of above 1.5 in last three years was dropped for being too leveraged. Similarly, interest coverage ratio, indicating the ability to service the debt, had to be above 5 for three consecutive years for the companies to make it to the list.
The next criterion considered was the return on capital employed (RoCE). RoCE is a measure to figure out how efficiently a company utilises its capital invested in the business. Too low a return and the company could end up in a debt-trap. Hence, companies that could get RoCE of above 15% for the past three years were only considered. Additionally, companies unable to generate positive cashflows from operations for at least two of the past three years were removed. Finally, the revenue benchmark to qualify as a small company was raised to 1,200 crore or below for the current financial year to accommodate the overall growth and inflation against 1,000 crore or below in the previous year. At the lower end, companies with a market capitalisation below 100 crore were excluded.

Top 10 Companies

ESTER INDUSTRIES 
FY11 saw the demand for polyester film — also known as BOPET film — move up strongly on products such as mobile touch screens, LED televisions and solar panels. The prices soared as supply failed to keep pace, enabling companies to make a killing. However, as supplies grew, BOPET prices came down substantially. Ester Industries’ June 2011 quarter net profit tumbled 81% y-o-y. This means the company is unlikely to maintain its feat next year. However, with its capacities more than doubling last year there will be a substantial volume growth.

ZYDUS WELLNESS 
Zydus Wellness, the 350-crore FMCG arm of Zydus Cadila group, has a strong product portfolio with an underlying health plank. The company has invested heavily on building its brands such as Sugar Free, Nutralite and EverYuth. Despite a subdued performance in the June quarter, the company’s business continues to hold the promise of strong growth. Sugar Free is India’s largest-selling low-calorie sweetener with an 86% market share. EverYuth range of skin-care products enjoy their leadership position in the scrubs and peel-offs category despite competition from MNCs and other Indian players. However, the company is facing intense competition in the face-wash category. Growing at over 20%, the company is poised to achieve its target of 500-crore revenue by 2013-14

NATIONAL PEROXIDE 
Improvement in the prices of chemical hydrogen peroxide helped the industry leader National Peroxide in FY11. The company achieved 49% jump in revenues and 255% in net profits, while its production improved 11.4% to 71,826 tonne. The company expanded its hydrogen peroxide capacity by 24%, for which it had to shut down its plant in the April-June quarter for 70 days. Even after commissioning the plant, the commercial production could begin only from September 2011 onwards. This is set to affect its numbers in the first half of FY12. However, the second half of FY12 onwards it will enjoy the full benefits of expanded capacity.

MAYUR UNIQUOTERS 
Mayur Uniquoters is India’s leading manufacturer of artificial leather and supplies to domestic automakers such as Maruti, Tata Motors, Hero MotoCorp, M&M, etc, and footwear makers such as Bata, Liberty, Action, etc. It has continued to grow well over last few years without leveraging its balance sheet and is one of the few companies giving quarterly dividends. The company has started supplying to overseas automakers such as Ford and Chrysler and is trying to enlist with GM, Toyota, BMW and Mercedes Benz. The company has maintained its position in the 100 Fastest Growing Small Companies list for second consecutive year and has proven a multibagger in last one year. It appears well placed to continue its steady growth in coming years.

SANDUR MANGANESE 
Sandur Manganese & Iron Ore is India’s secondlargest manganese ore miner and also operates a ferro-alloys plant with almost all its 2,000-acre mining land in Karnataka. The company benefited from the improved pricing scenario in FY11 although its sales volumes dipped on export ban in Karnataka, high freight costs and 20% export duty imposed on iron ore. The company’s June 2011 quarter numbers were hit by Supreme Court’s blanket ban on mining activity in Karnataka. This factor is likely to weigh on its overall performance of FY12 like other mining companies and could make it difficult to maintain its position in the list next year.

LUMAX AUTO TECHNOLOGIES 
Lumax Auto Technologies is an auto-component maker supplying transmission and steering components, body and chassis and electrical components. Growing production of automobiles by both Indian and foreign players, a buoyant replacement market and rising costs have benefited Lumax. It is a debt-free, cashrich company and is planning to add two more plants to the existing six facilities in Maharashtra. Its entry into infrastructure lighting, although small at present, could safeguard it from cyclicality of the auto industry in the future.

WABCO INDIA 
WABCO India, now a 75% subsidiary of WABCO Holdings of the US, is a supplier of auto components to commercial vehicles industry. A significant revival in Indian commercial vehicles industry, thanks to investments in development of road and infrastructure, enabled it to post a strong revenue growth. As investments in roads grow with more and more private participation, the long-term growth trajectory will remain strong for the commercial vehicle segment. However, in the shortterm, cyclicality in the commercial vehicle market and rising raw material costs could be a concern.

