Black Gold - 7th April 2008

7th April 2008

Black Gold

Himadri Chemicals’ ability to maintain strong margins and growth momentum, make its stock attractive for long-term investors

Ramkrishna kashelkar

KOLKATA-BASED Himadri Chemicals (HCIL) has lost 45% of its market capitalisation in the past three months even though its future growth prospects continue to be strong. HCIL is a leading player in coal tar derivatives, which are vital inputs in the production of aluminium and steel. The company is now expanding its capacities as well as product portfolio which, considering its ability to maintain strong margins, makes the scrip attractive for long-term investors.

BUSINESS:
HCIL has a combined coal tar distillation capacity of 2,19,000 tonnes per annum (tpa). It manufactures derivatives of coal tar such as coal tar pitch (CTP), creosote oil and naphthalene. CTP is primarily used in the aluminium and graphite industries and HCIL holds over 70% market share in India. Its clients include Nalco, Balco, Hindalco, Indal and HEG among others.

HCIL is a leader in a market that is growing fast resulting in improved operating margins. HCIL has also drawn up an aggressive capex plan to quadruple its capacity by ’12 at a cost of Rs 1,600 crore. Recently, HCIL raised Rs 118 crore through preferential warrants allotment and the board has approved an $80-million FCCB issue to finance the expansion.
In January ’08, it commissioned its 120-tpa advance carbon material plant in West Bengal, which will be expanded to 4,500 tpa by ’12. This plant will produce special grade carbon required for manufacturing lithium ion batteries. Further, HCIL has acquired a company in Hong Kong to expand its geographical footprint. It has also opened a representative office in China to streamline its import activities.

GROWTH DRIVERS:
Under the current expansion plan, HCIL’s distillation capacity will double to around 0.5 million tonnes by the end of FY09. Similarly, its 50,000-tpa carbon black plant will be commissioned during the year, while the full benefits of the advance carbon plant commissioned in January ’08 will also be available to the company. These will drive HCIL’s sales growth during FY09. On the other hand, the margins will be maintained at the current levels, thanks to rising demand and new value-added products.
The aluminium industry, which consumes nearly 80% of the coal tar pitch produced globally, is expected to grow at a CAGR of 7.5% over the next 3-4 years and the production of steel representing around 13% of the CTP consumption, is growing at around 6%. This, in turn, will boost demand for coal tar pitch.

FINANCIALS:
Since FY01, HCIL’s net profits have increased at a CAGR of 110% to Rs 323.3 crore in FY07 while sales have posted a CAGR of 32.5%. In the same period, the RoCE improved from less than 10% to 30%. During the quarter ended December ’07, HCIL posted 30% growth in net profit despite a 3% increase in revenues. The sales growth appeared muted mainly because of a weak pricing scenario. However, HCIL improved its operating margins even as its other income came down sharply.

VALUATIONS:
As HCIL’s expanded coal tar distillation capacities come on stream over the next year, the company is likely to nearly double its operating profits. Taking into account the recent preferential warrant issue, HCIL’s equity on a fully diluted basis stands at Rs 34.27 crore. It is expected to post earnings of Rs 39.9 per share for FY09 — nearly 70% above the EPS of 23.4 projected for FY08. This provides an attractive opportunity for long-term investors. ramkrishna.kashelkar@timesgroup.com

Crude transport clouds over Cairn despite many positives - 1st April 2008

1st April 2008

Ramkrishna Kashelkar MUMBAI

Crude transport clouds over Cairn despite many positives

OIL exploration and production company, Cairn India, has for the first time, come out with a reserves estimate for its exploration activities, apart from the Rajasthan fields. The development is likely to boost its valuations in coming days. The company disclosed that its exploration portfolio provides exposure to net unrisked recoverable resources in excess of 1 billion barrels of oil equivalent (BoE). This is a significant reserve accretion for the company, which could be valued at around $4-5 billion adding over 40% to its current market capitalisation of $10 billion.
Despite the positives, the company has been unable to resolve uncertainty over the cost of pipeline to transport crude oil to a port in Gujarat. The government has not approved the company’s request to include the $800 million cost of constructing the pipeline in the field development plan (FDP). However, it has already awarded the contract to construct the pipeline and work is expected to begin from second half of 2008.

Cairn India has also raised its estimates of proven and probable (2P) gross reserves from the three main Mangala, Bhagyam and Aishwariya (MBA) fields by 9% to 685 million barrels. The other Rajasthan fields have a gross 2P estimate of 1.7 billion barrels of oil equivalent (BoE). With the increase in reserves, the company also increased its production target from these fields by 16.7% to 1,75,000 barrels of oil per day (BOPD), while emphasising the production to start in H2 2009.

While exploring in different blocks for hydrocarbons, Cairn is also working on methods to extract more from the existing reserves. The production from its Cambay basin field reached its highest ever level in February 2008 as new wells drilled recently became operational. To boost its recoverable reserves from its Rajasthan fields, Cairn India has successfully tested enhanced oil recovery (EOR) techniques in laboratories. This is likely to add nearly 300 million barrels of incremental recoverable oil once implanted from year 2013 onwards.
Cairn posts Rs 24.5-cr loss
Cairn India has reported a loss of Rs 24.5 crore for the year ended December 31, 2007, compared with a loss of Rs 18.7 crore in the previous year. The strengthening of the rupee against the dollar resulted in the company recognising an accounting loss due to foreign exchange fluctuation of Rs 14.05 crore ($34.5 million). This arises on account of deposits held in dollars by foreign subsidiaries, which are intended to be used for capital imports. For the fourth quarter, the company has posted a loss of Rs 13.9 crore. ramkrishna.kashelkar@timesgroup.com

The Perfect Blend - 31st March 2008

31st March 2008

The Perfect Blend

Praj Industries is in an expansion mode and has a healthy order book position. The stock appears attractive for long-term investors

Ramkrishna kashelkar

THE CURRENT market meltdown has drastically reduced the valuations of several companies. However, in quite a few cases, the market has been too harsh on companies which have a promising future. This has created an excellent opportunity for long-term investors. One such company is Praj Industries, which has long been the market’s darling, due to its growth prospects in the ethanol industry.

The company has lost over half its market capitalisation in the past two months, without any corresponding change in its fundamentals or future outlook. Given that the company is in an expansion mode and is sitting on a healthy order book, it is expected to post a good performance next year. Long-term investors can consider the stock at current levels.

BUSINESS:
Pune-based Praj Industries is an engineering company and is the market leader in ethanol technology. It provides turnkey project implementation services to set up ethanol distillation units. The company has developed technologies to produce ethanol from a variety of feedstock such as sugarcane, sweet sorghum, corn etc and is trying to develop a commercially viable method to convert cellulose into ethanol. Besides ethanol — which accounts for over 80% of its revenues — the company also carries out distillation for breweries and plans to enter the bio-diesel space.

Praj has executed projects in over 35 countries. Over the past couple of years, it has taken steps to strengthen its global presence. These include an acquisition in the US and tie-ups with foreign companies in Europe and Brazil. With this, the company has established its presence in key markets across the world.

Over the past couple of years, the company’s shareholding pattern has witnessed a peculiar trend. The shareholding of the promoters and public has fallen, while institutional holding is on the rise. This indicates that the company is gradually becoming a professionally-dominated organisation, from a promoter-driven one. This augurs well for the long-term growth sustainability of its business model. Some of the most successful companies such as Larsen & Toubro,
ITC, HDFC and Infosys are majority owned by institutions.

GROWTH DRIVERS:
Ethanol and bio-diesel are gaining acceptance worldwide as eco-friendly fuels. Ethanol blending has already become mandatory for petrol in a number of countries, including its largest consumer, the US. The proportion of blending is slated to go up, with governments in the US and India mandating 10% blending over the next 2-4 years. The European Union is also contemplating to replace 10% of petrol consumed with ethanol. This is likely to create strong demand for turnkey solutions providers such as Praj Industries. The company already has an order book of Rs 900 crore, which will be executed over the next 12 months.

Praj is gearing up to cater to the fastpaced growth in future by expanding its capabilities. It has increased its manpower and set up its second manufacturing unit at Kandla SEZ. It has also established a full-fledged research centre for bio-fuels to develop new technologies in this field.

FINANCIALS:
Praj’s net profit has witnessed a cumulative annual growth rate (CAGR) of 43.2% over the past 10 years, while its net sales have grown by 27.3%. Although its dividend per share has increased over the past four years, dividend payout ratio has fallen, thanks to rapid spurt in net profit. The company has already disbursed 33% of its reported book profits for April-December ’07 via interim dividends.

Praj’s performance during the quarter ended December ’07 was lacklustre as it is in an investment phase currently. Its profit grew by 17.2% to Rs 39.4 crore, while net sales rose by just 1.3% to Rs 180.2 crore. But employee costs and other expenses rose significantly.

VALUATIONS:
At the current market price of Rs 132.10, the scrip is trading at a price-to-earnings multiple (P/E) of 19.8 based on its earnings in the past 12 months, which is nearly half its P/E just a couple of months ago. Considering Praj’s current order book, ability to win new orders and investment in research & development, we expect the company to maintain its EBIDTA margins above 20%. For FY09, we expect Praj to report earnings per share (EPS) of Rs 10.1. This discounts the current market price by 13.1 times, which appears attractive for long-term investors.

