Core Sectors: Unlocking India's Potential

The Indian economy has been struggling quite a bit over the past couple of years. The principle factor that has exacerbated the situation is the political inaction which has more fashionably come to be known as ‘policy paralysis.’ The urgency of steps needed to put the house in order is evident today more than any other time it ever was. With the general elections just six months away, all hopes to turnaround the economy are now being pinned on the new government that will come to power. Early signs of the economy turning its corners for the better are already becoming visible. All it needs is a more decisive and pro-business government to provide that much needed impetus to an economy ready to take off. 

Eight sectors which form the core of the Indian economy are getting ready for the next big round of growth. Businesses are expecting a more stable political regime to support their ambitions and the clarity on that front is more forthcoming in the present circumstances. This is a time to take stock of these core sectors to spot the investible opportunities that they may offer going forward. After all, these eight core Industries have a combined weight of 37.90 per cent in the Index of Industrial Production (IIP) and form a quarter of the frontline indices like Nifty (25.18) and the Sensex (22.98).

Government impetus on the development of these industries is a given. From infrastructure and power to steel and cement, each of these sectors will now see a renewed market interest as their future growth prospects become more and more clear. DSIJ presents a detailed analysis of each of the eight sectors which are sure to help you understand what’s in store going forward.

Cement

India is the second largest cement producer in the world after China. The country’s infrastructure potential is vast. According to a study by Global Construction Perspectives and Oxford Economics, it has the capacity to become the world’s third largest construction market by 2025, adding 11.5 million homes each year to become a USD 1 trillion per year market. 

The growth of the cement industry is directly linked to the growth of the overall economy and the real estate and infrastructure sectors in particular. The housing sector is the most important for cement demand in India, as this segment consumes almost two-third of India’s total cement production. As of 2012, there were 144 large and mini cement plants held by 42 cement companies in India. 

Despite the attractive prospects for the cement industry, it has not really seen a recovery since the 2008 financial crisis. The demand in cement hinges on government spending, which can mobilise infra activities in the country. Additionally, the demand in cement is also strongly related with corporate capital expenditure. Post 2008, the government spending on infrastructure and corporate capex was at considerably lower levels from its peak. 

In addition to this, the pricing power of the country’s cement companies has not been strong over the past few years. Due to a subdued economic environment looming over real estate and infrastructure, the demand for cement is at sub-par levels and there is considerable surplus capacity of upto 50-60 mtpa. Various new players have also entered into the market in the recent past, and lower consolidation activities are taking place across the sector. This has led to a controlling capacity of 30 per cent by the top two players, which is considerable lower from its peak of 42 per cent.

The key parameter to success for any cement company in the Indian industry is logistics cost efficiency. The energy costs for these companies have spiralled out of control in the last few years. The energy costs have eaten up a considerable portion of the realisations of Indian cement companies. Higher fuel prices have also hampered the logistics and bulk handling costs of these companies. Further heat will be generated by the issues of diesel price de-control and rising railway freights. 

Another problem faced by the older cement companies is their legacy plants and the ageing technology used in those plants. This leads to 25-30 per cent lower cement output. Further, the plants are logistically inefficient, being typically located near limestone mines rather than near consumption centres. The higher logistics costs and operational inefficiencies make these vintage plants redundant in the present scenario. 

On a positive note, the cement prices in the country have started to recover despite a subdued demand scenario across all the regions in India. 

On the financial front, the recent elapsed Q2 financial performance across the sector was weak due to the prolonged monsoon season causing a decline in dispatches. While the decline in prices of pet coke and imported coal shifted the cement companies towards these fuels and meant lower fuel and power costs, rupee depreciation has offset these lower costs to some extent. Freight charges continued to be on the higher side, impacting their bottomlines. 

Government spending is expected to rise over the next one year post the general elections. Healthy demand may be seen from rural India due to a good monsoon this year. On the flip side, higher costs, lower capacity utilisation and pressure on RoEs are expected to be strong headwinds over the next one year. Investors may consider buying in select cement companies for market returns. Pick companies which have good asset quality, strategically located plants, logistically efficient operations and low dependency on vintage plants.

All India	FY08	FY09	FY10	FY11	FY12
Year End Installed Capacity	198.3	219.2	270.8	303.8	334.2
Net Installed Capacity	166.2	204.7	241.9	292.2	311.4
Cement Production	166.8	181.4	200.7	207.9	221.4
Capacity Utilisation (on effective Capacity)	100.00%	89.00%	83.00%	71.00%	71.00%
Total Cement Consumption	166.9	180.9	201	210.7	225.2
Domestic Cement Consumption	163.3	177.7	198.6	208	222.3
Growth		8.82%	11.76%	4.73%	6.88%

[PAGE BREAK]

Fertilisers

The fertilisers sector is of utmost importance to the Indian economy for two simple reasons. One is that nearly 54 per cent of the population of India depends directly on agriculture, and the other is that agriculture is a significant contributor to the economy, accounting for 14 per cent of the GDP in 2012-13. Going forward, it is said that India will need an additional 35-40 million tonnes of foodgrain and a much higher amount of fruits and vegetables to feed its growing population. 

