Reliance, HLL, SAIL result analysis

QUARTERLY RESULT ANALYSIS: June 2004

RELIANCE
Growth in refining margins propels profits

Reliance Industries' net sales growth of 14.23 per cent and net profit growth of 30.16 per cent were slightly below Street expectations. Profits were primarily propelled by strong growth in refining margins and a surge in petrochemical prices. 

Reliance Industries
(Rs crore)	Q1 FY05	Q1 FY04	% change
Net sales	14280.00	12501.00	14.23
Other income	347.00	187.00	85.56
Operating profit	14627.00	12688.00	15.28
OPM (%)	102.43	101.50	-
Net profit	1437.00	1104.00	30.16
Net margin (%)	10.06	8.83	-
EPS (Rs)	10.30	7.90	-
Trailing 12-month EPS			39.55
Price-earnings ratio			12.36

• Petrochemical sales were up 17.33 per cent as polyester demand grew smartly (19 per cent) and domestic realisation in plastics and polyester intermediaries continued to rise. The growth in polymer demand was flat. Prices of polyester remained lacklustre while that of naphtha stood firm. Margins improved in polyester intermediaries and plastics.
• Domestic demand for petroleum products increased during the first quarter, showing a nearly double-digit growth of 9.5 per cent against a drop of about 2.7 per cent during the same period last year. Thus, the company processed 7.91 million tonnes of refining throughput - 96 per cent of its de-bottlenecked capacity (33 mt per annum) or 118 per cent of its nameplate design capacity (27 mt per annum).
• Refining gross sales were up 29 per cent while profit before interest and tax was up 39 per cent. Refining margins were substantially higher at $7 per barrel - roughly 40 per cent higher than the corresponding period last year despite a third of the company's refining throughput being exported.
• Reliance has been slow in ramping up its retail network. As against earlier plans to set up 400 retail outlets by July, the company has set up 100, and plans to expand its network to 2000 outlets by the end of FY05.
• The company sold about 2 mt to PSUs against 3 mt in the same quarter last year. Analysts say the ramp-up in retail network is a function of the domestic demand for petro products which will determine how much PSUs would be willing to buy from Reliance. This, in turn, will decide how much effort the company need to put in to increase exports which fetch lower margins.
• Reliance's infocom business has reported sales of Rs 1,100 crore, EBIDTA of Rs 127 crore and a net loss of Rs 98 crore. The company has till now invested about Rs 10,400 crore in its infocom business and no further investments are to be made.
• Incidentally, the 85.56 per cent jump in other income reflects the interest/premium on investments in preference shares of Reliance Infocomm, according to analysts.
• The company has not taken central sales tax (CST) credit for the first quarter in line with the government's policy of discontinuing the benefit from this fiscal. However, it has not reversed the CST credit of about Rs 350 crore taken last fiscal, which the Budget had not provided for. The company says talks are on with the government but no decision has been taken yet.

With global demand growth outpacing supplies and no capacity additions being planned for the next couple of years, petrochemical margins are likely to be buoyant.

Also, despite high international crude prices, refining margins have been robust across the globe as product prices kept pace with crude prices. Analysts are bullish on the stock, given that the company's two key businesses have seen strong growth momentum. The stock is trading at 10x FY05 earnings, making it fairly attractive.

HLL
Topline stagnates while margins slip

FMCG behemoth HLL posted disappointing numbers for the June quarter. Topline slipped 4.79 per cent to Rs 2,571.64 crore while PAT slipped 45.78 per cent to Rs 244.49 crore. Margins were another casualty with operating margins plunging over 63 basis points and net margins falling over 700 basis points. Interest outgo increased manifold to Rs 31.75 crore from Rs 1.31 crore.
 

HLL
(Rs crore)	Q1 FY05	Q1 FY04	% change
Net sales	2571.64	2700.97	-4.79
Other income	70.26	98.61	-28.75
Operating profit	318.89	506.86	-37.09
OPM (%)	12.40	18.77	-
Net profit	244.49	450.93	-45.78
Net margin (%)	9.51	16.70	-
EPS (Rs)	4.44	8.19	-
Trailing 12-month EPS			6.64
Price-earnings ratio			17.49

This, along with a 28.7 per cent drop in other income and extraordinary expenses of Rs 11.9 crore due to losses on disposal of the company's mushroom undertaking and a VRS, contributed to the fall in PAT.