RISKS:
Despite staying debt-free, the company has expanded its equity capital on several occasions to raise funds. This has resulted in dilution of earnings. If this trend continues in future, it will be detrimental to the interest of retail investors.

Time to be wary of this ‘elite’ PE100 club - 19th March 2008

19th March 2008

Time to be wary of this ‘elite’ PE100 club

Ramkrishna Kashelkar ET INTELLIGENCE GROUP

TAKING cues from the unrest in the global financial markets, Indian stock markets have crashed substantially over last few days. The Sensex has come all the way down to 14,809 shedding 29% from 20,827.5 on January 11, 2008. In the same period the price to earnings mul tiple (P/E) of the Sensex has plunged from 28.4 to 19 — a level, which was last seen only in March 2007. The price-to-earnings multiple reflects the investors' confidence in the future earnings of the companies constituting the benchmark index.

With its daily dose of bad news the stock markets continue to plunder investors’ wealth every day. However, even in these despairing times a quite a number of companies continue to command three-digit P/Es. It must be accepted that the number of companies claiming such high P/Es have certainly come down during the market meltdown and even for others the P/Es have eroded. Nevertheless, a P/E above 100 is certainly an indication of strong investor confidence about a company's bright future. While such PE may be justified in case of few companies, the same can't be true for all the companies in our list.

The elite group of 100-plus PE companies includes the over 90 companies such as Reliance Natural Resources (RNRL), Educomp and Moser Baer among others. Here we are excluding the recently-listed companies, which are yet to publish their full year's financials. Although the real estate industry got a thorough beating in the recent meltdown the companies such as Bombay Dyeing, Phoenix Mills, Jaybharat Textiles, Godrej Industries continue to occupy place in this elite club thanks to their real estate ventures.

BF Utilities — the division of Kalyani Group of India, using windmills to power steel plants operated by the large manufacturing company — is also trading at PE above 100. Despite lack of any major exploration success the valuations of Hindustan Oil Exploration have stretched up based on its hydrocarbon reserves.

However, the investors need to be wary of the fancy valuations attracted by such companies, which can evaporate quickly into the thin air. For example, against 29% fall in the Sensex, companies such as Moser Baer, BF Utilities, RNRL, Jai Corp have already lost over 55% of their market capitalisation since first week of January 2008.

ramkrishna.kashelkar@timesgroup.com

Simply Colourful - 24th March 2008

24th March 2008

Simply Colourful

Kiri Dyes and Chemicals appears to be a good investment bet, considering its growth prospects from backward integration

Ramkrishna kashelkar

COMPANY:
KIRI DYES AND CHEMICALS ISSUE SIZE: Rs 46.88-56.25 CRORE PRICE BAND: Rs 125-150 DATE: MARCH 25-APRIL 2, ’08
KIRI DYES and Chemicals (KDCL) is a Gujarat-based manufacturer of dyes and dye intermediates and caters to textiles, leather, paint and printing ink industries. It has a total production capacity of 10,800 tonnes per annum (tpa). It’s coming out with an initial public offering (IPO) to fund its proposed backward integration project to produce raw materials. Post-expansion, the share of chemicals and intermediates will go up in KDCL’s total revenues vis-à-vis revenues from dyestuff.

BUSINESS:
KDCL mainly manufactures reactive dyes, which are used in cotton-based fabrics and represent the single largest dyestuff produced globally, accounting for over 25% of total production. It operates four manufacturing units — three in Ahmedabad, which manufacture dyestuff, and one in Vadodara, which produces intermediates.

KDCL was traditionally a dyes manufacturer, but started manufacturing intermediates such as vinyl sulphone and H-acid in FY07. These intermediates accounted for a quarter of its total revenues in the first half of FY08. Nearly half of its turnover comes from exports, with Turkey, Korea, the US and Bangladesh accounting for two-thirds of its total exports turnover. To facilitate exports, KDCL has converted one of its Ahmedabad units into an export-oriented one, which enjoys tax exemption on export income till FY10. InNovember ’07, KDCL entered into a 40:60 JV with Zhejiang Lonsen Company to manufacture all types of dyes. Under the JV, a 20,000-tpa plant will be set up in India, which is scheduled to begin commercial production by end-’08.

The growth in the $23-billion global market for dyes, pigments and dye intermediates, has slowed down and is expected to hover around 2% over the next decade. This has increased competition in the industry and eroded its pricing power. India leads the production of reactive dyes in Asia. It currently exports nearly Rs 3,500 crore of dyestuff, 60% of which is contributed by dyes.

EXPANSION PLANS:
KDCL proposes to set up a 180,000-tpa greenfield intermediate chemical plant and a 2.9-mw co-generation power plant at Vadodara at a capital cost of Rs 43.8 crore. This will help it to secure raw materials at a reasonable cost, besides providing it with another source of revenue.

FINANCIALS:
For the half-year ended September ’07 (H1 FY08), KDCL reported a net profit of Rs 8.9 crore and revenue of Rs 97 crore. Between FY03 and FY07, its profit witnessed a CAGR of 20.8%, against a revenue growth of 10%. It has consistently improved its operating margins over the past few years, which stood at 15.8% during H1 FY08. Its debt-equity ratio fell to 1.31 on September 30, ’07 from 1.76 as on March 31, ’07. Its operating cash flows also turned positive during H1 FY08 after staying negative for a couple of years. This was due to a substantial fall in its debtors, coupled with rise in current liabilities.

VALUATIONS:
We expect KDCL to report an EPS of Rs 11.9 for the year ending March ’08 on post-issue equity of Rs 15 crore. Based on current market conditions and the company’s expansion plans, the forward EPS for FY09 and FY10 is 16.3 and Rs 21, respectively. At the lower and upper price bands, the P/E works out to Rs 7.6 and Rs 9.2, respectively, based on FY09 expected EPS. KDCL issued 12.5 lakh equity shares to pre-IPO investors at an average price of Rs 115.5. Considering this and the proposed IPO, the promoters’ holding will come down to 66.57%. Thanks to the current market meltdown, a number of comparable dyestuff and chemical companies are available at cheap valuations. For example, Atul is trading at a P/E of 6.8, Aarti Industries at 6.4, Bodal Chemicals at 4.1 and Metrochem Industries at 13.3. KDCL is currently passing through a phase of high growth and hence, its valuations appear reasonable.

The End May Be Over - 24th March 2008

24th March 2008 Lead Story

The End May Be Over

The stock market appears to have neared its bottom and further downside looks limited. Though the situation remains volatile, most of the current indicators are pointing towards stability. The long-term outlook appears clouded, but with a positive undertone. India Inc’s Q4 results will give a clear picture as to what lies ahead

Ramkrishna kashelkar

SUDDENLY, WHEN everything appeared to be going smooth, the stock market hit a speed breaker. As the problems in the US economy, led by the collapse of its housing industry and the subprime crisis, spiralled out of control, the investor community, globally panicked. The weakness in the stock markets worsened with large financial institutions selling off their stock market portfolios across the globe to meet the liquidity crisis. Once the fall began, it snowballed to gargantuan proportions, with most listed companies in the domestic stock market losing between 30% and 50% of their market capitalisation in the space of two months.

The downward journey of the stock market was accompanied by daily doses of bad news. The bears used every piece of negative information to hammer down stock prices. Before they could realise and react, retail investors were left with heavily depreciated portfolios.

However, we at ETIG, believe that the time has come to stop despairing and do a reality check. To assess and take stock of the situation, we carefully examined five factors that are most important for stock markets, namely, the economic outlook, global currency movements, India Inc’s quarterly performance, current market valuations and the Sensex’s technical overview. We believe that the five parameters determine the market’s movement in the long term. Our analysis reveals that the market seems to have reached its bottom, but some short-term volatility cannot be ruled out. Thus, longterm investors may find excellent opportunities to enter the market over the next few days. The others may consider entering once definite signs of recovery are visible.

MACRO SIGNALS
It’s true that in the case of a slowdown in the US, India’s exports to that country can go down. However, just around 14% of India’s exports are sent to the US, which means that the direct impact may not be that severe. On the contrary, it is believed that if US companies start facing the heat, they may be forced to outsource more to low-cost destinations such as India. This will increase India’s service and manufacturing exports to the US and improve the growth prospects of Indian companies in sectors such as IT&ITeS services, textiles and auto components.

Apart from problems emanating from the US, India still has its own worries. During ’07, the domestic manufacturing industry witnessed a slight, but persistent slowdown in growth to just 8.4% for the quarter ended December ’07, which further slowed down to 5.2% in January ’08. The performance of six core infrastructure industries decelerated sharply in January ’08, recording 4.2% growth, against 8.3% during January ’07. Fortunately, however, the services industry that contributes to more than half of India’s GDP continues to grow at over 10% yearon-year. The growth in the services industry is expected to push India’s GDP growth to 8.7% during FY08.