With a better monsoon this year, the sowing of the kharif crops has been good. The cropped area in the present fiscal as at the end of Q2FY14 has increased by 4.5 per cent on a YoY basis. Industry experts are of the view that the high moisture level in the soil will provide a good base for sowing of the rabi crop, and the growth that has been seen in the agricultural sector in the first half will get carried over into the next half of the year as well. Therefore, the harvest of the rabi crop is also expected to be encouraging. These factors apart, the new Minimum Support Price (MSP) augurs well for the fertiliser industry as a whole. 

Nutrient Consumption Among Asian Countries
Country	Kg/Ha
India	133
Bangladesh	170
Pakistan	135
Sri Lanka	106
China	333

One of the positive developments that bode well for the sector and the economy is the Nutrient-Based Subsidy or the NBS Scheme. With the introduction of the scheme, the subsidy as a percentage of total realisations has decreased from 59.80 per cent in FY11 to 37.40 per cent in FY13. This is slated to decrease further to 35.44 per cent in FY14. The NBS Scheme has given the farmers improved availability and access to new products and technologies. It has reduced the subsidy outgo for the exchequer and has brought certainty in the subsidy amount. 

The growth in population and increase in urbanisation have led to growth in the demand for food, which is likely to be the primary growth driver for the sector. To add to this, the nutrient application rates need to increase from the current levels to sustain the supply response to demand, as the cropping intensity, irrigation and other agricultural factors are improving.

If we look at the nutrient consumption among the Asian countries, we find that India’s nutrient consumption (kg/ha) is lower than that of countries like China (333), Bangladesh (170) and Pakistan (135). This gives us an idea that the use of nitrogen, phosphorus and potassium fertilisers is slated to grow going forward. The demand has remained subdued in the

Subsidy As %  of Total Realisations
Pre NBS	62.90%
2010-11	59.80%
2011-12	52.10%
2012-13	37.40%
2013-14E	35.44%

previous year, as the cost of phosphorus and potassium fertilisers was relatively high – lower urea prices has led to higher application of this fertiliser.

The low demand and failed monsoon in 2012-13 resulted in higher inventory levels. But in the current scenario, with good monsoon in 2013, it is expected that the consumption of phosphorus and potassium fertilisers will see a northbound move. The sector is also working on getting over the inventory that has gathered in the previous season.

With the rise in consumption of complex fertilisers, we feel that companies like Coromandel International, Tata Chemicals and Gujarat State Fertilisers Corporation may witness some interest among investors going forward.
[PAGE BREAK]

Infrastructure

Noted Indian economist Dr V K R V Rao once said, “The link between infrastructure and economic development is not a once and for all affair. It is a continuous process; and progress in development has to be preceded, accompanied, and followed by progress in infrastructure, if we are to fulfill our declared objectives of generating a self-accelerating process of economic development”. This indicates that there are no second thoughts to the fact that a country’s infrastructure development is directly proportionate to its economic growth and vice versa. Spanning from road-ways to airways, ports to airports and power production facilities, the Indian infrastructure segment is key for the development of the nation. It is said that a rupee invested in infrastructure projects generates prospects worth Rs 10 – that is to say, it generates around 10 times of opportunities. It is no wonder, then, that the sector enjoys intense attention from the highest echelon of policymakers of the country. 

Over the past few years, however, the sector has been going through a dull phase. There were quite a few roadblocks like higher interest rates which made some projects unviable, scarcity of funding and financing options, delay in environmental clearance and the lack of public projects. These affected the infrastructure companies severely. The impact was so much that few of the listed entities lost almost 80 per cent of their market capitalisation or more on the bourses. The higher debt burden resulted in many of these companies selling off some of their non-core assets. Policy paralysis at the centre only made matters worse. 

Quarter	Volumes In Major Ports (MT)	QoQ Change (%)	YoY Change (%)
Q1 FY12	147	-4	5
Q2 FY12	133	-10	2
Q3 FY12	138	4	-5
Q4 FY12	142	3	-7
Q1 FY13	138	-3	-6
Q2 FY13	132	-4	-1
Q3 FY13	135	2	-2
Q4 FY13	140	4	-1
Q1 FY14	137	-2	-1
Q2 FY14	140	2	6

However, things seem to be changing slowly and steadily. The UPA government, which had remained immobile for a long period, is trying to get things in place. Factors like the formation of the Cabinet Committee on Investment (CCI) and fast-tracking of power projects, road projects and some mining activities have provided much-needed impetus to the infra sector. Though the reaction comes really late, it is likely to provide some solace to the infrastructure players.

Before we get into the details of infrastructure sector, let’s understand what the different segments are and how it is closely related to the other core sectors.

The Indian infrastructure segment has five major divisions – ports, railways, roads, power and aviation. Most of the EPC (engineering, procurement and construction) companies also cater to the infrastructure sector. Here, we present our perspective on the various segments of infrastructure, focusing mainly on ports and roads. As for the others, aviation is still to get its balance right and railways are still a government-owned enterprise in India. The power segment has been covered ahead in this story.