• Though raw material costs slipped 2.67 per cent, as a percentage of sales they increased 119 basis points. Advertising and promotional expenses jumped 30 per cent (266 basis points as a percentage of sales).
• Revenues from the soaps and detergents segment slipped 2.86 per cent to Rs 1,177.63 crore. EBIT margins in the segment shrunk drastically to 14.54 per cent from 23.8 per cent, mainly due to the price war initiated by rival P&G.
• Revenues from the personal products division increased 5.17 per cent to Rs 636.76 crore. EBIT margins of the division witnessed an almost 350 basis points dip. However, the company's ice cream division delivered a 120 basis points jump in EBIT margins.
• HLL's foods business witnessed a 16 per cent slippage in revenues to Rs 82.23 crore while export revenues grew 3.8 per cent to Rs 333.82 crore. However, EBIT margins in exports fell 190 basis points.

HLL declared Rs 2.5 per share as interim dividend for FY05. The stock trades at Rs 116.2 at a P/E of 17.49. Though the results were disappointing, analysts say the company had to push its products through enhanced advertising which took a toll on margins.

While margins may continue to be under pressure in the short term, the price war is not expected to continue for a very long time. Analysts feel that investors may look to buy the stock at declines. They peg an EPS of Rs 7 for FY05.

SAIL
Firm steel prices boost profits

SAIL reported a 336.45 per cent rise in net profit for Q1 FY05, which is the highest ever profit reported by the company in any quarter since inception. Net profit surged to Rs 1,111.59 crore compared with Rs 254.69 crore in Q1 FY04. The company's net sales stood at Rs 5,270.87 crore, up from Rs 4,252.82 crore, an increase of 23.94 per cent.

According to analysts, the improved performance has come mainly on the back strong realisations owing to firm steel prices. According to the company, other factors like a reduction in proportion of semis by 11 per cent, higher sales of value-added products from integrated steel plants, a 1 per cent reduction in energy consumption and a 171 per cent increase in project supplies also helped it put up the impressive show. 

SAIL
(Rs crore)	Q1FY05	Q1FY04	% change
Net sales	5270.87	4252.82	23.94
Other income	56.17	25.85	117.29
Operating profit	1614.89	773.65	108.74
OPM (%)	30.64	18.19	-
Net profit	1111.59	254.69	336.45
Net margin	21.09	5.99	-
EPS (Rs)	2.69	0.62	-
Trailing 12-month EPS			6.09
Price-earnings ratio			6.40

• Domestic steel prices were higher by about 25-30 per cent during the quarter which resulted in a significant improvement in realisations.
• SAIL's operating margins stood at 30.64 per cent compared to 18.19 per cent in Q1 FY04, thanks mainly to the company's high operating leverage and control over expenditure heads.
• The company's operating efficiency was reflected in the rise in net profit, which was also aided by a big spurt in the other income component (117.29 per cent) and a 29 per cent reduction in interest expenses. Lower interest expenses were attributed to the company's efforts to control its debt burden by restructuring existing high-cost debt with lower interest-bearing instruments.
• SAIL lowered its debt by Rs 960 crore during the quarter, resulting in an improvement in the debt-equity ratio to 1.33:1 compared to 1.86:1 at the end of the March quarter.

The company is planning to increase its hot metal production by 1 million tonnes to 13 million tonnes in the short-term by de-bottlenecking. According to analysts, SAIL is expected to post higher sales volume going forward, on the back of the continuing upturn in the steel industry.

However, they caution that future performance will depend on the sustainability of international steel prices. Though the scrip is thought to be attractively placed at a P/E of 6x, at current levels of Rs 38, analysts point out that risks are higher, considering the fact that the company is a PSU.

MARUTI UDYOG
Improvement in operating margins lifts profits

Maruti Udyog reported handsome numbers for the June quarter with its revenues growing 23.84 per cent to Rs 2,527.57 crore and net profit surging 42.09 per cent to Rs 170.92 crore over the year-ago period. The performance was largely due to an improvement in operating margins and a reduction in interest expenses.

Sales volume was higher by 18.85 per cent. Sales of the company's bread and butter model, Maruti 800, declined 22 per cent. However, it was more than compensated by a robust 80 per cent growth in other offerings such as Alto, Wagon R and Zen. 

Maruti Udyog
(Rs crore)	Q1 FY05	Q1 FY04	% change
Net sales	2527.57	2040.99	23.84
Other income	88.89	66.88	32.91
Operating profit	306.74	197.84	55.04
OPM (%)	12.14	9.69	-
Net profit	170.92	120.29	42.09
Net margin (%)	6.76	5.89	-
EPS (Rs)	5.06	4.77	-
Trailing 12-month EPS			20.52
Price-earnings ratio			20.69

• Improved product mix and cost savings have seen the company's operating margins improve by a strong 244 basis points. Staff costs fell 21.77 per cent to Rs 46.07 crore while raw material costs and other expenditure rose 23.35 per cent and 10.61 per cent respectively. However, as a percentage of sales these expenses declined.
• Depreciation and tax outgo increased steeply by 46.47 per cent and 85.37 per cent respectively. However, interest outgo reduced by 17.32 per cent.