Going forward, the Indian economy and India Inc are also likely to get a boost from huge capital expenditure currently under implementation across manufacturing and infrastructure sector. Recent data from the Centre for Monitoring Indian Economy (CMIE) reveals that the total investment under implementation has grown to over $630 billion in the quarter ended December ’07, nearly 50% higher compared to $425 billion during the quarter ended June ’06. Even if just half of these projects get completed over the next three years, it will nearly double India Inc’s current asset base of $300 billion.

Considering India Inc’s current revenueto-assets ratio of 1.8, this additional investment can generate recurring annual revenues of over $500 billion for Indian companies. And if we assume that even around half of these revenues come to the listed players with their PAT-to-sales ratio remaining intact, their revenues and net profit will expand by around 60% and 50%, respectively.

Hence, this trend of rising investments, which hint at expansion of the economy, can be heartening. But a slowdown in the growth of imports of capital goods contradicts this view. The imports of capital goods registered an 18% growth in the April-October ’07 period, against a 48% jump recorded in the corresponding period of the last year. The domestic production of capital goods, however, continues to grow strongly.

But with high crude oil and food prices, inflation can be another major problem for the Indian economy. After staying at around 4% level for 25 consecutive weeks, inflation has risen steadily above 5.92% for the week ended March 8, ’08. The government is trying hard to control inflation with a variety of subsidies and proposed a 2% cut in excise duty across the board in the recent Budget. However, such measures will put pressure on the government’s exchequer and worsen fiscal deficit, thus resulting in higher inflation later.

CRUMPLING DOLLAR
Currency movements hold the key to fund flows across nations and can influence the stock markets strongly. As a direct result of the weakening US economic growth, the dollar has weakened substantially against global currencies over the past few months. Over the past 12 months, the US dollar has lost over 18% against major international currencies such as the Japanese yen and euro, while it has depreciated around 4% against the pound sterling and 8% against the Indian rupee. With the US Federal Reserve cutting interest rates relentlessly, the dollar’s position against its peers can deteriorate further in future. As the interest rate gap widens, logically, dollar investments should start flowing into emerging markets, which has not happened so far. However, as and when the uncertainty ends and the market comes out of the crisis engulfing the global financial institutions, foreign investors are likely to return to the equity markets.

THE MAGIC OF NUMBERS
But India Inc’s quarterly results will be the single most important specific indicator of the stock market’s performance over the next few months. Over the past few quarters, Corporate India has reported deceleration in earnings growth, which is worrying market participants. Worse still, bottomline growth is being increasingly fuelled by growth in the other income, rather than operating income. While the operating profit margin on an aggregate level appears intact, sales growth has visibly slowed down. For example, the set of companies, which reported a year-on-year (y-o-y) earnings growth of 31.6% in December, has recorded a y-o-y growth of just 16.4% in the December ’07 quarter.

How the future plays out will depend on India Inc’s results for the March quarter (Q4 FY08) over the next couple of months. And if the corporate advance tax figures are any indication, the tone appears robust. The advance tax payments for Q4 FY08 have jumped 110% compared to last year, indicating better corporate results than what the current sentiment indicates.

The market has so far been wary of unpleasant surprises in Q4 results, fearing that companies may report heavy losses from treasury operations. The fears were fuelled by two major instances — firstly, when ICICI Bank reported its $263-million markto-market losses to its portfolio, and secondly, when L&T acknowledged a potential Rs 200-crore loss on hedging transactions, or nearly 10% its estimated FY08 net profit. The advance tax payments of both these companies have doubled during the current quarter, which should put investors’ worries to rest.

WORTHY OF YOUR ATTENTION
The current meltdown has eroded nearly 29% of market capitalisation since January 11, ’08, resulting in more sober levels in the valuation. The Sensex is currently trading at a price-toearnings multiple (P/E) of 19.5, substantially down from 28.4 in January. Compared to this, the benchmark index of China, Shanghai Composite, is trading at a P/E of above 33.

The latest estimates from the International Monetary Fund (IMF) put China’s growth in ’08 at 10%. Against this, the most conservative estimates of India’s growth this year expect the economy to expand by 7%. If we work out the forward P/Eto-growth (PEG) ratio after factoring in these expected growth rates, the Sensex with a PEG of 2.7 appears more attractive against 3.3 for the Shanghai Composite.

We can also look at the valuation issue from another angle. Analysts expect the Sensex to close FY08 with an EPS of Rs 820-830, which is projected to grow over 15% in FY09 and cross Rs 950. At the current level, the Sensex is discounting this forward expected EPS for the next year at 15.8, which is substantially below its average P/E of 18.2 since ’00. This indicates that fundamentally, the stock market has neared its bottom and further downside is limited.
GETTING TECHNO
While we have considered fundamental factors, it will certainly help to take a look at the technicals of the Sensex. The technical analysis depends heavily on past trends in the market movement to predict its future trajectory.

The current bull run in Indian equities started in the summer of ’03 from a Sensex level of just under 3000. In the past five years, we have seen four meaningful corrections.

The first one took place in May ’04, post the debacle of the NDA government at the Centre; the second one occurred in May-June ’06; the third one in early ’07 and finally, the current one.

However, during all the previous three corrections, the lows that the Sensex made were deeper than the lows it had made during the previous corrections. At the same time, after making deeper lows, it went on to make a higher top.

In the last significant correction that we saw in early ’07, the Sensex had made a bottom at around 12300. So, as long as that is not violated during the current crisis, we can still consider the current fall as just a correction in the bull market and expect to see a bounce-back.

At the same time, a point to be noted is the similarity between the current correction and that of May-June ’06. In ’06, the Sensex lost 30% of its value from a high of 12671 in May to a low of 8799 in June.

Similarly, from the intra-day high of 20206 in January to a low of 14677 last week, the Sensex has lost a similar 30% of its value. So, if last week’s lows are not violated, the bottom may just be in place.

While we try to take a stock of the situation, it remains dynamic and ever changing. Most of the current indicators are pointing towards stability. The short-term risk appears to be minimal and the long-term outlook appears clouded, but with a positive undertone.

The quarterly results from April onwards will give a clearer picture about where India Inc stands. At the same time, changes in the economic data in India and more particularly, the US, should also be tracked to get a better view of things. For those investors who have faith in India’s long-term growth story, the next few days may be a good time to enter the market.

(With inputs from Pallavi Mulay and Shakti Shankar Patra)

You may feel heat of oil flares soon - 20th March 2008

20th March 2008

You may feel heat of oil flares soon

Pallavi Mulay & Ramkrishna Kashelkar ET INTELLIGENCE GROUP

THOUGH crude oil has begun to hit new highs with unfailing regularity over the past two months, the rise has not begun to upset our monthly budget thanks largely to government subsidies. This state of bliss may not last for too long. Considering the pace of price rise in crude oil, its impact is likely to be felt soon. Crude oil prices, which have already breached a level of $110 per barrel are up by nearly 10% since December end, compared to 15-25% fall in major stock indices during the period.

The rising oil prices are building up an underlying inflationary pressure. Though petroleum products’ prices are administered in India and there is an incomplete pass-through of the burden to the final consumers. Nearly a fifth of the incremental change in inflation was accounted for by fuel price index for the week ended March 3. The burden of in most visible in case of aviation turbine fuel (ATF), naptha and bitumen, which are traded at market-determined prices. There price are up by 27-39% year-on-year for the week-ended March 3. This will impact air travel, power and polymers (plastic products and synthetic material) directly. We need to prepare to pay more for most manufactured products in the future.

A strong demand growth and high profit margins have given India Inc the leeway to absorb a part of input cost hikes in the past. But, as corporate earnings have slowed and economic growth is likely to soften, companies are running out of headroom to absorb further increases in crude oil prices. Most manufacturers are expected to take a price hike and some have done so in last few month. More increases in crude prices or a hike in domestic fuel prices will build up more pressure.

Retail prices of petrol and diesel are unlikely to go up, considering the forthcoming general elections and higher food prices. The government may compensate oil-marketing companies by issuing more oil bonds and this will increase future subsidy burden. This will create more liabilities for the future government and raise fiscal deficit few years down the road. Oil bonds will only delay the pain and will come back to haunt tax-payers in future.

Another fallout of rising oil prices is the depreciation in rupee against dollar. A stronger rupee helps cool domestic inflation by lowering the price of imports, which include crude oil food and many industrial raw material. However, a weaker rupee adds fuel to the inflationary pressure in the domestic economy. Rupee has depreciated by 2.4% during the month ending March 18. The net import bill (underlying assumption is that domestic consumption will grow at a three-year CAGR of 3.75%) is likely to touch a level of Rs 2,47,580 crore by March 2009 (almost $62 billion at current exchange rate), recording a growth around 19%. Such heavy import bill will account almost 5.5% of GDP further weakening rupee.

In short, rising oil prices weigh heavily on Indian economy. The demand growth is showing signs of moderation especially in interest rate sensitive sectors such as construction, consumer durables and automobiles sector. In order to stimulate the growth, interest rate cut is expected. However, rising oil prices have put RBI in a dilemma. So far, RBI has fought inflation by cooling off investment lead economic growth and is likely to continue with this policy. But what if GDP growth slips below 7%. It will amount to a severe slowdown in economy coupled with oil induced inflation and may began to hurt all and sundry.