Ports’ Volumes 

India has as many as 187 minor ports, but the bulk of the business is carried on through its 12 major ports. These 12 big ports, which account for about 58 per cent of the total cargo shipped through the country, handled 140 million tonnes (MT) of goods in the second quarter of FY14. This was around 137 MT in Q1FY14 and 132 MT in Q2FY13, which meant a six per cent rise on a yearly basis and two per cent sequentially. However, the scenario remained subdued overall, which is evident from figures in the table.
[PAGE BREAK]

Government Initiatives 

National Highway  Added  In Five Year Plans
Plan	Km Added
10th Plan	9008
11th Plan	10228
12th Plan	36500

The Indian government plans to earmark USD 1 trillion for the development of infrastructure over 2013-18. To attract investments in the sector, it has modified its policies so that developers no longer have to wait for clearance from forest authorities to commence construction. Another supportive policy came from the central bank, which reclassified loans to road builders as secured rather than unsecured loans, which would give more comfort to banks to lend to projects.

The ministry had set a target to approve 30 projects in FY 2013-14 to add a total capacity of 284 million tonnes at an investment of Rs 26000 crore. During the past few months, project awards have picked up pace and a total of 13 project awards (including 5 PPPs) worth Rs 38.31 billion have been made so far, for a capacity addition of 80 million tones. This amounts to about 70 per cent of the total capacity additions awarded in the previous fiscal. However, a large number of project announcements would have to be made during the H2FY14 for the ministry to achieve the targeted capacity addition and investment in the maritime sector.

Road Infrastructure 

The Indian government is very particular about the development and maintenance of India’s huge road network. The number of vehicles in the country has been growing at an average rate of 10.16 per cent per annum over the last five years. Thus, a need for an efficient and world-class road network becomes inevitable for smooth movement of goods and services. India’s road network, spanning across 4.69 million km, is the third-largest in the world next only to the US and China. The country relies heavily on its robust road network that carries almost 65 per cent of freight and 80 per cent of passenger traffic. The government intends to earmark USD 1 trillion for infrastructure development over next five years. To speed up the same, it is also trying to rope in private investments through Public- Private Partnerships (PPPs).

While policy-level tweaks are being implemented to make the sector more investor-friendly, the emergence of new players has made this segment highly competitive, resulting in lower margins for the companies.

Government Initiatives 

Government’s  Road Infra Spend
Year	USD Billion
FY09	6.9
FY10	6.8
FY11	8.3
FY12	8.6
FY13	8.6
FY14	11
FY15	13.4
FY16	16.1
FY17	19.2

The Indian government has been very proactive in implementing new policy measures to give impetus to road infrastructure in the country. The most significant policy change is the departure from the conventional PPP model for such projects. Under the PPP model, developers finance construction out of their own funds, often in exchange for the right to charge toll fares. The government has decided to restore the form of contract where it funds part of the road building, taking on more of the risk of the project itself. This initiative has also attracted foreign private equity players.

The Road Ahead 

Major companies have witnessed some improvement in their order book position. Many of the players in the sector are now focusing on their international order book. Though the margins are lower by around 200 basis points, it provides a consistent cash flow. But the moot question is how the companies manage to maintain the order flow along with sustainable margins. The projects, especially road projects, have been highly competitive and we expect margin erosion to continue in the upcoming two quarters. Interest cost would also remain on the higher side.

Going forward, with the government trying to focus on fast-tracking few infrastructure projects, it is likely that the sector may start picking up. With the authorities and builders increasingly focusing on transit efficiency, India is poised to attain the next level in highways development. Experts believe that public funding or other alternative financial models apart from PPP would be instrumental for attaining the required targets. However, the management of one of India’s largest infrastructure companies maintains, “The efforts from the government are good, however it will take at least two to three quarters to trickle down into our order book”.
[PAGE BREAK]

Mining

Mining forms an important part of India’s core sectors. India has long been recognised as a nation well endowed with natural mineral resources and is ranked fourth among the mineral producer countries behind China, United States and Russia on the basis of volume of production. Thus, it is one of the important sectors in India’s economy and contributes about two per cent to India’s GDP.

The country produces as many as 87 minerals, which includes four fuel minerals, 10 metallic minerals, 47 non-metallic minerals, three atomic minerals and 23 minor minerals. This makes it clear that mining is one of the core sectors that drive growth. Not only does it contribute to GDP, it also acts as a catalyst for the growth of other core industries like power, steel, cement, etc., which in turn, are critical for the overall development of the economy. An analysis by FICCI states that just one per cent expansion in the growth rate of mining and quarrying results in 1.2-1.4 per cent expansion in the growth rate of industrial production and an approximate increment of 0.3 per cent in India’s GDP growth.

However, the contribution of the sector to India’s GDP has been on the wane for the past two decades. While it contributed 3.4 per cent to the country’s GDP in 1992-93, it declined to three per cent in 1999-2000 and further to 2.3 per cent in 2009-10. With the sector contracting in absolute terms in the last couple of years, its GDP contribution has come down to two per cent in 2012-13. 

The reasons behind this fall are quite simple. The sector is reeling under a lethal mix of high borrowing costs on one hand and policy paralysis on the part of the government on the other. Mining projects across the country have been stalled owing to environmental, regulatory and land acquisition issues. Apart from this, the recent scam in the sector (in addition to the ban on a few iron ore mines) dragged the sector down to further lows. 

