Reliance Petroleum - IPO Analysis

Rich pricing of a great dream

Though the project does not have negatives, a fall in the market can give a better opportunity to enter as the project will be commissioned only in Dec.'08

Reliance Petroleum (RPL) was incorporated as a 100% subsidiary of Reliance Industries (RIL) in October 2005 to set up a grassroot petroleum refinery and polypropylene (PP) plant in the special economic zone (SEZ) at Jamnagar. This new refinery, located adjacent to the existing refinery and petrochemical complex of RIL, will comprise secondary processing facilities to maximise the quantity of value-added products such as alkylates, diesel, aviation turbine fuel, and polypropylene.

RPL's new refinery in Jamnagar will have a capacity of 5,80,000 barrels per day (bpd) and a polypropylene unit with a capacity of 9,00,000 tonnes per annum. The estimated cost of the project is $6 billion, or Rs. 27000 crore, and it is expected to commence production only in December 2008. The refinery will be even more complex compared with RIL's existing refinery, processing lower quality crude and earn better margin.

The project will be financed by an equity of Rs. 112500 crore and debt of Rs. 157500 crore. RPL has got a syndicated loan of Rs. 6750 crore from 14 leading international and domestic banks and plans to raise an equal amount if the need arises. Further, the RIL board has resolved to provide for any shortfall in financing if RPL is unable to tie-up for its entire requirement of debt.

Recently, Chevron Corp. – world's fourth largest oil company – decided to buy 5% equity stake in RPL for $300 million. Chevron will buy RPL's 22.5 crores equity shares of Rs. 10 each from RIL at Rs. 60 each and has obtained a right to increase the stake by another 24% on completion of collaboration agreement between Reliance and Chevron. The RIL's shareholding in RPL will come down to 75% on sale of first 5%, which will further fall to 51% after the company sells 24% stake to Chevron. The exact time frame or pricing for the sale of this 24% stake is not disclosed yet. The company also entered into two MoUs with Reliance. Through these MoUs Reliance and Chevron plan to optimize the crude supply and marketing of final products apart from the refinery technology, envisage cooperation to set up a technology development centre in the country and sets out the intent to collaborate in other areas of energy value chain

RPL is offering 135-crore equity shares of Rs. 10 each at a price band of Rs. 57 to Rs. 62 each. The promoters will subscribe to 90-crore shares, leaving a net of 45 crore shares to the public. The company has privately placed 45-crore equity shares at Rs. 60 each on the eve of the IPO to raise Rs. 2700 crore.

Strengths

* RIL established its refinery in a record 36 months. RPL also expects to commission its mega refinery in another 36 months. The company has tied up with Bechtel for the execution of the project with a single responsibility cost cap contract.

* Despite the complexity, the capital cost of the refinery is going to be lower compared with similar projects in Asia as RPL will benefit from RIL's existing setup including fabrication shop, pipe shop, and an all-weather port. As it is in an SEZ, the company will not be required to pay any customs / excise duties and will also be exempt from income tax for five years from commencing business. It will get 50% income-tax exemption for the next five years, which can be extended for another five years subject to certain reinvestment conditions.

*The margin of the new refinery will be higher than the industry average due to the following factors:

• Ability to handle lower quality crude due to higher complexity will lead to a saving of $2 - $3 per barrel.
• The all-weather port in Jamnagar can handle very large crude carriers (VLCCs), translating into an estimated saving of 10 cents per barrel of crude.
• As it is in SEZ, the refinery will not be compelled to produce LPG or kerosene, which its counterparts in the domestic tariff area (DTA) have to compulsorily produce and sell at subsidised rates.
• The output from this refinery will conform to environmental norms by 2011-12. Thus, the refinery will be able to obtain some premium on its output products before other players achieve compliance.
• The large size gives the refinery the advantage of economies of scale.

RPL estimates the global demand for refined petroleum products to rise rapidly over the next decade. The refining sector world over is facing the challenge to produce cleaner fuels even as crude supplies of heavy and sour varieties are rising. The RPL refinery is well positioned to exploit both these situations.

Weaknesses

*The possible post-listing negative triggers can be:

- Fall in already high Asian refining margin (which is volatile and fluctuates every quarter).