Time To Step On The Gas - 17th March 2008

17th March 2008

Time To Step On The Gas

Gail is likely to benefit from higher availability of natural gas in coming months. Its capex plans and growing businesses make it a good long-term investment

Ramkrishna kashelkar

GAIL (INDIA) is the country's largest natural gas company with annual revenue of around Rs 17,000 crore and market capitalisation (m-cap) of around Rs 35,600 crore. The company owns and operates the largest natural gas pipeline network in India and handles over 75% of the total gas transported in the country. Gail is investing heavily to lay more pipelines to widen its reach, and will be a major beneficiary of the likely jump in domestic production of natural gas. Gas production in India is likely to double in the next couple of years, which may boost Gail’s gas transportation business. Investors can take exposure in Gail with a two-year horizon.

BUSINESS:
Currently, Gail operates in all segments of the natural gas value chain — from processing, transporting and marketing, to producing downstream petrochemicals using natural gas as feedstock. With a 6,800-km-long pipeline network, Gail continues to remain the largest natural gas transporter in India. In order to achieve backward integration, the company has invested in 29 exploration blocks and three coal bed methane (CBM) blocks. It recovers LPG from its seven natural gas treating plants and sells to oil marketing companies.

Gail has also invested in companies which cover other aspects of the natural gas business, such as liquefied natural gas (LNG), city gas distribution (CGD) and gas-based power projects. It has set up joint ventures in Russia, Egypt and China to market natural gas. The company has embarked on an ambitious expansion plan to invest nearly Rs 29,000 crore over the next five years to augment its gas pipeline network, exploration & production (E&P) activities, petrochemicals, city gas projects and LNG, among others. The completion of Gail’s capital expenditure (capex) programme, will help double its natural gas transmission capacity, extend retail gas sales to 200 cities, expand its LNG terminals and increase its petrochemicals capacity by 60%.

GROWTH DRIVERS:
The company's gains will accrue incrementally as the availability of natural gas improves in India. Within the next two years, the total domestic natural gas production is likely to double to 160 million cubic metres per day (mcmd) from the current 81 mcmd. The availability of natural gas is likely to further shoot up to 285 mcmd by ’12.

Currently, the central government plans to bring the gas produced by the Panna, Mukta and Tapti consortium to Gail for marketing from April ’08. This will boost the company’s revenues. Similarly, natural gas production from Reliance Industries’ Krishna Godavari (KG) basin oilfields is likely to start by mid-’08. Gail has already entered into a memorandum of understanding (MoU) with Reliance Industries (RIL) for transporting its gas. Moreover, Gail holds a stake in five E&P blocks, which have recently struck gas and are under development.

FINANCIALS:
Despite its robust performance, Gail’s growth has been stunted over the years due to the burden of sharing subsidy. During FY07, the discounts extended to oil marketing companies were equivalent to over 60% of Gail’s reported profit of Rs 2,386.7 crore. The company’s net profit has witnessed a compound annual growth rate (CAGR) of 14.4% over the past 10 years, while sales have posted a CAGR of 10.9%. Gail has consistently paid dividends, which have witnessed a CAGR of 21.4% during the same period. The company’s dividend yield currently works out to around 2.4%.

VALUATIONS:
Gail’s current market price of Rs 421.60 discounts its trailing 12 months earnings by 13.9 times, which appears fair, considering its current business profitability. However, the company is likely to post steady growth in the coming months, thanks to the increasing availability of natural gas and its capex plans.

With commissioning of new pipelines and improvement in gas availability, Gail is likely to earn additional revenues of Rs 1,250 crore annually by FY09 and another Rs 2,750 crore annually from FY11 onwards. This alone will translate into a CAGR of 16.7% in operating profit over the next four years.

Gail’s investments in petrochemicals, CGD and exploration business will add value to its business over the next 2-3 years. Long-term investors with a two-year horizon can accumulate the stock at its current price. Gail’s dividend yield is likely to rise to 4.5% by ’11 at historical cost, provided the company maintains its payout ratio. This is an added incentive for investors.

RISKS:
The company’s future profitability may suffer if its subsidy burden increases disproportionately.

ramkrishna.kashelkar@timesgroup.com

With growth on its side, way ahead won’t be bad - 14th March 2008

14th March 2008

With growth on its side, way ahead won’t be bad
The Current Sensex Level Justifies Itself Even At A Low P/E Of 15-16

Ramkrishna Kashelkar ET INTELLIGENCE GROUP

THE current market meltdown has left the investors shocked and stunned. The only question in everyone’s mind today is does the market have further downside left or has it bottomed out? Practically, everyone is offering some or the other opinion on this question.

We believe that the one of the fundamental ways of reviewing the current market conditions is to look at valuations in the light
of their historical values. If, historically, a particular scrip was being valued at 10 times its annual earnings, then we can assume that it reflects its fair value. If the current valuations are substantially above these levels, it will mean that a further downside is to be expected.

The latest rally that the equity market witnessed throughout year 2007 peaking in the first week of 2008 stretched the valuations to historic highs. The bullish enthusiasm meant that the future growth potential of companies was discounted at higher rates than witnessed in the past. In terms of the market lingo, it meant that the price-toearnings multiples (P/Es) increased to very high level. At its peak in the first week of January 2008, the Sensex P/E had breached the 28 level and it matched the levels last seen during the height of the dotcom boom in 2000.

Reminding of the crash of 2000 could be painful for many investors. It was not only severe, but also long-lived and the bear grip on the markets remained tight for years. The BSE Sensex hit the bottom at 2,924 points in April 2003, when its P/E declined to 12.7. Only after this, the markets stabilised and then gained gradually. Since September 2007, in just three months, the Sensex gained around 33% — a gain that has been wiped out now. With the crash, the valuations too have moderated with the market capitalisation of Sensex at just 19.4 times its constituents’ trailing 12-month earnings. A study of the share price movement of the Sensex companies indicates that more than half of them are now trading below their 5-year average PE. Just 11 companies command a PE, which is higher compared with their average PE over past five years period.Does this mean that fundamentally speaking, the valuations have become reasonable and there is little, if any, downside left? It may not be so. A closer look reveals that the 11 scrips with higher PEs include RIL, ONGC, L&T, HDFC and ICICI. These companies together have 60% weightage in the Sensex, if their valuations were to come down to historical levels, the market will fall substantially.

Comparing the current crash with year 2000 puts forward a key question: will the aftereffects of the current crash continue over the next couple of years as witnessed in 2000? The answer would probably be ‘No’, as the situations differ considerably. India’s economy during the 2000-2003 period was passing through a lean phase and it was no wonder that it weighed down on the stock market. However, the economy is expected to post a growth of 8.7% in FY08 and the future growth, although slower, is expected to remain above 8%. Looking at the situation from a different angle, market experts are expecting earnings per share of Sensex companies to reach around Rs 950-1,000 levels in FY09. Thus, the current Sensex level justifies itself even at a low P/E of 15-16.
ramkrishna.kashelkar@timesgroup.com

Join The Treasure Hunt - 10th March 2008

10th March 2008

Join The Treasure Hunt

Shiv-Vani will generate healthy returns over the next 18-24 months, given its bulging order book and favourable outlook for the E&P sector

Ramkrishna kashelkar

SHIV-VANI Oil & Gas Exploration Services is one of India’s leading companies providing integrated support services to onshore petroleum exploration companies. It clocked a turnover of Rs 400 crore during the year ended December ’07. It is the only player in the country to provide integrated services for developing coal bed methane (CBM) projects. Considering its bulging order book position and favourable outlook for the exploration and production (E&P) industry in India, the company will generate healthy returns over the next 18-24 months.

BUSINESS:
Shiv-Vani offers integrated service solutions for exploration of oil and natural gas till their exploitation. Its involvement in an E&P block starts with seismic surveys and continues till drilling, apart from repair and maintenance of oil wells. Shiv-Vani owns 25 onshore rigs, with seven more set to join the fleet by June ’08. It has tied up with Express Drilling of the US to emerge as the only integrated CBM services provider in India. It mainly works for PSUs like ONGC and Oil India. It operates from three bases and owns 600 transport vehicles, which makes it easy to move equipment to remote locations. It is executing a few contracts in Oman and the US; these accounted for a quarter of its revenues last year.

GROWTH DRIVERS:
India’s exploration industry has received a boost due to the government’s New Exploration Licensing Policy (NELP). Considering high crude oil prices and commitments of E&P companies under earlier NELP rounds,the boom in the domestic E&P sector may continue. This will drive demand for services provided by Shiv-Vani. Its unexecuted order book stands at over Rs 3,500 crore, of which, 70% will be executed in the next 24-30 months. Its first CBM contract, worth Rs 650 crore, with ONGC started in December ’07. This will boost its revenues and profits from March ’08 quarter onwards.

FINANCIALS:
Shiv-Vani has registered a cumulative annual growth rate of 78.7% in net profit over the past four years, while sales grew 42.8%. During the 12-month period ended December ’07, its net profit more than doubled to Rs 76 crore, while net sales surged 44% to Rs 395 crore. The company plans to close this accounting year for the 15-month period in March ’08 .