ECLERX SERVICES 
Mumbai-based KPO operator eClerx has benefited from the buoyancy in the demand from the global financial market. Despite talks of a global slowdown, eClerx reported a strong sequential growth of over 6% in the five out of the six quarters ended September 2011, validating success of its business model. PBDIT margin above 33% shows that the new business did not come at the expense of profitability. This has helped in offsetting the impact of higher taxes due to minimum alternate tax on SEZ income. The company offers critical back-end services to the financial sector, which are not affected by the movement of business cycles. This should keep the company going during tough times.

HAWKINS COOKER 
Hawkins Cookers is seeing a huge demand for its products but was unable to meet it because of labour issues at its plants. Last year, the company’s net sales grew 17%. The profit declined due to higher raw material prices. But now most of the labour issues have been resolved and input prices have come down from their peak. Hence the company will be able to run its plants more efficiently and higher growth can be expected. Besides, the company is financially sound with high return ratios, strong cash flows and low debt.

EVERONN EDUCATION 
Education services provider Everonn Education has reported strong buoyancy over the past three years backed by sound return and liquidity ratios. Its stock has, however, plummeted 44% from the year-ago level following the judicial action against its erstwhile MD in early September.
The company has appointed new leadership and has ensured the soundness of its business fundamentals. In the past one month, its stock has recovered from the lows of 228 to the current level of 380. Its performance under the new leadership in the next few quarters will be crucial to restore the investor confidence.

SECTOR ANALYSIS: PETROLEUM INDUSTRY

Refining Industry Faces Hard Times as Global Growth Cools

Crude oil prices have remained volatile through the last quarter amid growing global economic uncertainty. Worries about the pace of economic growth on one hand and rising hopes of a Libyan production recovery on the other have weighed on oil prices. Consequently, average Brent crude oil price ruled some 4.2% lower in the September quarter from the June quarter. It had fallen over 20% from its peak in April 2011 indicating a ‘bear market’. However, the prices later recovered. In the last week of June, the government reduced various duties and increased diesel and LPG prices marginally to help bring down the local oil industry’s losses. However, the rupee’s depreciation in September is likely to increase the burden further. The performance of the stateowned oil companies in the September quarter will, therefore, be again dependent on government aid. Reliance Industries’ results showed signs of a slowing growth that had investors worried over a possible phase of stagnation. Similarly, Petronet LNG’s stock fell although it doubled its September quarter net profit on fears that further growth will be difficult to come by. Heavy rupee depreciation led to a forex loss of 352 crore forMRPL impacting its profits. 

The refining industry could be entering a long phase of downturn if global economic growth continues to cool off, as 2012 and 2013 are likely to see substantial capacity addition. Substantially lower prices of WTI crude oil will help shield US refiners, but European refiners could see a number of closures in the coming months.
The industry’s performance on the stock market continues to remain subdued. While industry leader RIL suffers from its own woes, ONGC’s performance has been languishing due to government’s followon public offer plans. Similarly, Cairn was hit by the hangover from the Vedanta deal. Natural gas major Gail has fallen due to worries over volume stagnation after domestic natural gas production continued to dwindle.

CAIRN INDIA: Royalty Burden Bites, but Future Seen Secure

Cairn India’s profits for the September ’11 quarter took a hit as the company provided for the cumulative royalty payment to ONGC for the Rajasthan fields. On booking this one-time expense, the problems attached to the acquisition of its holdings by Vedanta seem to be behind it and the company appears poised to capitalise on its upcoming volume growth.
In its bid to obtain government approval for the Vedanta deal, Cairn India had to accede to the government’s demands to bear royalty and cess burdens in proportion of its stake in the Rajasthan block. This also meant it had to refund ONGC the royalty it had paid on Cairn’s behalf since production was commissioned in August 2009. As a result, Cairn booked . 1,355 crore of extraordinary expenditure towards its share of royalty up to June 30, 2011.
Although the company received nearly 48% higher revenues from selling every barrel of crude oil in the September ’11 quarter compared to the year-ago period, its revenues stood 1% lower at . 2,652 crore. The key reason was the royalty burden, which amounted to nearly . 770 crore, which it did not have to bear last year. A sharp jump in other income meant that the pre-tax profit for the quarter was up 28%.
Within just two years of operating the Rajasthan fields, the company has reduced its debts substantially and is now a cash-rich company. As of end-September ’11, it held net cash of . 7,129 crore, or almost $1.5 billion. With strong operating cash flows, it is ready to meet all its capex requirements. The company faces a bright future ahead with a scalable reserve base in the Rajasthan fields and discoveries in other blocks. In the Rajasthan fields, it is scheduled to increase the output 40% to 175,000 bpd by March ’12. The production from the Rajasthan block could touch 240,000 bpd. However, these plans are dependent on receiving timely approvals from its joint venture partner ONGC and the government.
The Q2 results would appear dismal at first glance. However, it was known that it had to book the one-time loss on royalty burden. Its profitability will resume the new normal trajectory from the December quarter onwards. Its share price is expected to show a better link, with crude oil prices in the coming months. 

