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Oil Country Tubular: An oddball in the sector - Outside View by Luke Verghese
 
 
Oil Country Tubular: An oddball in the sector

Making a go of it internationally in the rough and tumble world of oil and gas

A spirited company operating in the oil and gas sector

This rather oddly named company based in Andhra Pradesh, has just concluded 26 years of existence as a corporate entity. It is run by two mutually related entrepreneurs K Suryanaryana, the chairman, and Sridhar Kamineni, the managing director. It claims that it is a uniquely integrated facility and is one of the leading companies in the world, processing a wide range of Oil Country Tubular goods - drill pipes, heavy weight drill pipes, tubing, casing, drill collars and other oil field accessories required for oil drilling and exploration. It was initially set up with a capital outlay of Rs 500 m. It is presently in the process of an expansion scheme costing Rs 1.5 bn. It registered a nett turnover of Rs 4.8 bn in the financial year ended March 2012, against nett revenues of Rs 3.3 bn previously.

Would revenues of this size make for the company being one of the leading companies in the world in its line of activity? The good tidings however is that the company claims that due to the increase in the Oil and Gas exploration activities there is a growing demand for the company's products. That would amount to stating the obvious, but let that be. The management also claims that the major achievement of the company due to their continuous research and development activities is the indigenisation of toolings, and improvements in the manufacturing process and operational procedures. The company spent a princely sum of Rs 3.5 m during FY12 in revenue expenditure in this endeavour.

Concentrating on the export market

The company is basically concentrating on the export demand for its products and services. This is really bold stuff! In FY12 exports accounted for over 86% of the gross revenues of Rs 4.8 bn while in the preceding year the contribution of export income in overall revenues of Rs 3.3 bn was even more impressive at over 96%. In the latest accounting year the company claims to have penetrated the Canadian market in addition to the North American market and it has also expanded the customer base to the Central Asian region. In the segment reporting schedule, the foreign revenue accretals arise from Brazil, Canada, UK, and the USA. Given the country's own frenetic expansion in the oil and gas exploration scenario, one wonders why the company has chosen the foreign market route to earn its succour.

A part of a large group agglomeration

Oil Country Tubular is a part of a larger group agglomeration given that it has substantial inter-se transactions with group companies on revenue and/or capital account.

The promoters on their part control just over 48% of the paid up equity of Rs 443 m - of the face value of Rs 10 each according to one schedule. But in the group holding structure, two closely held group corporate entities, United Steel and Allied Industries, and UMW India Ventures Ltd hold 32.4% and 14.9% or a total of 47.4% of the voting stock of Oil Country Tubular. An individual and co-promoter K Suryanaryana holds another 5% of the voting stock as promoters' holding. The holding of the other co-promoter the CEO, Sridhar Kamineni is not separately stated (as his holding is below 5%), but he too obviously has a stake. In any event the combined stake holding of the promoters from the information that is made available adds up to close to 53%. These different percentage figures of the promoters' stake in the company simply do not add up. But let that be. The company on its part has a stake in a group associate - an equity holding of 20% in United Seamless Tubulaar Pvt. Ltd with a face value of Rs 522 m (inclusive of share application monies).

The company's operations are conducted through a complex resource mix - which includes massaging the ego of closely held group companies. It apparently does not manufacture any of the products that it retails - there is no installed capacity or production statistics in the annual report. At least this is my understanding of a reading of the schedules to the annual report. It imports the vast majority of the products that it requires in value terms. Imported raw materials accounted for 78% of all raw materials consumed. It is not known whether the company adds any value to these 'raw materials' post purchase. But the biggest item of sales by far is Casing and Production tubing accounting for 65% of all rupee sales. Next in line are Drill pipes bringing in another 22% of revenues. Bringing up the rear end are drill bits and such like including job works. Of the export effort, direct exports accounted for 41% of all exports. The balance constituted domestic sales but gets classified as deemed exports. The US is its biggest market followed by Brazil and Canada. All the export markets are individually but varyingly profitable according to the segment reporting schedule.