VALUATIONS:
Shiv-Vani is trading at 28.1 times its trailing 12-month EPS. In comparison, at CMP, its forward P/E works out to 13, based on FY09 estimated earnings. We estimate Shiv-Vani to close FY09 with topline of Rs 1,000 crore and net profit of Rs 200 crore. This provides upside potential for long-term investors. The estimate accounts for 25% equity dilution over the next 18 months on conversion of outstanding convertible bonds and warrants.

No tax sop for new refinery projects - 4th March 2008

4th March 2008

No tax sop for new refinery projects

BUDGET MEMORANDUM HAS INTRODUCED SUNSET CLAUSE FOR 100% TAX EXEMPTION FOR MINERAL OIL REFINING, POST ’09

Ramkrishna Kashelkar, MUMBAI

INVESTMENTS by oil refiners in new refinery projects could be in jeopardy after the latest Union Budget, which has a provision that strips new refinery projects of income tax benefits. As things stand, a petroleum refinery is eligible for 100% income tax exemption for the first seven years of its operation. The Budget memorandum has now introduced a Sunset clause for 100% tax exemption for refining of mineral oil, if the project starts after April 2009.

This means the new refineries will no longer enjoy the I-T benefits, under Section 80-IB of the Income-Tax Act that other projects have had. If implemented, the provision could grossly reduce the return on capital and increase the payback period for new refinery projects. SV Narasimhan, finance director of India’s largest petroleum refining company Indian Oil, expressed concern over the development. “The removal of tax benefits is a big concern for the industry. Considering the huge investment needed in setting up a re finery, these incentives were essential for their economics to work out well We plan to take up this issue with the government at the earliest to restore these benefits,” he said. Industry sources said the move could impact new investments in the business.

Among those facing the heat imme diately will be Bharat Petroleum’s Bina refinery and the Hindustan Petroleum Mittal joint venture refinery at Bhatin da. The Rs 10,500-crore Bina refinery is expected to be completed by December 2009, while the Bhatinda refinery is scheduled to commence operations only by end of 2010. Both will not be el igible to claim tax benefits. However Reliance Petroleum’s 27-million-tonne new refinery at Jamnagar is luckier, as it is on schedule to commission opera tions by December 2008.

Tax consultants Ernst & Young ac knowledged the problem in their re port on the Union Budget 2008. The report said, “The removal of tax holi day on refining will adversely impact new refinery projects.” Tax holiday claims for production of natural gas could also be questioned in the future the report said.

The Budget has actually proposed a new provision in sub-section (9) of Sec tion 80-IB, to provide that no deduc tion will be allowed to a mineral oil re finer if they begin operations after April 2009. However, confusion exists with the same Budget memorandum re defining the words ‘mineral oil’. Ac cording to the memorandum, “For the purpose of this section, the term ‘min eral oil’ does not include petroleum and natural gas, unlike in other sections of the Act.” In the absence of any clear un derstanding as to what ‘mineral oil would mean if not petroleum crude most of the refiners are convinced that their new projects will get hit. Howev er, one public sector refiner said the de velopment does not apply to the petro leum refining sector.

OIL’S NOT WELL
Currently, a petroleum refinery is eligible for 100% I-T exemption for the first 7 years of operation
This means the new refineries will no longer enjoy the I-T benefits, under Section 80-IB of the Income-Tax Act
Among those facing the heat immediately will be Bharat Petroleum’s Bina refinery and the Hindustan Petroleum-Mittal joint venture refinery at Bhatinda
However, Reliance
Petroleum’s 27-million-tonne new refinery at Jamnagar is luckier, as it is expected to be commissioned by Dec ’08

TROUBLE AT HOME - 1st March 2008

1st March 2008

TROUBLE AT HOME
EXCISE PAIN FOR PETCHEM PLAYERS

Piyush Pandey & Ramkrishna Kashelkar TEAM ET

BUDGET 2008 HAS MADE IT MORE DIFFICULT for export-oriented units (EOUs) to sell in the domestic market. EOUs, generally eligible to sell up to 50% of their annual sales domestically, will now have to pay customs duty at 50% of applicable rates for such sales, compared to 25% till now. India’s largest petrochemicals company, Reliance Industries (RIL), whose Jamnagar refinery enjoys EOU status, is likely to be affected by the change. Others like South Asian Petrochemicals and IG Petrochemicals, which enjoy EOU status, will also witness an erosion in their competitive advantage when selling in India.

Also, costs are likely to go up for polymer manufacturers as the finance minister has reimposed 5% import duty on naphtha, from nil last year. “Thanks to a complex regime of export benefits and duty exemptions, naphtha is exported from refineries and is imported by manufacturers of polymers, leading to price distortions and revenue losses,” he said.

This will adversely impact companies like RIL and Haldia Petrochemicals, which use naphtha for polymer production. Till now, RIL used to export naphtha from its refinery availing of the benefits of being an EOU, while its erstwhile subsidiary IPCL used to import it duty-free.

Petrochemicals manufacturers are not happy with the development. “We are disappointed by the re-imposition of 5% import duty on naphtha used in production of polymers. This is not in line with the basic rule that customs duty on raw materials should be less than that on the finished product,” said Chemicals and Petrochemicals Manufacturers Association of India president KG Ramanathan.

The general reduction in excise rates from 16% to 14% and the cut in central sales tax to 2% will help the petrochemicals industry. “The waiver of loans and interests to farmers will help increase plastic consumption in the agriculture sector,” said Supreme Industries MD MP Taparia.

The fertiliser industry will benefit from the reduction in duty on sulphur, which has been cut from 5% to 2%.

Some Like It Hot - 25th February 2008

25th February 2008

Some Like It Hot

Considering Nitin Fire Protection’s high growth and earnings visibility, investors with an 18-24 month horizon can put money in the stock

Ramkrishna kashelkar

NITIN FIRE Protection (NFPCL) offers turnkey fire protection services to commercial and industrial clients with expected annual consolidated turnover of Rs 130 crore in FY08. It has set up a unit to manufacture high-pressure cylinders in Vizag SEZ. It has bagged orders worth Rs 170 crore for this plant, to be executed over 15 months, while growth from its core business continues unabated. Considering NFPCL’s high earnings visibility, investors with an 18-24 month horizon can invest in it.

BUSINESS:
NFPCL operates via six subsidiaries and offers products & services in fire security, electronic security and intelligent building management systems segments. It also trades in high-pressure seamless cylinders, which it sources from China. It recently set up an arm in Jabel Ali Free Trade Zone, Dubai, to offer fire protection services. NFPCL has set up a 500,000 units p.a. facility to manufacture high-pressure cylinders used for CNG. Located in an SEZ, this facility will cater to export demand. With this, NFPCL will become the second-largest producer of high-pressure seamless cylinders in India. The company holds 10% stake in an oil exploration block in Rajasthan, adjacent to Cairn’s discovered oil fields. Its exploration activities will begin soon and continue for 2-3 years. NFPCL may invest Rs 12 crore over the next three years in this activity.

GROWTH DRIVERS:
Its CNG cylinders plant will be commissioned in this quarter. The unexecuted order book for this plant is over 120% of NFPCL’s annual turnover. The demand for CNG cylinders is set to remain strong in future. Meanwhile, NFPCL’s fire protection business is set to grow 20-25% y-o-y for the next two years.

FINANCIALS:
For Q3 FY08, NFPCL saw 165% jump in net profit to Rs 15.3 crore, and 48% rise in net sales to Rs 101.5 crore. For FY07, it had net profit of Rs 10 crore on sales of Rs 100.5 crore. It has been able to maintain OPM at 18%. High-pressure cylinders may generate OPM in excess of 20%.

VALUATIONS:
NFPCL is set to close FY08 with net profit of Rs 21.3 crore, which may rise to Rs 40.6 crore in FY09. The CMP of Rs 459.75 is 27.3 times and 14.3 times the expected earnings for FY08 and FY09, respectively. Considering its high growth and earning visibility, the valuations seem attractive for investors. NFPCL does not have any direct peer. Everest Kanto Cylinders — India’s largest producer of high-pressure seamless cylinders — is trading at a P/E of 29.6, while electronic security provider Zicom trades at a P/E of 19.4.

RISKS:
NFPCL has no experience in manufacturing high-pressure cylinders. Commissioning of this unit was planned in October ’07, but was delayed.

Lots In The Pipeline - 25th February 2008

25th February 2008

Lots In The Pipeline

Deepak Fert & Petrochem’s revenues will rise once it secures additional supply of natural gas. Investors with an 18-24 month horizon can consider the stock

Ramkrishna kashelkar

DEEPAK FERTILISERS and Petrochemicals (DFPCL) has an annual turnover of Rs 950 crore. It derives over 72% of its revenue from chemicals and 28% from fertilisers. Successful commissioning of Dahej-Uran pipeline (DUPL) may provide upside once the company secures additional natural gas. Investors with an 18-24 month horizon can consider the stock.