• Natural disturbances in Gujarat (the area has experienced many natural disasters in the recent past).
• Unfavourable events affecting the supply of crude oil, which can sharply push up crude oil prices.

Valuation

With no financial track record and no operational income expected to be generated till December 2008, institutional investors will drive up and down the scrip depending on their perception of the refining margin in FY 2009-10. At the offer price of Rs 57-62, large part of the possible upside has been skimmed. Hence, until the project is commissioned, the scrip may underperform the market. Markets can also throw up better opportunities to invest in this scrip in future.

Sharekhan - Investor's Eye

ORG Informatics
Cluster: Emerging Star
Recommendation: Buy 
Price target: Rs194
Current market price: Rs143

ORG Info bags Rs170-crore order

ORG Informatics has announced that it has bagged a Rs170-crore order from Bharat Electronics Ltd (BEL) as the second part of the order for the convergent billing system to be implemented by BEL for Mahanagar Telephone Nigam Ltd (MTNL). ORG Informatics had secured the first part of the order worth Rs255 crore on March 15, 2006. In our Stock Update dated March 16, 2006, we had indicated that we expected the announcement of the second part of the order (to be worth over Rs125 crore) in the following few weeks. 

 

Associated Cement Companies
Cluster: Apple Green
Recommendation: Buy 
Price target: Rs1,050
Current market price: Rs912

Results above expectations

Result highlights

• ACC's Q1CY2006 pre-exceptional net profit at Rs247 crore is above our expectations primarily because of the higher than expected improvement in the cement realisations and the lower than expected rise in the freight cost. 
• We had mentioned in our earlier cement estimates that the cement price rise and volume growth are above consensus estimates and hence shall lead to an upgradation of the consensus earnings. This is clearly reflected in ACC's consensus net profit estimates of Rs165 crore, which are way below what the company has actually delivered. 
• The net sales for the quarter grew by 19% driven by a 27.4% growth in the cement revenues. The cement volumes registered a growth of 12.9% whereas the cement realisations improved by 12.8% year on year (yoy).
• The growth in the net sales was lower than that in the cement revenues, as the Q1CY2006 revenues do not include the revenues from the refractory business, which had been divested by the company in September 2005. 
• The company's operating profit margin (OPM) for the quarter improved by a staggering 890 basis points primarily driven by a sharp 12.8 % improvement in the cement realisations, which brought the operating leverage into play.
• With a 19% growth in the revenues and an 890-basis-point improvement in the OPMs, the operating profit for the quarter jumped by a whopping 91% and stood at Rs315 crore. 
• With a 5% decline in the interest cost, the profit before tax (PBT) for the quarter jumped by 124% and the same stood at Rs281 crore. We have shown a year-on-year (y-o-y) comparison on the PBT basis as last year there was a tax write back of Rs25.7 crore on account of the reduction in the corporate tax rate. 
• ACC's pre-exceptional net profit grew by 63% to Rs247 crore. The reported net profit, which includes the gain from the divestment of ACC's stake in Eternit Everest and the tax provision made for the earlier quarters (which we have treated as extraordinary items) stood at Rs235 crore, up 42%.

Sharekhan Valueline - April 2006

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EIH Hotels

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Indian Hotels & Bharat Bijlee - Sharekhan

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Aditya Birla Nuvo

Aditya Birla Nuvo 
Cluster: Apple Green
Recommendation: Buy 
Price target: Rs1,031
Current market price: Rs836

The Idea stake gets bigger
The Aditya Birla group (ABG) has agreed to acquire the Tata group's 48.1% stake in Idea Cellular—through Aditya Birla Nuvo (ABN) and Birla TMT Holdings—for a total consideration of Rs4,406 crore. ABG would acquire 108.9 crore shares of Idea Cellular from the Tata group at Rs40.5 per share, thereby matching the offer of Maxis Communication. The Malaysian company had offered to pick up the Tata stake at Rs40.5 per share. After the acquisition, ABG will own a 98.3% stake in Idea Cellular. This deal pegs the total value or the enterprise value (EV) of Idea Cellular at Rs13,461 crore (including a debt of Rs4,309 crore). The same translates into an EV/subscriber (at the current subscriber base of 0.7 crore as in February 2006) of US$427. The valuation is in line with the recent Hutch-Max India deal concluded at US$429 but is marginally lower than the Aircel-Maxis Communication deal signed at US$485. 