Overall, issues like regulatory challenges, inadequate infrastructure and unsuitability of projects have resulted in de-growth of the sector. After clocking an average growth rate of 4.8 per cent over the five years between 2006-07 and 2010-11, the sector has witnessed a drop of 0.6 per cent for two consecutive fiscals now (2011-12 and 2012-13). 

Moreover, despite India’s significant geological potential, the country does not rank very high in terms of its mineral resource base among similarly endowed nations. Another concern is related with the role and participation of public v/s private players. As per the National Mineral Policy, 2008, the private sector should have been at the forefront of mineral production, but in reality the public sector continues to play a dominant role, accounting for 68 per cent of mineral production during 2011-12. Clearly, policies and incentives have not been conducive to foster participation of the private sector players. 

There is significant mineral potential that still lies untapped in India, but historically, the mining sector has struggled to exploit this potential on account of three major factors – regulatory and administrative procedures, inadequate infrastructure facilities and sustainability. Within merely two decades of liberalisation of the economy, the sector came to be mired in scams, conflicts, violence and ecological degradation – much in contrast with the constitutional objectives. These challenges have limited the overall investment in mining and exploration activities in the country, as evident from very low inflow of FDI in this sector. India’s spend on mineral exploration is less than 0.5 per cent of the global spending on the same in 2010, much below its fair share given the size of the mineral resource potential.

Given this unutilised potential, the Ministry of Mines, Government of India, has targeted significantly higher share of GDP from mining. It aims to increase share of mining and quarrying in the GDP from current two per cent to five per cent over the next 20 years. This requires mining to grow at 10-12 per cent per annum.

To bring back the sector on track, India needs to tackle regulatory challenges like ambiguity on transfer of mining lease, lack of a transparent allotment system and delays in approvals. The issues related with inadequate infrastructure also need to be addressed in terms of connecting remote areas and railway connectivity. Last but not the least, the unresolved policy issues are the major roadblock. If these problems are addressed, we feel that the mining sector may witness a comeback in the next few years.

Mineral	Current Reserves (Mn Tonnes)	India's Ranking	Reserve Life (Years)
Coal	113000	4	187
Limestone	12715	-	55
Iron Ore	7000	7	47
Bauxite	900	6	66
Barite	34	2	30
Chromite	66	3	24
Zinc Metal	11	7	8
Manganese Ore	138	5	47
Lead Metal	3	7	26
Copper	4	-	9
Aluminum	2.3	5	-
Source: Ministry of Mines, Government of India, US Geological Survey
Goldman Sachs & Morgan Stanley Metals Playbook

[PAGE BREAK]

Oil & Gas

If you have to name one sector that has the maximum impact on the Indian economy in terms of both operational and fiscal efficiency, it would be Oil & Gas. In fact, in the last couple of years, the Indian economy is really feeling the heat due to some persistent issues in this core sector. As a nation, India does not have as much clout on world affairs as to wield control on the factors that affect the global oil and gas scenario. Being an energy starved country, importing more than 70 per cent of our oil and gas requirement, we have to withstand a host of pressures from outside, be it price spurts or supply shortages. 

The present scenario is quite subdued. Of the 211.42 MT of crude oil consumed during FY12, we have just produced 38.09 MT of crude domestically and 172 MT of crude was imported. What was more disturbing was that in spite of every effort, Indian crude oil production saw a CAGR of just 4.18 per cent, while consumption jumped by six per cent. This state of affairs clearly necessitates immediate corrective action. 

Higher Natural Gas Prices: Lending A Boost 

With a production of 101 mmscmd of gas in FY13 against a demand of 243 million standard cubic feet per day (mmscmd), India’s gas production scenario is particularly disturbing. On the supply side, just 146 mmscmd of gas was available, out of which around 45 mmscmd was expensive imported LNG. The current cost of imported LNG is between USD 12-14 per unit. With gas demand slated to move up to 517 mmscmd by FY22, significant efforts and funds are required to boost production. 

This area presents a very big opportunity for the players both in the private and public space. The current price of gas is USD 4.2/mmbtu, but as per the Rangarajan Committee recommendations, the government has finalised doubling the price to around USD 8.4/mmbtu from April 2014. This would certainly be a booster for companies like ONGC, OIL and Reliance Industries.

Today, ONGC and OIL have a cumulative production of around 26 billion cubic metres (BCM) of natural gas annually and are selling that gas at Administered Pricing Mechanism (APM) price. On the other hand, RIL along with its international partner BP, holds an estimated 4 tcf of gas reserve in the KG-D6 block. Though its cur- rent production is declining continuously, it holds the potential to become a real game changer for RIL as both the companies are planning to invest USD 5 billion in this space in the coming years. Experts are of the opinion that if the gas price of USD 8.4/unit becomes a reality, then this space would see an investment of more than USD 15 billion from both domestic and international players.

Companies like GAIL are reeling due to non-availability of gas, as the realisations are continuously declining and its PAT is evaporating very fast. “The decline in our PAT and gas volumes is due to the lower supply of domestic gas from the D6 block of the KG basin. But I think that the decline in PAT has bottomed out and in the coming quarters we will see some improvement in profits”, shares B C Tripathi, CMD, GAIL.