Petronet LNG: A disproportionate rise in operating cost squeezes margin by 50 bps to 8.4%

Petronet LNG posted yet another quarter of strong performance with its profits for the September ’11 quarter doubling from the year-ago period. The strong domestic demand for natural gas enabled it to operate its LNG importing plant at 106% capacity. The company appears well placed to maintain its performance in coming quarters.
Petronet LNG’s net sales for the quarter were 76% up against the September ’10 quarter as volumes jumped 35.4% to 135 trillion British thermal units (TBTUs). Other factors to boost revenues were a strong jump in LNG prices that are passed on to customers and a marginal growth in re-gassification charges.
A disproportionate jump in operating costs dented its operating profit margins, which dropped 50 basis points to 8.4%. Depreciation and interest costs, which are the largest cost items for the company, fell 1% and 7%, respectively, thereby boosting the pre-tax profit by 94%. A marginal dip in the effective tax rate took net profit higher by 99% to . 260.3 crore.
Rising LNG prices in the spot market had raised concerns about demand destruction, if it became cheaper to use fuel oil. The current spot LNG prices translate into $15-17 per million BTUs (MMBTU). Nearly 15% of the company’s volumes come from spot cargos.
However, the management explained in its post-results conference call that its capacity is fully booked for the next three-four months with customers ready to pay the increased prices. The volumes from the long-term contract with RasGas had averaged 90 TBTUs in the first half of FY12, which should move up to 94 in the second half.
The company is setting up another LNG terminal at Kochi with 5 MTPA capacity at a cost of . 4,200 crore to be commissioned by December 2012. It is also setting up a second jetty at Dahej at a cost of . 900 crore, which will enable it to improve utilisation of its existing capacity by another 20-25%.
The scrip is trading at a price-toearnings multiple (P/E) of 13.5 considering its profits for the last 12 months. However, based on annualised profits for the first half of FY12, the P/E works out to 11.7. 

Petronet LNG: A disproportionate rise in operating cost squeezes margin by 50 bps to 8.4%

Kajaria’s Prospects Justify Valuation

Co aims to maintain growth momentum in H2 too

In spite of turbulent market conditions, Kajaria Ceramics achieved a rare distinction of hitting an alltime-high on October 13, when it announced its September ’11 quarter results. Braving the strong cost pressures that lowered its margins, the company posted a strong 42% net profit growth.  

The company achieved a 42.7% jump in net sales to . 316.4 crore supported by 37% growth in volumes to 9.6 million square meters (msm). Its operating profit margin for the quarter slipped 90 basis points to 14.8% due to higher raw material costs, increased gas prices and a depreciating rupee. With its expanded and new capacities, the company is replacing its earlier imported products with indigenously manufactured ones while outsourcing the low-value products — a strategy which is supporting its margins. 

This is reflected in its trading activity. Revenues from trading, which stood at 45% in FY11, dropped to 40% in Q2. This was achieved in spite of a 50% jump in traded volumes to 3.05 msm, indicating a nearly 12.9% fall in realisation per unit of traded product. In the manufactured segment, revenues grew at 51.8% to . 189.4 crore even as the volumes grew 31% to 6.59 msm indicating an 8.9% improvement in realisations. Over the past six months, the company’s debt remained unchanged at . 285 crore. Its debt-to-equity ratio at end of September ’11 was 1.1 against 1.3 at end of March ’11. Its working capital cycle has improved substantially to 38 days in the September quarter from 100 days a year ago.
The company plans to maintain its revenue growth momentum in the second half of FY12 as well with increasingly more revenues coming from manufactured products.
Its Gujarat-based subsidiary Soriso Ceramic is doubling its 2.3 msm capacity of ceramic floor tiles by February 2012. The company has also forayed in high-end sanitary ware and wooden flooring and is aiming to become a complete solution provider.
The company’s growth momentum and promising prospects have helped it command a premium valuation over its peers. The scrip is trading at a P/E multiple of 12 times compared to a P/E between 5 and 7 for its peers such as Somany Ceramics, Nitco Tiles and Asian Granito.