BUSINESS:DFPCL manufactures various chemicals. It enjoys 45% market share in nitric acid, 35% in ammonium nitrate and 16% in methanol. It is the only producer of isopropyl alcohol (IPA) in India. It also trades in some chemicals and fertilisers. But the lack of availability of sufficient natural gas remains a key problem. DFPCL recently diversified into the realty sector and has built a specialty shopping mall ‘Ishanya’ with 5.5 lakh sq ft leasable area in Pune. DFPCL also entered into a JV with Yara International, a global manufacturer of ammonium nitrate and specialty fertilisers. The JV will invest in the 300,000-tonne ammonium nitrate plant the company plans to set up at Paradip at a cost of Rs 400 crore. At current prices, this plant will generate annual revenue of over Rs 300 crore. The company is building storage tanks to facilitate imports of ammonia that will free up natural gas for other products. It also plans to reduce greenhouse emissions from its factories.

GROWTH DRIVERS:After completion of DUPL, the company has drawn a test quantity of natural gas and seeks to finalise a firm supply for future use. Higher availability of natural gas will not only help it to operate its facilities at full utilisation levels, but will also enable it to save on high-cost naphtha. Volume growth from IPA business and revenues from ‘Ishanya’ will drive DFPCL’s profitability. At current lease rates, ‘Ishanya’ may add 10% to its operating profit.

FINANCIALS:The company’s net sales saw a CAGR of 20.5% over the past four years, while net profit rose 10.1%. During the quarter ended December ’07, net profit fell 1% to Rs 24.5 crore, while revenue rose 13% to Rs 274 crore.

VALUATIONS:The company’s EPS for trailing 12 months stood at Rs 11. The CMP of Rs 130.75is 11.9x this EPS. Supply of natural gas may boost its revenues by Rs 200 crore on a full-year basis. In addition to the savings on naphtha, this can boost its annual operating profit by Rs 45 crore. Although the company appears fairly valued at current price, the potential benefits from additional gas supplies have not being taken into account. It has consistently paid dividends. The stock can generate value for investors.
CONCERNS: DFPCL has faced delays in project execution. Its future growth may suffer if it is unable to secure additional supply of natural gas in time

LIFE IN THE SLOW LANE - 18th February 2008

18th February 2008 Lead Story

LIFE IN THE SLOW LANE

India Inc’s Q3 earnings show that while the growth story is intact, it’s not quite setting the blistering pace it once did. R Kashelkar and S Mishra explore...

THE STOCK market is being hammered, thanks to fears of a US recession and a number of subprime skeletons tumbling out of the closet. For those hoping that third-quarter (Q3) FY08 results will bring some cheer to the flagging market, the performance of India Inc has not been too encouraging. This was expected, given that some of the major economic indicators such as GDP, industrial production and exports are slowing down. While there have been some outperformers in Q3, at an aggregate level, signs of a slowdown are definitely visible.

We analysed the results of 2,380 companies for the quarter ended December ’07 and found that net sales grew by 16.4% over December ’06, while the growth in bottomline was restricted to 16.1%. The fact that this is the lowest YoY growth rate in the past six consecutive quarters strengthens the overall concern that the growth has begun to peak out. This sample excludes banking and oil & gas companies, which distort the real picture due to their size and fluctuating incomes.

The disconcerting trend that was witnessed in the past two quarters — wherein other income grew at a faster clip than operating income — continued in Q3. Other income, which contributed just 22% to the net profit in the December ’06 quarter, accounts for over 34% of the same in the December ’07 quarter. There is a disproportionate rise in interest costs as well, and increased tax provisions have also played a prominent role in the erosion of growth in net profit. However, to its credit, India Inc as a whole has displayed great resilience in maintaining operating profit margins higher than year-ago levels despite a slowdown. The aggregate operating margin in Q3 FY08 was 19.2%, against 19% in the corresponding quarter of the previous year.

Our analysis also reveals that the slowdown is secular in that it cuts across sectors. However, the slowdown in growth of the cement sector is the most striking. The cement industry managed to clock a meagre 6.2% growth in net profit, compared to the whopping 216.1% profit growth in December ’06 quarter.

The other industries that have reported consistently falling growth figures include capital goods, entertainment & media, steel and pharmaceuticals. However, packaging, chemicals, fertilisers and automobiles bucked the trend, showing a higher growth in the December ’07 quarter, compared to December ’06. The packaging industry’s good show is largely attributable to the significantly improved numbers published by Jindal Poly Films, Max India and Cosmo Films. The net profit of the packaging industry spurted 104.5% during Q3 FY08, against a growth of 29.5% in the December ’06 quarter. However, it must be noted here that other income played a significant role in boosting the profit of Max India.

The chemicals industry also had an exciting quarter, recording 42% profit growth during the quarter vis-à-vis 21% in the year-ago period. The profit growth in this industry was led by India Glycols, Phillips Carbon Black, Pidilite, Aarti Industries, DCW, Bihar Caustic & Chemicals and Hikal, while leading companies such as Deepak Nitrite, Chemplast Sanmar, Atul and Nocil found the going tough.

The fertiliser industry has been another outperformer during this period, led by substantially better profits reported by Gujarat Narmada Valley Fertilisers (GNFC), Zuari Industries, Coromandel Fertilisers and Mangalore Chemicals, while other companies suffered. The aggregate profit of this industry grew by 26.3% in Q3 FY08, against 24.3% earlier. However, it must be noted that GNFC’s profits were boosted due to the merger of Narmada Chematur.

The auto industry posted 14.6% YoY growth in net profit in the December ’07 quarter, against 10.6% recorded in December ’06. But this was mainly on account of higher other income, rather than operating income. Sharp jumps in other incomes of Tata Motors, M&M, Ashok Leyland and Hindustan Motors boosted the industry’s performance.

Sectoral woes apart, our analysis reveals that while operating margins remained stable during the quarter, the industry’s profits were eroded by interest costs and tax provisions, which are heading northwards. India Inc’s interest costs, which were around 2.7% of its net sales in the December ’06 quarter, have gone up to 3.6% in Q3 FY08. While the rise in interest costs can be explained by an overall increase in the cost of borrowed funds, an increase in corporate indebtedness cannot be ruled out. The industries which have witnessed the steepest rise in interest cost as a percentage of net sales are telecom, shipping & logistics, FMCG, steel & alloys, entertainment & media, cement and sugar. A FEW industries such as power, consumer durables and textiles have reduced their interest burden in proportion to their net sales.When it comes to tax provision, analysis shows that there has been a steady rise in tax provisions as a percentage of net sales, from 3.6% in the December ’06 quarter to 4.1% in December ’07. The two main reasons for this are marginal rise in the effective rate of tax and higher other income boosting pre-tax profit.

The cement industry witnessed the highest spurt in tax provisions, which stood at 10.5% of its December ’07 net sales, up from 7% in December ’06 and just 2.6% in December ’05. Fertilisers & agrochemicals, power and plastic & rubber products were some of the other industries that witnessed a disproportionate rise in tax provisions. On the other hand, telecom & equipment, textiles and shipping & logistics registered a gradual decline in the same.

The proportion of depreciation to net sales has remained range-bound in the past at around 3.5%. This indicates that the rise in depreciation is in line with growth in net sales. A rise in overall depreciation indicates increasing capital expenditure by corporates and hence, growth in depreciation is heartening. With new investments taking place, industries such as cement, shipping & logistics, sugar and telecom & equipment have witnessed a steady growth in depreciation as a percentage to net sales. On the other hand, for industries such as power and steel & alloys — where the gestation period for new capacities being commissioned is typically several quarters — this figure is on a downward trend.

India Inc’s December ’07 quarterly results have brought forward strong evidence which reinforces the nagging worries of investors. The growth in corporate sales and net profit has further slowed down, and if one has to go by global economic indicators, the immediate future doesn’t appear very cheerful. At the same time, interest, depreciation and tax put together are now taking a larger toll of 11.2% of net sales, compared to around 9.8% in the year-ago period. And other income is providing support to the growth in bottomline. If one removes the effect of other income from the profitability analysis, India Inc’s net profit level appears even more worrisome.

However, all’s not lost. One good thing that has come out over the past few quarters is India Inc’s ability to maintain its operating margins. The other positive is that given the upsurge in capital expenditure the economy is witnessing, corporates are expanding capacities and several infrastructure projects are under way. Lastly, so far, domestic consumption continues to be strong and this is likely to support India’s growth going forward, even when export growth stagnates due to the economic slowdown in the US. However, we may have to wait for another couple of quarters to confirm this conclusion. ramkrishna.kashelkar@timesgroup.com

Petro cos stay afloat on other incomes - 15th February 2008

15th February 2008

Petro cos stay afloat on other incomes

Ramkrishna Kashelkar

THE petroleum industry came out with mixed results for the quarter ended December 2007. Dismal performance at the operating level during the quarter was boosted by extraordinary items — the prominent one being Rs 4,733-crore profit reported by Reliance Industries (RIL), contributed by stake sale in Reliance Petroleum (RPL).

