Energy: Will FY03 bonanza last?

A look at the graph below makes it clear that energy stocks have been a favorite on the bourses. In the past one year, among the major gainers were IOC (103%), IBP (78%), Mangalore Refineries (164%), Bongaigaon Refineries (79%), ONGC (50%) and GAIL (48%). These gains were in stocks across the sector, be it exploration, standalone refineries or marketing and refining players. Dismantling of APM at the start of FY03 was a key trigger to a slew of healthy financial results during the year. Let's take stock of the situation across the various sub-segments of the Indian energy sector and its prospects going forward.

Energy sector comprises of companies in exploration, refining and marketing segments. In case of exploration, ONGC is a major player. ONGC clocked the highest ever net profits and became the only company in India to cross over Rs 100 bn mark. As a result of APM dismantling, ONGC was allowed to sell crude oil at higher prices linked to international prices (earlier its selling price of crude was fixed by the government at US$ 16 per barrel). This helped the company post nearly 70% growth in the topline in FY03. This apart, the crude oil and natural gas production for the company were also at higher levels during the year. The company was successful in making oil and gas discoveries at six places in FY03 (See ONGC: Drilling new highs). Its equity investments through its subsidiary company, ONGC Videsh, finally bore fruit when it received around 1.6 m tonnes of crude from Sudan fields during the month of the May. During FY04, the company has plans to invest around Rs 160 bn to boost its exploration thrust. It has garnered 37 blocks out of the 70 blocks offered in three rounds of NELP so far.

Refining and marketing players like HPCL, BPCL and IOC too declared encouraging results for FY03. On a consolidated basis, the topline of these three increased by about 14% during FY03. This was on account of higher petroleum product prices. As a result of APM dismantling, these oil PSUs were allowed to link the petroleum product prices in line with prevailing international prices of crude oil. Prices of crude oil strengthened by about 45% during FY03. Oil PSUs increased the prices of petroleum products to align it with crude oil prices. As a result of which the price of petrol increased by 26% while that of diesel increased by over 33%. This helped these companies post a double-digit topline growth. This apart, the capacity utilization of the refineries was also at higher levels during the year.

(Rs m)	4QFY02	4QFY03	Change	FY02	FY03	Change
Net sales	425,128	563,142	32.5%	1,760,834	1,998,479	13.5%
Other Income	5,802	8,747	50.8%	17,215	24,149	40.3%
Expenditure	381,473	518,227	35.8%	1,661,101	1,855,653	11.7%
Operating Profit (EBDIT)	43,655	44,915	2.9%	99,733	142,827	43.2%
Operating Profit Margin (%)	10.3%	8.0%		5.7%	7.1%
Interest	5,003	1,907	-61.9%	21,432	11,614	-45.8%
Depreciation	6,149	7,828	27.3%	24,029	27,170	13.1%
Profit before Tax	38,305	43,927	14.7%	71,487	128,192	79.3%
Extraordinary items	141	-153		141	-153
Tax	17,491	10,963	-37.3%	26,403	39,017	47.8%
Profit after Tax/(Loss)	20,955	32,811	56.6%	45,225	89,022	96.8%
Net profit margin (%)	4.9%	5.8%		2.6%	4.5%
No. of Shares	1,417.5	1,417.5		1,417.5	1,417.5
Diluted Earnings per share*	59.1	92.6		31.9	62.8
P/E Ratio					5.9
(*annualised)

As mentioned above, the prices of crude strengthened during the year. Crude being a major raw material for these companies, the expenses of the companies increased as a result of this during FY03. Raw material cost as a percentage of net sales increased from 28% in FY02 to about 34% in FY03. Also, the cost of purchase of products for resale increased during the year. Overall, the expenses increased by about 12% during the year. Since the rate of increase in topline was at a faster clip, as compared to that of the expenses, operating margins on a consolidated basis improved by about 140 basis points. However, IOC (up 210 basis points) and HPCL (up 140 basis points) were able to increase the operating margins at higher rate as compared to BPCL (up 30 basis points).

Apart from the increase in sales volumes and higher product prices, interest expenses also saw a significant decline (46% YoY) owing to prevailing lower interest rates. This also added to the bottomline growth. Bottomline on a consolidated basis increased by about 97%. Part of this gains were on account of increase in inventory levels also. Thus, the first year of dismantling came as cheers to the oil PSUs and helped them post better results during the year.

Standalone refineries were no exception to this trend. Some of them saw a turnaround in their fortunes, while others clocked their best results so far. The case in point, Mangalore Refinery, which was a sick company earlier, successfully reduced its losses by about 16% during FY03. The company recently came under management control of ONGC and is expected to operate at 100% capacity utilization during FY04, which is likely to improve the financial health of the company going forward. After coming under the control of IOC, Bongaigaon Refinery too saw a turnaround during FY03. After getting parental support from BPCL and IOC respectively, Kochi Refinery (562%) and Chennai Petroleum (375%) improved their bottomline significantly. On a consolidated basis, standalone refineries, which were into losses last year made net profits during FY03.

Thus we have seen that the companies have posted their best ever-financial results during FY03. Not surprisingly then, this sector figured prominently in the investors' buy list. But now what?

The price of crude oil has stabilized during the first quarter of FY04. Also, overall petroleum product sales in the first two months of FY04 (April-May) have declined, probably feeling the lag effect of weak economic growth last year. Moreover, the extraordinary gains seen by oil PSUs in FY03 were largely a result of their alignment with the international crude prices. Going forward, clocking FY03 growth rates will be a tough ask for most of the oil PSUs. So it will be prudent for investors not to get carried away by the FY03 performance. But at the same time, we expect consumption of petro products to continue seeing healthy growth, in expectation that the economy will grow at a faster pace. Consequently, long-term prospects of the companies look good.

With the entry of private players in the marketing front like Reliance and Shell, competition in this front is expected to increase manifolds. The oil PSUs have realized this fact and have aggressive plans to meet the foreseen competition. With the recent discoveries, more deep-water and coal bed methane blocks are being opened up for exploration. In this light, it is likely that global oil majors show an interest in the exploration blocks offered in NELP-IV. This apart, the government's keenness to divest oil majors HPCL and BPCL by the end of FY04 also bodes well for the sector's prospects.