Diesel Subsidies To Be Passé

Today, the biggest problem for the sector is the subsidy burden that oil companies have to bear. During FY13, the overall subsidy was at Rs 161029 crore. Due to the sudden decline in the rupee and increase in crude oil prices in the international market, this is estimated to soar to Rs 140000 crore for the current fiscal in spite of the deregulation process started by the government a year ago. Over the years, both upstream and downstream oil companies are expected to be acutely affected by this problem.

Under-recoveries On Petroleum Products (Rs/Cr)
Particulars	2010-11	2011-12	2012-13	2013-14 (E)
Petrol	2227
Diesel	34706	81192	92061
PDS kerosene	21772	29997	29410
Domestic LPG	19484	27352	39558
Total under-recoveries	78190	138541	161029	140000
Burden sharing
Government	41000	83500	100000
Upstream companies	30297	55000	60000
OMCs	6893	41	1029
Total	78190	138541	161029
Source: Ministry of Petroleum and Natural Gas

In FY13, ONGC, Oil India (OIL) and GAIL have contributed Rs 60000 crore towards subsidy discounts and during the first half of current year the subsidy burden is already more than that of last year. ONGC, the biggest oil producer of the country, has paid Rs 26418 crore during first half. Sudhir Vasudeva, CMD ONGC explains, “We have paid Rs 49421 crore last year, and at the current rate, the figure will already go to more that Rs 52000 crore this year. If the government wants us to pay more, then we have been forced to pull Rs 5000 crore from our cash reserves to meet our operational expenses. That situation would certainly be very troublesome for us”.
[PAGE BREAK]

The government is well aware of the gravity of this situation and seems intent upon deregulating at least diesel, which was the main culprit, cornering Rs 92061 crore worth of subsidies in FY13. Union Minister for Petroleum and Natural Gas, Veerappa Moily has set a deadline of six months to fully deregulate diesel as against the 50 paise increase happening on a monthly basis for the past one year. Currently, oil companies are suffering an under- recovery of about Rs 9.28 per litre of diesel, while that for LPG and kerosene is at Rs 482 per cylinder and Rs 35 per litre respectively. If complete deregulation of diesel indeed takes place, it will certainly help oil companies.

The government also seems very sensitive towards the financial health of companies like GAIL and spared at least this company from the subsidy burden owing to its very nature as a gas transporter. “I think for us, a major game changer would be the subsidy burden that is capped at Rs 1400 crore by the ministry owing to the representation made by GAIL. GAIL is demanding to be spared from sharing the subsidy burden with ONGC and Oil India as it is not a typical upstream company but just a transporter of gas”, Tripathi explains.

Deregulation coupled with a strengthening rupee would certainly be a boon for the sector. The declining rupee has seen oil marketing companies take a huge hit in the form of forex losses and the interest burden due to late release of cash subsidies to OMCs. Indian Oil (IOC) alone was hit by an exchange loss of Rs 2158 crore during the quarter while it has absorbed Rs 413 crore of diesel subsidy. The company’s net profit in Q2 declined by a whopping 82.5 per cent due to insufficient subsidy payment by the government. On similar lines, BPCL and HPCL’s net profits also declined by 81.5 per cent and 86 per cent respectively.

A Bright Future 

As per the EIA, India had 43.8 tcf of natural gas reserves at the end of 2012, and if policies are made and implemented in conducive manner, it can alter the oil and gas scenario of the country. In fact, overseas giants like BP also believes that proper planning can bring about a sea change. 

As for oil, companies like Cairn India can receive the advantage of full scale production starting to come in from the Rajasthan fields. The company’s crude oil production reached 213300 barrels of oil equivalent per day (boepd) during Q2, marking an increase of 0.4 per cent on a QoQ basis, and expects production to reach 225000 boepd by the year end.

Upstream companies are getting into unconventional energy sources like shale gas, coalbed methane and deep water drilling that can provide them with good growth in the time to come. Already, the Government of India has approved the shale gas policy, which is expected to boost further investment in the sector and also help the country to become self sufficient in oil and gas production. Apart from this, with deregulation in diesel prices, companies like RIL, Essar, ONGC, etc. are looking to get into retail, which can bring them additional revenue. 

Companies like ONGC and OIL have been given enough power to acquire oil equity abroad, and they have been benefited by it. ONGC Videsh (along with OIL) has recently acquired a big stake in Mozambique for USD 5.12 billion and already a sizeable amount of the topline and bottomline is coming from overseas operation. In fact, it has acquired around USD 11 billion worth of over-seas assets in the past one year. “By 2030, we want get to a production level of 130 MT. Of this, 70 MT will come from domestic production and 60 MT from overseas”, Vasudeva says. 

Considering all of this, upstream companies can certainly be a good investment on a long-term basis.

The Milestone Iran-US Deal

The recent historic Iran-US deal an prove to be a big boost for IOL and gas sector. The deal will have a great effect on sentiments across the globe, and immediate impact would come in the form of softening of international crude prices. As per the estimates, it will certainly help in dragging oil prices by five to seven per cent, and for every dollar’s decrease in crude price, the subsidy burden will decline by more than Rs 4000 crore.