The stock is currently trading at Rs 424.60, implying a P/E of 20x on annualised Q1 FY05 earnings. Analysts say long-term prospects of the company look attractive given the strong growth expectations in the auto sector.

The company's leadership position in the entry level segment, which accounts for the bulk of the passenger cars sold in the country, is a big positive. The company has also started working on a diesel engine plant to tap the diesel car market.

This is expected to augment growth. However, factors such as interest rate hikes, rise in fuel prices and deficient monsoons may cloud the outlook for the near term.

PATNI COMPUTER
Forex loss, salary hikes weigh down margins

Patni Computer Systems recorded a 10.41 per cent sequential growth in PAT to Rs 61.81 crore, backed by a 17.27 per cent jump in revenues to Rs 3,66.75 crore in the June quarter. The company attributes the surge in revenues to better utilisation of resources, an improvement in realised billing rates and increased billing volumes.

However, a greater-than-proportional rise in expenditure weighed down margins. Operating income was also impacted by the forex loss incurred during the quarter. Other income rose 43.43 per cent to Rs 5.68 crore as Patni derived the benefit of an expanded corpus under management following the conclusion of its IPO.

• Operating margins slipped 278 basis points while net margins fell over 100 basis points. SG&A expenses increased 7.4 per cent to Rs 65.05 crore. However, as a percentage of sales, SG&A expenses reduced to 17.7 per cent from 18.3 per cent.
• Cost of revenues increased 12.4 per cent to Rs 212.81 crore. The increase in direct costs was largely due to the annual salary revision that lifted offshore resource expenses. Following the increase in salaries (which are a large component of direct costs) cost of revenues increased to 58.0 per cent of revenues from 57.1 per cent.
• The company incurred a foreign exchange loss of Rs 8.55 crore compared to a gain of Rs 1.42 crore in the preceding quarter due to the sharp depreciation of the rupee.
• GE contributed 33.4 per cent of operating revenues compared to 36 per cent in the preceding quarter. Non-GE business expanded 15.2 per cent.
• Fixed-price contracts contributed 44.1 per cent to revenues compared with 47.3 per cent. Some of the reduction in the contribution from fixed-price business can be attributed to the shift in concentration of GE business, which accounted for a significant proportion of fixed-price projects.

Over the longer term, Patni expects to operate in an operating margin band of 17-19 per cent. Any surpluses over that level will be re-invested in creating resources that would support the company's long-term growth objectives. The stock is trading at Rs 298.85.

Analysts say the growing proportion of non-GE business augurs well for the company. They are hopeful that the company should not have much trouble sticking to its margin targets.

TATA POWER
Better fuel mix improves EBIDTA

Tata Power's first-quarter results were marginally better than analysts' expectations. The company posted a 15.53 per cent growth in its operating profits to Rs 369.78 crore, mainly driven by a better fuel mix. Tata Power has improved its fuel mix by replacing high-cost liquid fuels with coal, leading to lower costs. Fuel costs in the quarter were 1 per cent down to Rs 512.9 crore.

• The company posted just a 0.53 per cent increase in net sales to Rs 1,086.85 crore but operating margins expanded by around 450 basis points on the back of cost-cutting initiatives and operational efficiencies.
• The power generation business saw an impressive growth in volumes - up 12.7 per cent to 3373 million units. However, revenues from the business posted a marginal decline of 0.7 per cent to Rs 1,039.26 crore as tariffs were lowered by 9.2 per cent by MERC (Maharashtra Electricity Regulatory Commission) from June 1 , 2004.
• Realisations have been lower due to lower tariffs and a better fuel mix (a better fuel mix lowers costs and benefits are passed on to customers).
• Net profit reported a menial 2.22 per cent increase to Rs 101.64 crore mainly due to a deferred tax charge of Rs 19.95 crore.

Analysts expect Tata Power to perform well considering its move towards attaining a better fuel mix and improving operational efficiency. Going forward, they expect the company to post earnings of Rs 22 for FY05. Given the current price of Rs 264.15, the stock currently trades at a P/E multiple of 11 times its Q1 FY05 earnings.

STATE BANK
Lower treasury income hits performance

The biggest bank in the country posted results below analysts' expectations. However, the reason for the lacklustre performance was not very much of a surprise - falling treasury income which resulted in an 18.03 per cent decline in operating profits to Rs 2,071.4 crore (operating margins fell around 400 basis points). Profits from sale of investments plummeted a whopping 81.6 per cent to Rs 149.94 crore. 