Either by itself and/or through its subsidiaries ABN will acquire 33.9 crore shares representing 15% of the equity capital of Idea Cellular for Rs1,373 crore. After this transaction, the equity holding of ABN and its subsidiaries in Idea Cellular will increase from 20.7% to 35.7%. The transaction will be strictly in agreement with the growth strategy of ABN that seeks to invest in high-growth businesses like those of telecom, information technology (IT) and garments.

Plethico Pharmaceuticals IPO

Plethico Pharmaceuticals (PPL) manufactures branded formulations for domestic and non-regulated export markets. The company is promoted by Shashikant Patel, who is the chairman and managing director; and his two children, Chirag Patel, who is a whole-time director and CEO, and Ms Guaravi Parikh, executive director). After the issue, promoters' stake will stand around 86%.

PPL has two manufacturing units at Manglia and Kalaria in Indore, Madhya Pradesh, and a unit in Kandla Special Economic Zone. The plants at Indore produce tablets, lozenges, capsules, syrup, powders, nutraceuticals and herbal formulations. The Manglia plant manufactures effervescent tablets and rifampcin. The products of PPL fall under anti-diabetic, anti-rheumatic, hepato-protective, anti-lipidemic and rejuvenating agents.

PPL is shortly going to launch sugar free lozenges. The company has developed herbal vegetarian capsules for the first time in India for exports to Russia.

Currently, PPL operates three SBUs in the over the counter (OTC) segment: neutriscience (sports nutrition and supplements), confectionary and OTC drugs.

The current issue is purposed to finance the upgradation of the Kalria plant for UK ??(MHRA) compliance, which will absorb around Rs 25.70 crore, and set up a plant in Jammu and Kashmir (J&K), which is WHO GMP compliant, with an investment of Rs 30.90 crore. PPL plans to start organic farming in J&K to support its herbal products. The company will keep Rs 28 crore for any acquisition opportunities in the OTC, domestic herbal and nutraceuticals space in India. Rest of the amount will be spent on the setting up an R&D center, a corporate office in Mumbai, and working capital requirement.

The upgradation of the Kalaria plant (to be completed by January 2007) will help PPL to foray into the UK generic and herbal markets, and give a thrust in the existing markets in CIS, Russia and Africa. This plant will produce only cephalosporin products. The production from the J&K plant (to be completed by July 2007) will be earmarked for domestic market.

Strengths

• Wide range of products numbering around 400 across 40 therapeutic areas de-risks the business.
• Global presence in around 45 countries across the globe. To strengthen the marketing and distribution network, PPL is in advanced stage of acquiring the controlling stake in the Rezlov group, which has strong presence in CIS, Russia and Cambodia.
• PPL earns substantial revenue (around 68%) from exports of which around 70% comes from herbal products.

Weaknesses

• PPL does not have presence in regulated markets like Europe and the US.
• Despite a host of products, PPL has been able to create identity only in few brands like Travesil (a cough and cold herbal medicine, which gives Rs 35 crore of revenue), Coach's formula (a protein rich nutritional preparations for atheletes), and Bytes candy. .
• Half of the sales are locked up in debtors. Debtors of Rs 43.6 crore (around 20% of sales) are due for more than six months. Exports to CIS and African countries involve long credit periods and attendant risks.

Financials

PPL's performance for the latest year ended September 2005 is not comparable with prior periods due to the change in accounting period and the sale of the ethical division in the previous year.

In the first quarter of fiscal 2006 (ended December 2005), PPL's revenue stood at Rs 63.09 crore. On the back of 33.6% operating profit margin, the company earned 21.19-crore operating profit. The profit before tax (PBT) in the quarter stood at Rs 20.90 crore at a PBT margin of 33%. The profit after tax (PAT) at Rs 19.91 crore gave a net margin of 31.6%. These margins are high.

Valuation

PPL's FY 2005 (ended September 2005) EPS stands at Rs 16.5 at the upper price band and Rs 16.4 at the lower price band. PE at price band of Rs 280 and 300 stands at 17.1 and 18.3, respectively, which is in line with industry composite P/E.