Due to sanctions, India had curtailed its oil imports from Iran to 11 MT in the current fiscal from 21 MT earlier. With the sanctions vanishing, the old volume can certainly be a reality in the next six months, that too in rupee terms. This can be of great help to our energy-starved nation. The deal will also facilitate the import of oil from Iran, as it will solve the insurance crisis for Iranian cargo. The Rs 2000 crore Energy Insurance Pool (EIP) that Indian refiners had made (as European companies did not provide reinsurance cover to Indian companies on the cargo coming from Iran) will also not be required any more. These factors will certainly help to increase imports from Iran.

Certain groups of people are more enthused by this deal as they are mulling the revival of Indo-Iran gas pipelines via Pakistan (a pipeline till Pakistan is already available). The Indian government and business delegations are will visit Iran in the near future to discuss the prospects of 5 MT of LNG imports, gas pipelines, stake purchase in oil and gas blocks in Iran, swap deals, etc.

All in all, it seems sensible to invest in stocks of Oil & Gas companies on a long-term basis. Companies like Cairn India, RIL and ONGC look particularly attractive as new developments are in the offing. Considering the gas requirement in the country, LNG importer Petronet LNG also looks very attractive on a mid-term basis.
[PAGE BREAK]

Power

It is always been said that one sector that can make or break India’s dream of becoming an industrial and financial powerhouse would be the power sector. In spite of many shortcomings and roadblocks, this sector managed to fare well enough in the past decade. Its performance during the 11th Plan was particularly impressive, with capacity addition of around 55000 MW as against the revised target of 62000 MW, taking the overall capacity to 193000 MW. The USP of this performance was the strong show put up by the private sector, which accounted for 30 per cent of the capacity addition at 18000 MW. 

Buoyed by this performance, the Government of India set another ambitious target for the 12th Plan at 76000 MW. For this, it is estimated that over Rs 13 lakh crore would be needed for generation, transmission, distribution, R&D, captive power plants, renewable projects and maintenance of existing power plants. This presents a huge opportunity for the power companies, as with the growth of the economy, India would require more and more power, and to meet this demand the power sector would have to do well. 

Industrial Demand A Dampener 

Despite a robust performance during the 11th Plan, the power sector is reeling particularly due to the shortage of demand owing to the slackening pace of growth. With the country is witnessing a slowdown and GDP slated to remain around five per cent, power sector has started experiencing a slowdown in the demand for power. 

During Q2FY14, the demand for power rose by around five-six per cent but the supply increased by more than eight per cent during this period owing to capacity addition by the companies. This put pressure on the generation companies, which were already reeling under supply-side issue of coal and gas, expensive overseas coal and high interest cost. “It is right that owing to the drop in demand upto now, the generation losses for NTPC were also huge, i.e. around 22-25 per cent. But let me tell you that the better part for NTPC is that our financial numbers don’t change due to generation losses”, explains Arup Roy Choudhury, CMD, NTPC.

Experts are of the opinion that the drop is a temporary phenomenon, and as demand picks up, it will again boost the fortune of power sector as the Indian economy would certainly bounce back to eight-nine per cent growth. At such growth levels, the Plant Load Factor (PLF) of generation companies would automatically reach around 75 per cent. Due to languishing demand, this has come down drastically to 64 per cent in the first half of FY14 from 70 per cent during the corresponding period last year. Thereby, capacity utilisation is coming down on one hand, and on the other, demand is declining from the most lucrative segment, i.e. industry. Industry contribution to total consumption has dropped from 62 per cent to 44 per cent during first half on a YoY basis. 

Improving Fuel Supply Situation 

The biggest worry for the power sector is the fuel supply constraint, be it coal and gas. Many power plants are experiencing pressure due to inadequate supply of coal from domestic vendors, particularly Coal India. As a result, they are compelled to resort to imported coal, which is expensive and of lower quality. Last year saw the tussle between CIL and the biggest generator of the country, NTPC, over supply issues, but this situation has improved now and would improve further in future. “Today, CIL is giving us 140-145 MT of coal and we are looking at 160-165 MT of coal from them by the end of the 12th Plan. By the end of 12th Plan we would need 220-230 MT of coal. So, from that perspective we would need just 20-30 MT of imported coal”, informs Arup Roy Choudhury. 

The government may also allow companies to sell captive coal to other companies working in steel, power and cement, as the panel headed by Planning Commission member B K Chaturvedi recommended recently. This will certainly be a booster for the sector and improve the coal supply going forward. During FY13, India imported 141 MT of coal at a staggering USD 16 billion, while the deficit was at more than 200 MT. 

The situation on the gas front is even worse, with domestic gas output declining fast. During FY13, the country produced 101 mmscmd of gas, while the demand was at 243 mmscmd. Another catch came in the form of gas pricing. This is currently at USD 4.2/mmbtu, but the government has approved a price hike to USD 8.4/ mmbtu from April 2014. This would make power generation through gas plants totally unfeasible. “If you ask me then even at USD 4.2 per unit price of gas, I and finding it hard to sell the power so what will happen at USD 8.4 per unit we all can assess”, remarks Choudhury.

Today, more than 16000 MW of capacity is sitting idle due to non-availability of gas. The fate of these plants is to be decided by the government. The government is planning to go for gas pooling with imported LNG to help these power plants, and companies are hopeful that something would be done on this front soon.