Heavy dependence on imports and exports

Given the need to both import and export in large value terms, the company has considerable dollar denominated foreign exchange exposures. At year end the dollar exposures in rupee terms amounted to Rs 1.1 bn. This will play heavily in the negative zone in the current fiscal year given the sharp drop in the value of the rupee. It has as it is booked a loss of Rs 36 m on forex losses in the latest accounting year. The company also has relatively high overall gearing - this is to be seen in the context of the current capital expenditure program too. The total borrowings at year end including borrowing classified as current liabilities, amounted to Rs 2.5 bn against Rs 1.4 bn previously.

Group companies have some say in its operations

The inter-se group transactions extend in all directions. Capital expenditure contracts of Oil Country Tubular (OCT) are apparently handled by a privately held group affiliate, and OCT's biggest shareholder United Steel Allied Industries Pvt. Ltd (USAI). USAI is also the beneficiary of material loading and unloading contracts and of office rent paid to it. The biggest beneficiary in its inter-se dealings is the privately held, United Seamless Tubulaar in which OCT has a 20% stake. OCT buys raw materials from its sibling, and in turn OCT sells goods and services to its sibling. Other material purchases are affected through another closely held worthy going by the name of Usai Forge Pvt. Ltd. Advertising, printing, and supply of stationery are parcelled out to another tooth fairy V Max Studio and Advertising. Everything it would appear has been very well planned out down to the T. None of the closely held companies appear to be granting any return favours to the listed company. But that is the right way to go about it, what?

If the closely held companies are helping themselves to some of the goodwill of OCT, then the two co-promoters' of OCT are not very far behind in taking in a bit of the action themselves, it would seem. The chairman and the CEO between themselves took home a combined remuneration of Rs 56 m during the year. This payment accounts for 19.4% of the total employee benefit payouts of Rs 291 m during the year. Not bad going at all!

Its working results

This is not to suggest that the products that the company hawks do not bring home the bacon at the end of the day. On gross revenues including other income, in all toting up to Rs 4.8 bn, the company togged up a pre-tax profit of Rs 565 m during the year. The figures for the preceding year are Rs 3.3 bn and Rs 457 m respectively. To its credit it is able to manage its trade receivables to its advantage. On a rough reckoning such receivables accounted for 56 days sales, but inventory levels at 139 days sales eats into working capital costs.

The company however does find the going difficult on the cash flow generation front. The cash flow generation from operating activities as presented by the company looks inflated due to the classification route that the company has chosen to present some of the balance sheet items. Borrowings repayable over the next one year have been classified as working capital loans and adjusted in cash flow from operations in the cash flow statement. This led to an increase in cash flow generated from operations by Rs 917 m. In the preceding year the cash flow from operations was higher by Rs 318 m. If the increase in bank borrowings is excluded, then the cash flow generation from operations would be lower at Rs 630 m and Rs 105 m in FY12 and FY11 respectively.

Strictly speaking any funds flow changes involving borrowings whether of the short term or long term nature is to be grouped in the working of cash flow from financing activities. The total borrowings at year end, and as stated earlier, has actually zoomed to Rs 2.5 bn from Rs 1.4 bn previously. The rise in borrowings is because the cash flow generation was grossly insufficient to finance the fixed assets expansion. Borrowing more cash leads to many possibilities. The company needs to match the cash inflow with the expansion of its capacity on the one hand, and its ability to pay its tithes on its borrowings and repay the loans on due date on the other.

Expansion schemes on the anvil

However the company appears to be targeting more new markets abroad and its revenues and profits are rising each year. What is most creditable is that it is able to do so even after targeting foreign markets exclusively. It is now counting on achieving revenues of Rs 6 bn in the current fiscal. The expansion of its facilities will mark up its 'productive' capacity to 2.5 lakh tons from 1 lakh tons currently. It also boasts a fairly widespread shareholder base of over 35,000 members.

It is not easy to take a call on this company given the several contradictions. There is for example the over dependence on group companies both on revenue and capital account to earn its succour and such acts automatically send out negative vibes. But at the same time the company is some sort of a pioneer seeking to establish a base in the oil and drilling sector in foreign shores.

In sum total, like the proverbial curates egg, it is good in parts.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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