Multiplex Cinemas - Karvy

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10 Paisa and Midcaps.in

Newsletter dated 9/04/2006 (10paisa.com )

 S.No.            Scrips                       BSE Code           Recommended Rate         Target Rate.
1.            Tainwala Chemicals       507785                13.25                               17.00

2.           Winsome Yarns                514348                19.20                               24.00

3.           D & H Welding                 517514                22.70                               29.00

4.           Chowgule Steamships      501833                26.10                               33.00

5.           Sarda Plywood                 516003                29.45                               37.00


Newsletter dated 9/04/2006 ( Midcaps.in)

S.No.       Scrips        BSE Code     Recommended Rate   Target Rate.
1.     Oriental Carbon    506579          31.90             40.00

2.       Media Video      530435          46.30             58.00

3.      ETC Networks      532615          54.95             69.00

4.    Ashco Industries    517565           57.30             72.00

5.     Todays Writing     531830          77.10             97.00

Kale Consultants

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IPO - Lokesh Machines: Invest

An investment can be considered in the initial public offer of Lokesh Machines. At Rs 130 — the lower end of the band — the offer is priced at 20 times the annualised FY-06 per share earnings on the post-issue equity. Our recommendation is based on the positive outlook for the automobile industry, revenue visibility in terms of securing long-term contract with Ashok Leyland, good order-book, performance over the years and the ability to withstand a downturn.

Steady performance

Lokesh Machines makes machine tools and auto components. Promoted by a first generation entrepreneur, the company has delivered consistent performance over the last decade even when the entire machine tool industry was in dire straits. The company's ability to maintain growth during a slowdown when most engineering companies struggled to make profits, enthuses confidence in the management.

Lokesh Machines kept up with the growth momentum by diversifying its customer base, adding auto components to its portfolio, exploring export opportunities and coming up with innovative import-substitute products for the Indian market. Over the last decade, the company's revenues have grown from Rs 5 crore to Rs 75 crore in FY-05.

Auto capex, key driver

The capacity expansion in the automobile and auto component industry would be the key demand driver. Capex in these two industries alone is expected to be about Rs 5,000 crore and Rs 2,000 crore annually over the next three years. With both multinationals and domestic companies expanding, the demand for machine tools is expected to be robust.

The positive demand outlook for the commercial vehicle industry improves revenue visibility for its auto component division. The company makes cylinder blocks and heads for commercial vehicles. Mahindra and Mahindra, and Ashok Leyland are the two key customers. Though client concentration involves some risk, the favourable outlook for these companies for at least the next couple of years mitigates this risk.

Moreover, the company has been gradually diversifying and supplies to other big firms such as Bharat Forge and Honda Motors. Having supplied to big names, the company could overcome the client concentration risk over a period. The fresh capacities for cylinder blocks and heads would be exclusive for Ashok Leyland under a three-year contract. This gives revenue visibility in the near- to medium-term.

Breakthrough in exports

Over the last two-three years, Lokesh Machines has been able to break through the export market for general purpose machines. Exports accounted for about 10 per cent of the revenues in FY-05. It has export orders worth Rs 3.3 crore for FY-07, double that in FY-06, though on a small base. The total order-book, as on February 2006, was roughly Rs 31 crore, approximately half the turnover for FY-05.

Offer details: The funds generated from the IPO would be used to create additional capacities for cylinder blocks and heads and modernise the machine tool capacity. The output would be exclusively supplied to Ashok Leyland for the next three years and is renewable on a yearly basis. The new facility would add 40,000 units to its existing capacity of 1,20,000 units.

Lokesh Machines expects to raise Rs 39 crore to Rs 43 crore. The offer is to be priced in Rs 130-140 band. The bid closes on April 13, 2006. The offer is lead-managed by Karvy Investor Services and UTI Securities.

Low returns scare investors away

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Reliance Petroleum: Focus on risks

The biggest risk to the project is a delay in its commissioning beyond the scheduled December 2008.

There are others with better integration levels in their businesses and deeper pockets planning to set up similar projects closer to the markets in the US and Europe.