Capacity Commissions To Help 

On one hand, power plants are sitting idle and there is drop in demand. On the other, the interest cost for companies is on a roll, as they have taken huge debts to set up capacities. Interest cost for almost all power generation companies has gone up drastically during Q2. The interest cost for companies like Adani Power, NTPC and Jaiprakash Ventures has gone up by 287 per cent, 104 per cent and 24 per cent respectively, eating into their profits. 

Though the total income for the sector has jacked up marginally by 0.41 per cent, but the other parameters remained sluggish during Q2FY13. Its net declined sharply by 34 per cent to Rs 4104.05 crore from Rs 6239.17 crore last year. The gravity of the situation can be gauged from the fact that the PAT margin also came done from 16.83 per cent to 11.02 per cent, while the interest cost has appreciated by 69 per cent. This situation is certainly alarming, but as the economy improves and the demand for power picks up, higher revenues would relieve companies of this burden.

CERC’s Recommendations May Play Spoilsport

Recently, the Central Electricity Regulatory Commission (CERC) has come out with a regulation draft regarding tariffs for the period 2014-19. It is being said that if these recommendations are accepted, it will spell doom for the power generation companies. These regulations would help to bring down tariffs for consumers but would hurt power companies as they will change many factors related with efficiency. First in question is the proposed regulation of giving incentives on the basis of Plant Load Factor (PLF) instead of the Plant Availability Factor (PAF). PAF is a measure of the actual capacity available for generation, while PLF is the power generated daily. If this suggestion is taken up, generation companies will face losses – in spite of having capacity, if they don’t produce electricity due to lack of demand from state discoms, their PLF will go down and they will lose valuable incentives. Companies like NTPC augment capacities by forecasting the demand of a particular area. In such cases, if the state government does not want to purchase power owing to scarcity of funds, the generation companies will be the losers in the bargain. 

Another important factor is the impact of tax arbitration. It is beneficial for the consumer, but is going to impact the income of power generators. Presently, companies can charge the applicable tax from the consumers even if they pay lower tax due to various exemptions, incentives and depreciation. Now, companies can only charge tax that they have actually paid. This will lead to crores in losses for generation companies. NTPC alone is estimated to lose Rs 500 crore on account of this. 

In addition to this, the incentive on account of efficiency in terms of heat rate will also go down as per the proposed recommendations. 

Arup Roy Choudhury, CMD, NTPC maintains, “One needs to understand that it is just a draft notification and not the final order from the regulator. We are studying the same. Prima facie, we find positive changes. We will put our stand before the CERC as this paper is under discussion. We would like to assure our investors of continued returns and thank them for their support”.
[PAGE BREAK]

Steel

After recording double-digit growth in FY11 and FY12, growth in the steel sector plunged to a mere 2.5 per cent in FY13. One of the prime reasons for this was the slow-down in the end-user industries due to deceleration in the Indian economy, which nearly halved from 9.3 per cent recorded in FY11 to five per cent in FY13. Steel consumption growth has an elasticity of about little more than 1 to GDP growth, and thus, the fall in GDP growth has clearly led to the slump in the demand for steel. 

Beside this factor, the external environment too was not very conducive for the steel sector to grow. The Euro zone is still struggling to stabilise, the US is staging a recovery slower than the earlier post-crisis period and overcapacity in the Chinese steel industry is preventing a rise in steel prices. 

Nevertheless, the situation is expected to improve on all fronts from here on. GDP growth for second quarter of FY14 came at 4.8 per cent on yearly basis, which was higher than the consensus of 4.6 per cent and 4.4 per cent in the preceding quarter. This shows that growth has bottomed out in Q1FY14. Underscoring this is industrial growth, which improved to 2.3 per cent in Q2FY14 against 1.3 per cent in Q2FY13, helped by a rise in manufacturing and construction. This also indicates that the worst is over for the end-user industries of steel, and hence, the demand may pick up going ahead. This will be further aided by a substantial number of clearances given by the Cabinet Committee on Investment (CCI) to large projects.

Of course, some may argue that it is not clearances but the implementation of such projects that will really lift the demand for steel and other commodities. For the smooth implementation of projects, the Prime Minister’s Project Monitoring Group will now start supervising the implementation of as many as 99 infrastructure projects, with investments worth Rs 3.6 lakh crore already cleared by it. According to the Institute For Steel Development & Growth, Indian steel consumption growth has an elasticity of about 1.1 to growth in GDP, and as the growth picks up from here on, it will revive domestic steel consumption.

In addition to these, there are also other factors which will help domestic companies to expand the demand for their products by increasing their footprint in the international market. First, the sharp depreciation in the rupee against the major currencies is improving Indian steel companies’ competitiveness in the world market. This can be gauged from the sharp decline in steel imports. In the first quarter of FY14, steel imports have declined by 34.1 per cent whereas exports increased by 12.7 per cent. The trend has continued in the recent months too, and many experts are projecting a 25 per cent jump in steel exports in FY14.