A set of nine companies operating in petroleum exploration and production, refining and marketing witnessed a 16.3% growth in aggregate net sales. Operating profit growth was restricted to 3.1% due to under-recoveries from sale of fuels by marketing companies. Net profit rose by 48.2% on account of higher extraordinary income. If one were to exclude this item, the real growth in PAT would have been just 7.7%.

Integrated marketing players continued to suffer from underrecoveries as domestic fuel prices did not rise in line with the increase in international prices of crude oil and petroleum products. These companies — Indian Oil, HPCL and BPCL — could not derive any benefit from higher gross refining margins, higher help from the government and higher discounts from upstream oil companies. BPCL’s net profit fell by 4% while HPCL reported a net loss. The industry leader Indian Oil registered a 16.7% improvement in bottomline at Rs 2,091 crore.

In the private sector, RIL enjoyed an excellent quarter, posting refining margins of $15.4/barrel. Sub-optimal performance of its other business segments resulted in operating margin falling below the year-ago level. The other private sector refiner Essar Oil continued to lose money during the quarter.

Standalone public sector refiners reported multifold rise in profit due to strong refining margins. Being comparatively smaller in size, their performance did not have any material impact on aggregate results. The three standalone refiners — Mangalore Refinery (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery (BRPL) — together represented around 9% of the aggregate December 2007 sales of the industry and around 6% of PAT. The rising crude oil prices, at as high as $100 per barrel in the global markets, could not improve the performance of the country’s largest petroleum exploration and production firm ONGC.

Under the government directive, the company had to extend record-high discounts, exceeding $30 per barrel to marketing companies. ONGC’s sales dipped 2.9% during the quarter and operating margins weakened. However, higher other income and fall in depreciation helped the company curtail the fall in net profit to 6.5%.

Going forward, fate of oil marketing companies depends on the government’s decision on fuel prices. The strong performance by refining companies and private players may continue depending on the gross refining margins. However, the rate of growth is likely to remain tapered.

ramkrishna.kashelkar@timesgroup.com

High user charges take the sheen off new airports - 9th February 6, 2008

9th February 6, 2008 Main page story

High user charges take the sheen off new airports

User Fees,Airport Charges Make Flying A Costly Affair

Ramkrishna Kashelkar & Cuckoo Paul MUMBAI

EXPECTATIONS of air travellers that privatisation of Indian airports will bring in efficiency and make air travel cheaper seem to be completely misplaced. User fees and recovery of infrastructure charges by concessionaires on fuel, baggage handling will be passed on to passengers, thereby increasing the cost of air travel. After the muchdiscussed user development fee of Rs 675 that every passenger using the new Bangalore airport will have to pay, the GMR group-promoted Hyderabad airport has written to oil companies saying it will impose throughput charges of Rs 2,170 per KL of aviation fuel.

Oil companies have confirmed that they will pass on the cost to airlines. Airline executives said they would resist any increase in costs because margins in the business are already wafer-thin. The Federation of Airlines plans to take up the issue with the ministry of civil aviation. However, if they were forced to pay the charges, airline sources said they would have to pass them finally on to passengers. Incidentally, airlines are already fighting with airports on a similar increase in ground handling charges. Domestic airlines already collect Rs 1,600 as fuel surcharge on every ticket. This charge has been kept constant even though fuel prices have declined in January.

The confusion on how much to charge on each of these counts is compounded because of the lack of an airport regulator to decide on the issue. The proposed AERA (Airport Economic Regulatory Authority) Bill is slated to be presented in Parliament in the Budget session. The two new airports in Hyderabad and Bangalore will, however, be open for business in March.

The aviation fuel station at the Hyderabad airport, being built by GHIAL, owes its existence to an open access policy that allows every eligible oil company to market fuel. Throughput charges cause heartburn

ALMOST all oil refining companies, including RIL, MRPL and Essar Oil, had expressed interest in operating at this airport. But the higher throughput charges have come as a shock, said one private refiner who did not wish to be identified. GMR Group spokesman clarified: “No final decision has been taken on the fuel pricing yet.’’ However, the e-mail sent to the oil companies and available with ET details the proposed charges. The communication states that GHIAL plans an ‘infrastructure recovery charge’ of Rs 1,500/KL and throughput fee of Rs 670/KL. A service tax of 12.3% will be extra. The new airport is scheduled to be opened on March 16.

There is no information yet from the other private airport, which is being constructed by Siemens-led consortium in Bangalore. The BIAL airport spokesperson said the charges are still being worked out. However, oil companies maintained that a similar increase could be on the cards. A consortium of oil PSUs — Indian Oil and Indian Oil Tanking — is putting up aviation fuel facilities at this airport and they will be recovering the charges subsequently.

“Worldwide, throughput charges are imposed by airport authorities to recover the capital expenditure of setting up the infrastructure over a period of time. But at these high rates, GHIAL’s capital costs will be recovered in just 3-4 years. After that, it will be just pure profits to the airport owner,” said an airline company official.

While throughput charges at major airports are currently not very high, the tendering process for upgrading airports in Chennai and Kolkata had revealed that players were willing to pay up to Rs 1,200 per thousand litres of aviation fuel. However, the aviation industry appealed to the ministry against this method of deciding the throughput charges.

ramkrishna.kashelkar@timesgroup.com

The Time’s Ripe... The Time’s Ripe...

11th February 2008

The Time’s Ripe...

Budget-speak may result in stocks getting hammered & that’s when smart money moves in

Ramkrishna kashelkar

BUDGET ANNOUNCEMENTS don’t affect all sectors or companies uniformly. While some tax proposals improve market sentiment with regard to certain sectors, others have a negative influence on some other sectors. A case in point is the excise duty hike on cement and withdrawal of indirect tax exemption available to construction companies with retrospective effect announced last year. The market reacted swiftly, pulling down the stock price of most of the stocks in the two sectors.The ET Cement index fell by 6% on budget day, while ET Construction index shed 8%.

The pessimism in the two sectors continued for over a month. However, by the end of ’07, most of the stocks in the two sectors reached new highs. Is it a coincidence or is this a regular feature in the budget month? To find out, we studied the movements of ET sectoral indices on budget day and during the following weeks, for five years since ’03. Additionally, we compared the Sensex returns in February and March for every year since 1991.

The results were startling. We found that every budget leads to a fall on the budget day (and the following weeks) in some or other sectors. And this provides a buying opportunity for investors, since the fall is a temporary phenomenon. In ’07, for instance, the ET Construction index more than doubled from its closing value on budget day. In ’03, shipping, textile and sugar indices witnessed a similar trend.These three indices fell the most on budget day and ended March with a negative return of 10%. In the next 12 months, however, their value nearly tripled.

The Sensex exhibits similar gyrations during and after the budget. In 13 of the past 17 years since 1991, the benchmark index has fallen in the month of March. But the post-budget blues are almost often preceded by a mini rally in February. Hence, the decline in stock prices due to the budget has no relation with the expected future returns in the following months. Instead, investors can use this as a buying opportunity. As the fall continues for at least two weeks after the budget, investors need not rush to buy the stock on the budget day. They will be better off if they accumulate their favourite stocks over a period of time and thus, lower the average investment cost. For example, in ’04, the ET Consumer Durable index fell over 2.5% in the week following the budget day. Subsequently, it declined by another 9% in the next week and finally ended the month with a negative return of 14.5%.

But here’s a word of caution for investors. Do not buy a stock only because it fell on the budget day. Instead, buy those stocks that are growing and are expected to grow even after the budget.What matters in the medium and long term is the demand for goods and services offered by the company. In a growing economy, the company can easily pass on tax increases to its customers. santanu.mishra@timesgroup.com

Robust pharma show turns it on for Jubilant - 31st January 2008

31st January 2008

Robust pharma show turns it on for Jubilant

HELPED by strong growth in the pharma segment, Jubilant Organosys reported 37% growth in its sales at Rs 641.6 crore for the quarter ended December 2007. Strong improvement in operating margins helped the company report 42% growth in net profit despite a spurt in interest and depreciation costs.

Jubilant had recently acquired the contract manufacturing of sterile injectables business of Hollister-Stier, which contributed Rs 81.1 crore to the topline during the quarter. This helped the company almost double its revenues from customised research and manufacturing services (CRAMS) segment to Rs 342.8 crore. As a result, the revenues from pharmaceuticals and life sciences segment jumped 74% to Rs 397.8 crore.

The scrip lost 1% to close at Rs 311.3 on BSE in a weak market when the benchmark Sensex lost 1.8% to 17,759. Despite a faster growth in staff costs, thanks to foreign acquisition, Jubilant’s operating margins improved by 540 basis points to 20.2%. This was on account of a fall in the proportion of raw material cost to net sales. Both the segments — pharma and life sciences, and industrial and performance products — registered improvement in margins.

During the quarter, Jubilant recorded highest growth in its international sales, where both regulated as well as other markets witnessed strong growth. The sales in regulated markets jumped 73% to Rs 241.6 crore while sales in other international markets increased 45.7% to Rs 104.6 crore.

The company’s interest burden rose by over 150% to Rs 12.3 crore during the quarter, thanks to higher debts. The company had outstanding debt of Rs 2,003.5 crore at the end of December 2006 quarter against Rs 1,541.4 crore a year ago. The current debt includes outstanding FCCB proceeds of Rs 1,080.1 crore.