Therefore, a late entry for RPL's refinery could mean taking on high-quality competition right from the start.

A repeat of the story with the original Reliance Petroleum whose project was delayed by four full years could prove dangerous for the new RPL.

The original RPL, which was subsequently merged with Reliance Industries in 2002, floated its IPO in September 1993 with a stated plan of commissioning its 9 million tonne capacity refinery by the second quarter of 1996. As it turned out, the refining capacity increased three-fold to 27 million tonnes(further expanded to 33 million tonnes now) but the refinery was commissioned only in the end of 1999.

Of course, it is true that the project was implemented in 36 months because work on the ground began only in 1996. Yet, the fact is that it was delayed compared to the original schedule stated in the offer document of the IPO.

RPL will also be up against some quality competition in the Western markets dominated by multinationals such as ExxonMobil, Royal Dutch/Shell, ChevronTexaco and BPAmoco all of which are well-integrated across the chain from exploration and production to refining and marketing.

The absence of a marketing network could prove to be a handicap for RPL at a time of low refining margins.

There will be some close linkages between RPL and several of its group companies. For a start, the parent company, Reliance Industries, will offer the critical services of crude sourcing and also marketing the refined products.

The experience of Reliance Industries in both these areas will be a strong asset but the corresponding liability could be a clash of interests; according to the offer document, Reliance Industries will offer its services at cost during the implementation and operational phases of the project.

There are also other tie-ups that RPL will have such as for power (with Reliance Utilities and Power), for usage of port and terminal facilities (with Reliance Ports and Terminals) and for civil construction of the refinery (with Reliance Engineering Associates Pvt. Ltd).

These three companies are controlled by the promoters of Reliance Industries and will offer their services on terms similar to what they provide to others in the proposed SEZ, says the offer document.

Reliance Infrastructure, a wholly-owned subsidiary of Reliance Industries, will implement the SEZ.

The principle of arm's length transactions will be of utmost importance given this business structure.

Finally, from the perspective of investors, the track record of the Reliance group in mergers of group companies has to be taken note of.

The original Reliance Petroleum was floated as a separate company that also made its IPO and listed on the market.

Though it was always said that the company would be kept independent, it was eventually merged with Reliance Industries in 2002.

Others such as Reliance Polyethylene Ltd. and Reliance Polypropylene Ltd., which also came out with IPOs in the early-1990s and listed on the market, were also merged with Reliance Industries later.

While there is nothing wrong per se in mergers of group companies so long as they are done on fair terms, those who do not prefer the uncertainty associated with such moves are bound to see this as a risk factor.

Reliance Petroleum: A high-octane offer

This public offer of equity shares by Reliance Petroleum Ltd (RPL), the group's first visit to the primary market in the last 12 years, can be considered favourably for investment. The project is well-planned and backed by good reasoning, and the group's experience of commissioning and running the large capacity, state-of-the-art refinery at Jamnagar is a big positive.

The biggest risk to our recommendation would be a delay in commissioning the refinery by the set deadline of December 2008 as time-to-market will be critical for this export-oriented project.

Multinational competitors are already talking about the same opportunity that RPL has spotted and it is only a question of time before they embark on similar projects to supply high-quality fuel to the American and European markets.

RPL is a 80-per cent subsidiary of Reliance Industries and given the track record of the group in merging subsidiaries with itself, a similar action in the case of RPL some time in the future cannot be ruled out, especially because the two companies are in similar businesses.

Investors should also note that performance-linked appreciation in the stock is more than three years away and an investment now should necessarily be with a long-term perspective. Our recommendation is not linked to possible speculative gains on listing.

WHY ANOTHER MEGA REFINERY?

The new 29-million-tonne (5,80,000 barrels-a-day) refinery will be housed in a special economic zone adjacent to the existing refinery of Reliance Industries and supply exclusively to the export market, specifically the United States and Europe.

It will be a technologically advanced refinery, more advanced than the existing one, and will be capable of processing the heaviest and sourest of crude oils to produce high quality refined products. The associated feature of the project will be a polypropylene plant of 9 lakh tonnes.

The entire project, designed to capitalise on the twin aspects of increasing demand in the West for high quality products that meet stringent emission standards and the widening gulf between the global prices of heavy and light crude oils, rests on two major pillars.