The situation in the exporting countries is also picking up. In Europe, for example, the consumption of steel is set to increase. In the month of October 2013, steel consumption in Europe grew at a rate of 6.8 per cent on a yearly basis, which was better than the previous two months and negative growth in the first seven months of CY13. In other important development, China plans to cut 80 MT of steel production by 2017 to tackle pollution. Out of this, 40 MT will be closed by next year alone. If we look at the demand-supply situation in China, it had an excess capacity of 39 MT in the year 2012. Therefore, the closure of steel plants will definitely help in reviving steel prices globally and in India as well. 

Apart from this, we are also witnessing improvement in the availability of raw materials for steel companies in India. With the Supreme Court of India allowing iron ore mining to resume in Category ‘A’ and Category ‘B’ mines in Karnataka, availability of this key raw material is expected to improve going forward. However, the situation is not as optimistic with respect to coking coal, another important raw material used in the steel industry. India imports almost 60-65 per cent of its coking coal requirement, as the domestically available stock has high ash content and is not suitable for steel industries. The fall in prices of coking coal in the international market by around 10 per cent in the last few months has been largely offset by the fall in the value of the Indian rupee. 

Overall, the impact of the falling rupee is clearly reflected in the performance of steel companies. On an aggregate basis, the topline of steel companies increased in single digits on a yearly basis in Q2FY14. This increase was despite week steel prices and was largely helped by the higher volumes. Profitability in the same period improved due to the fall in raw material prices as a percentage of sales. 

The first half of FY14 was marked by poor domestic demand and realisations in the sector. However, we believe that this is going to change in the second half, which is typically better for steel companies. The factors mentioned above will definitely help this sector to regain its sheen.

Total Finished Steel (Alloy and Non-Alloy)
Year	Production  For Sale	Import	Export	Consumption	GDP  Growth Rate
2007-08	56.08	7.03	5.08	52.13	9.3
2008-09	57.16	5.84	4.44	52.35	6.7
2009-10	60.62	7.38	3.25	59.34	8.6
2010-11	68.62	6.66	3.64	66.42	9.3
2011-12	73.42	6.83	4.04	70.92	6.1
2012-13	56.72	5.79	3.78	73.3	5
Source: Joint Plant Committee, a body under the Steel Ministry

[PAGE BREAK]

Telecom

It was supposed to be a sunrise sector that ushered a communication revolution in India across the urban as well as the rural areas. But it got mired into various troubles both regulatory and operational and lost its coveted position. Nonetheless, in the last couple of quarters things are turning around for good for the sector. 

Regulatory troubles are one of the prime reasons why the sector has underperformed in the last few years. Nonetheless, recent developments such as reduced spectrum costs, relaxation in M&A norms, flexible payment mechanism for future spectrum costs, as well as spectrum sharing and trading will help the sector get over the regulatory uncertainty going forward. 

The minutes of usage (MOU) over the last five years (FY08-13) in India had grown at a CAGR of 26 per cent. This growth was driven by deep cut in tariffs due to a highly competitive environment, aggressive subscriber acquisitions that resulted in multi- SIM usage and increase in network coverage to reach rural areas by incurring huge capex. However, such growth has largely been margin dilutive for the companies. For example profit margin of Bharti Airtel, has shrunk from 22.31 per cent at the end of FY07 to 2.83 per cent at the end of FY13. 

Nonetheless we now see structural improvements in the way new subscribers are being added, which is accompanied by reduction in marginal costs of acquiring new subscribers. Commission cuts, stringent subscriber verification norms and fewer subscriber churns are helping companies to control costs. In addition to the lower cost structure, higher penetration and network coverage will lead the future growth of this sector. It will primarily come from rural areas where the teledensity is still at 41.7 compared to 144.02 for the urban areas at the end of September 2013. What will also help increase teledensity in rural areas is the normal monsoon that has in past helped to add new rural subscribers. Exit of some of telecom players like Aircel, Uninor, etc from various circles will also help incumbents to increase their MOU. It is estimated that 30 per cent of the FY14 incremental minutes will come from these exits. 

Consolidation in the sector has again put the power of pricing in the hands of the operators. There have been a couple of rounds of tariff hikes in certain circles and more hikes are expected in the near to medium term. We already see benefits of that as average revenue per minute (ARPM) improved in Q2FY14 to Rs 0.44 per minute from Rs 0.42-0.43 in FY13 for the top four operators. The operating leverage benefit is immense for companies from such tariff hikes. For example each Rs 0.01 improvement in revenue per minute translates to an increase of 6.6 per cent in EBIDTA for Idea Cellular. With the lowest tariffs in the world, we see a lot of scope for improvement in the performance of companies, especially with the return of pricing power. 

The next round of growth for the sector will come from the data proliferation, which is still at infancy in India and is expected to grow in lower teens for the next couple of years. For FY13, data contribution to the entire revenues formed a mere seven per cent, which is likely to grow at 12-13 per cent by FY15, according to Fitch ratings. The increasing data revenue contribution is also margin accretive. 

All the above factors are definitely going to help the sector to fight other bigger problems under which it was reeling for a while; the main being the debt levels. Indian telecom companies have seen a significant increase in their debt levels since March 2010 and those remain at elevated levels. For example RCom saw its debt to equity ratio doubling since FY10 to 1.11 in FY13. Nonetheless, generation of better free cash flows going forward will help companies to repay and manage their debt. Therefore, we believe that FY14 will prove to be a turning point for the telecom sector and investors should not be missing this call.