Going forward, the company’s focus on CRAMS business is likely to bring in healthy revenue growth as the order book continues to increase. The capacity expansion at its recently acquired business of Hollister-Stier is likely to be commissioned by the end of FY2008, which will bring in additional revenue growth. The company plans to start production of new active pharmaceutical ingredients (APIs) in coming months. Similarly, the new drug delivery system (NDDS) and new drug development businesses are likely to attract larger contracts from existing as well as new customers.
ramkrishna.kashelkar@timesgroup.com

Seeking Refined Tastes - 28th January 2008

28th January 2008

Seeking Refined Tastes

HPCL needs to earn a PAT of Rs 3,000 crore a year to fund its capex. Unless the current level of under-recoveries reduces, achieving this target seems challenging. C Ramulu, director, finance, HPCL, gives an insight into the company’s growth plans

INTERVIEW BY PETROLEUM ANALYST
RAMKRISHNA KASHELKAR

Currently, oil marketing companies are incurring heavy losses due to under-recoveries. What is the ideal solution to this problem?
Of late, oil prices have increased substantially. As under-recoveries increase, we need to rationalise the burden borne by all the stakeholders, including upstream companies, downstream refineries, the government and consumers. One way of reducing the burden is to cut excise duty rates and move to a system of specific duties from the current ad valorem levies. (Due to ad valorem duties, taxes increase with soaring oil prices.) The industry has made representations to the government to consider this option. However, the government’s concerns regarding fiscal and revenue deficit also have to be taken into account.

Besides petroleum refining and marketing, in which other segments of the energy value chain is HPCL making substantial investments?
Some of our current revenue streams are under strain. A company of HPCL’s size must have robust alternative revenue sources to sustain its growth. We are looking at exploration and production (E&P) as a key growth driver in the long term. We are also studying investment avenues in the natural gas value chain and petrochemicals. We have interest in 22 exploration blocks, including two blocks outside India. In 5-7 years, we will invest over Rs 5,000 crore in E&P activities. We are keen to operate oil-producing blocks on a revenue-sharing basis and are scouting for suitable opportunities.
We are also investing in the natural gas business, especially in city gas distribution projects. HPCL has already set up three joint ventures (JVs) with Gail for this purpose, namely Bhagynagar Gas in Andhra Pradesh, Aavantika Gas in Madhya Pradesh and a yet-to-benamed JV in Rajasthan. These companies will market CNG in the domestic market and enter the piped natural gas (PNG) business as more gas becomes available. Wind power generation is another area in which we plan to invest up to Rs 475 crore to generate 100 mw of electricity. The first phase of 25 mw has been partially commissioned in Dhule district of Maharashtra.

What is the progress of the new refinery project at Bhatinda? How do you plan to supply crude oil to the same?
The 9 million metric tonne per annum (mmtpa) refinery at Bhatinda is a JV between HPCL and Mittal Energy. The total project cost works out to Rs 18,900 crore at current prices. The equity portion in the project will be Rs 7,230 crore, while the debt portion will be Rs 11,670 crore. The project represents the largest foreign direct investment (FDI) in the petroleum downstream sector and is also the largest rupee-debt syndication ever made in India. We have already acquired 2,000 acres for this project. Licensor agreements have been signed, the EPC contractor has been appointed and around Rs 2,000 crore has been committed. The mechanical completion is scheduled for September ’10. This, along with some minor additions at existing refineries, will push up our total refining capacity from the current 16.5 mmtpa to 28 mmtpa by ’12. To supply crude oil to the refinery, a 1,000-km pipeline is being laid from Mundra to Bhatinda at a capital expenditure (capex) of around Rs 4,000 crore, which forms part of the project cost.

What are your plans with regard to setting up another refinery at Visakhapatnam (Vizag), along with a petrochemicals complex?
Under the Petrochemical and Petroleum Investment Region (PCPIR) policy, the Andhra Pradesh government plans to develop nearly 35,000 acres from Vizag to Kakinada. We are the anchor industry for developing the PCPIR in Vizag and have been allotted 1,500 acres. We have signed a memorandum of understanding (MoU) with Total of France, Mittal Energy, Gail and Oil India for a new 15-mmtpa refinery-cum-petrochemical complex there. At present, feasibility studies for this new project are under way. We will have a better idea about the total capex involved once our feasibility studies are over.

What are your major capex plans for the next five years? How do you plan to finance the same?
Our estimated capex for the next five years is Rs 18,000 crore. These funds are required to fund ongoing initiatives and invest in new initiatives such as upstream E&P, upgradation and modernisation of existing refineries, creation of additional tankages, investment in equity of JVs (including Bhatinda refinery), setting up of LPG bottling plants, as well as upgradation of facilities at retail outlets and petrochemicals.
Financing the capex is a challenge for HPCL in today’s environment. Even if we consider 1:1 debt-equity ratio, we need to generate a profit of Rs 9,000 crore over the next five years to fund our capex plans. After paying 30% of profit after tax (PAT) as dividend, HPCL requires a PAT of Rs 3,000 crore per year. Unless the current level of under-recoveries comes down, achieving the PAT target seems challenging.

What cost management measures is HPCL undertaking to keep the business on track, even while it incurs operating losses?
In the case of refineries, we have increased our capacity utilisation. As a result, against the rated capacity of 13 mmtpa, we processed 16.5 mmtpa, translating into a capacity utilisation of 128%. We are also maximising processing of sour crude to improve our gross refining margins (GRMs). Currently, nearly 63% of the crude oil processed by HPCL has high sulphur content, which is a significant improvement over earlier years. We have recently commissioned a 60,000-tonne LPG storage facility at Vizag. This will result in freight savings of $35-40 per million tonne, as imports through very large gas carriers (VLGCs) become possible. To reduce the cost of transport, we are also investing in product pipelines.

Sustainability of LIC HF quarterly show in doubt- 18th January 2008

18th January 2008

Bakul Chugan & Ramkrishna Kashelkar

Sustainability of LIC HF quarterly show in doubt

SETTING aside fears of a slowdown in the housing market, LIC Housing Finance reported a strong 38% Y-o-Y growth in its net profit for the quarter ended December 31,2007. The company’s net profit crossed Rs 100 crore aided by a 35% growth in income from operations to Rs 534 crore on a Y-o-Y basis. While the topline growth has been more or less in line with that in the previous quarter, net profit has taken a beating by nearly 15%. This is on account of the sequential dip in topline as well as bottomline growth.
According to the management, gains from a steady increase in home loan rates, which were available in the first half of FY08, may not be available from Q4 onwards. Also, an increase in provisioning and adspend have hit profit margins this quarter. The company has, till date, incurred an ad expenditure of Rs 20 crore, of which Rs 10 crore was incurred in December quarter alone.

While the industry’s operating profits are generally at the mercy of interest rates, LIC Housing has maintained its growth momentum in income from other sources. This includes the processing fees and income from investment in mutual funds. This raises doubt about the sustainability of these returns.

The company has also pared its non-performing assets (NPA). While gross NPA is down to 2.8% from 3.6% Y-o-Y, the net NPA stood at 1.6% as of December 2007. The management successfully used the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (Sarfaesi Act), to recover Rs 243 crore of doubtful debts. The company is now targeting gross NPA of less than 2% and net NPA of less than 1% by end of March 2008.

On the growth front, the company intends to raise capital of Rs 300-400 crore to lower its debt-equity ratio and meet future capital requirements. The same will be raised by way of preferential allotment to promoters and FIIs. Having consolidated its position in the housing loan market, the company now intends to expand its business and is in the process of launching an realty fund in the next financial year.
Margin play puts MRPL on top
Mangalore Refinery and Petrochemicals (MRPL), India’s leading standalone refinery, came out with better-than-expected December quarter results. The company’s net profit nearly tripled to Rs 350 crore. The growth was driven by improvement in gross refining margins (GRMs), which rose to around $7.7 per barrel as against a mere $1 in the December 2006 quarter. Gross refining margin is the differential between the cost of crude oil and the realisation from sale of refined products.

The quarter witnessed higher margins for the refiner on diesel and naphtha. The numbers provide a broad direction as what to expect from other petroleum refining companies, when they publish their quarterly results later. MRPL’s topline during the period grew 11%. The company could process only 3.02 million tonne of crude, which was 10% lower compared with the 3.36 million tonne processed during the December 2006 quarter. The loss of production was caused by a 25-day maintenance shutdown at its hydro-cracker and hydrogen generation units.

Substantial expansion of margins doubled MRPL’s operating profit. Other income more than halved, but a drop in interest costs helped the company more than double its pretax profits. A fall in the effective tax rate also helped in the PAT spurt. Profit growth was also aided by sale of value-added products such as mixed xylene and crumb rubber modified bitumen (CRMB).
Going forward, MRPL will benefit from its full refining capacity. However, it is too early to guess how the refining margins will behave in the coming months. While the Asian market remains comfortable, the US market is showing signs of weakness in GRMs. It is not yet clear whether the weakness could extend to other regions in the future.