First, the best quality crude oils have already been discovered and tapped. These crude oil grades trade at high premium in the world market and are low on sulphur and light in density. The newer crude oil finds and hence, future output, would be of lower grades that are high on sulphur (sour) and heavy in density.

Most of the existing refineries worldwide that were set up in the latter part of the last century are designed to process high quality crude oil grades.

To process the heavy, sour crude grades that are now increasingly floating in the market, these existing refineries have to invest in upgrading their secondary processing and conversion capabilities. There is a place for new refineries that are complex enough to process the so-called "dirty" crude oils and yet produce the highest quality petrol and diesel to meet the stringent emission norms that are constantly evolving.

And that brings us to the second pillar. Quality norms for transportation fuels in the US are set to become more stringent with ultra-low sulphur diesel and petrol free of MTBE (methyl tertiary butyl ether, a carcinogen), which the old refineries are not capable of producing.

This opens up an opportunity for those willing to invest in new facilities designed to make products capable of meeting the advanced norms. Europe and large markets in Asia such as Korea, Japan and China are following suit with similar norms.

SEIZING OPPORTUNITY

The combination of refineries that can process low-grade crude to produce high-grade products is the window of opportunity (read accompanying story) that RPL is seeking to exploit. Of course, it does help that the gap between product demand and refining capacity worldwide is narrowing and refinery utilisation rates are running at their highest levels in the last two decades. Demand could outstrip refining capacity in the next few years as tightening product norms lead to shutdown of old refineries that cannot match the new requirements. But how are the margins?

PROFITABILITY EQUATION

This is the interesting part of the entire business. Heavy and sour crude oil grades trade at a sharp discount to the superior light and sweet variety and this gulf has been widening the last couple of years. In 2005 the price differential between the Arab Light and Arab Heavy grades, for instance, was as high as $5 a barrel.

Gross refining margin, that is the difference between the total value of finished products and the cost of the crude oil, can be lucrative where a refinery has the capacity to use the cheaper low-grade crude oil to produce the superior-grade products that sell at a premium.

This is exactly what RPL is endeavouring to do. The product slate of RPL's refinery will be tilted more in favour of high-margin, in-demand products such as petrol, diesel, kerosene, alkylates (high-octane additive to gasoline that commands a premium in the market) and petroleum coke.

CAPITAL INCENTIVES

The only catch here is that the capital costs of setting up such a high-complexity refinery is higher than a normal one. Compared to a capital cost of $24/barrel/day for the existing refinery of Reliance Industries, the new one of RPL is expected to cost $28/barrel/day.

This is where the benefits of being located in a special economic zone (SEZ) kick in. The project will be entitled to duty-free imports of capital equipment and crude oil; it will be exempt from duties on exports of products; from excise duty on products purchased from within the country; from service tax on taxable services rendered to it by others and, finally, from all stamp duties on land transactions and loan agreements.

In addition to the above, 100 per cent of profits derived from exports will not be subject to income tax in the first five years and this will fall to 50 per cent in the next five. These benefits, put together, will go a long way in boosting the refining margins and reducing the capital cost for RPL's project.

WHY A SEPARATE COMPANY?

The main reason for implementing the project through a separate subsidiary company appears to be its location in a SEZ. The different business model of the company, catering as it does to a predominantly export market, and the opportunity for unlocking value through a separate vehicle and give an opportunity for investors to participate in it, are put out as other reasons for implementing the project through a new company.

From the perspective of a Reliance Industries shareholder, it is good that the project is not on its books for the simple reason of its size and quantum of investment. Though Reliance Industries will still be investing Rs 8,280 crore to acquire 80 per cent of RPL's equity, the debt of Rs 15,750 crore will not be on its balance-sheet.

Importantly, the risks associated with setting up and commissioning a Rs 27,000-crore project will not weigh down on the balance-sheet or the stock price of Reliance Industries.

OFFER DETAILS

In all, 135 crore shares will be on offer of which 45 crore shares are available for retail investors. The price band will be between Rs 57 and Rs 62 and retail investors have the option of paying Rs 16 per share on application. The offer is open from April 13-20.