State Bank of India
(Rs crore)	Q1 FY05	Q1 FY04	% change
Interest income	7666.57	7770.26	-1.33
Interest expended	4712.50	5085.58	-7.34
Net interest income	2954.07	2684.68	10.03
Other income	1538.72	1752.94	-12.22
Operating profit	2071.40	2526.94	-18.03
OPM (%)	22.50	26.53	-
Net profit	1058.40	900.36	17.55
Net margin (%)	11.50	9.45	-
EPS (Rs)	80.00	68.00	-
Trailing 12-month EPS			72.93
Price-earnings ratio			3.50

• A rise in net interest income was not enough to offset the impact of the fall in profits from investments. Net interest income rose 10.03 per cent to Rs 2,954.07 crore, fuelled by a 7.34 per cent fall in interest expended to Rs 4,712.5 crore. The fall in interest expended can be attributed to a dip in cost of deposits to 5.42 per cent from 6.6 per cent.
• Net profit rose 17.55 per cent to Rs 1,058.4 crore due to lesser provisions made by the bank in the quarter (provisions were 37.7 per cent less at Rs 1,013 crore). Consequently, net margins improved to 11.5 per cent from 9.45 per cent.
• Net NPAs increased marginally from 3.45 per cent to 3.84 per cent.
• The bank's average level of advances increased nearly 14 per cent to Rs 17,666 crore while average deposits (excluding Resurgent India bonds and India Millennium deposits) rose 20 per cent to Rs 49,240 crore.

Analysts are of the opinion that the bank needs to gear up its loan book in order to achieve growth since treasury income is likely to see a falling trend in the coming quarters due to a possible tightening of interest rates.

Going forward, a conservative 18 per cent growth in earnings is expected (an EPS of Rs 124 is expected for FY05). Currently, the stock trades at a P/E multiple of 3.5 times its Q1 FY05 earnings given a stock price of Rs 441.95.

DR REDDY'S LABS
Rise in operational expenses hits profitability

Pharma major Dr Reddy's Laboratories posted a 78.16 per cent drop in net profit to Rs 17.30 crore during Q1 FY05, down from Rs 79.20 crore in the corresponding period in FY04. Total revenues rose 6 per cent to Rs 510.80 crore from Rs 481.20 crore.

While the profitability has been hit mainly due to a fall in the value of the rupee and a huge increase in the operational expenses, the growth in revenues was attributed to poor sales in generics and bulk drugs segments.

• The sales growth of the company was below expectations due to a 60 per cent drop in the sales of generics in the US market as a result of heightened competition.
• During the quarter, the company faced increasing pricing pressure on two of its best selling generic drugs in the US market - Fluoxetine and Tizanadine. The combined sales of these drugs in the US market dropped to $6.4 million from $17 million in Q1 FY04.
• Sales of bulk drugs went up 10 per cent while that of formulations grew 15 per cent due to the better performance of the company in the Indian markets apart from its increased focus in Russian and CIS markets.
• Expenses went up to Rs 248.20 crore (Rs 216.20 crore), propelled by an increase in expenses towards research and development (61.04 per cent) and a rise in selling, general and administrative expenses (12.36 per cent).
• The company suffered a steep fall in foreign exchange gains at Rs 36.60 crore compared with Rs 76.40 crore.
• Operating margins came down to 3 per cent from 20 per cent.

Even though the performance of Dr Reddy's has been poor this quarter, analysts are optimistic about the long-term future of the company. During the past quarter, the company has submitted two abbreviated new drug applications (ANDAs).

Given its strong pipeline of products, Dr Reddy's Labs is expected to bounce back from its poor performance in the past quarter, which has been one of its worst for some time. At Rs 745 levels, the stock is trading at a P/E of 29x.

The scrip is considered risky in the short-term due to continued pressure on earnings and the company's high dependence on the success of patent challenges.

ONGC
Subsidies a drag on profits

ONGC reported impressive growth in sales and earnings despite the discounts allowed on sales of crude oil, kerosene and LPG to oil marketing companies as part of the subsidy-sharing arrangement announced by the government in October 2003. Net profits were up 8.15 per cent at Rs 2,308 crore (on a like-to-like comparison, net was up 33 per cent) while net sales increased substantially 30.85 per cent.

• Sales were lower by Rs 815 crore due to the subsidy burden/discounts allowed during the quarter.
• Profits were lower by Rs 754 crore before tax and Rs 478 crore after tax due to subsidies. Accounts for the corresponding previous quarter did not carry the impact of subsidies as the subsidy-sharing order was issued only in October 2003 and ONGC had provided for the same in the third-quarter. Considering that the subsidy impact for the corresponding quarter in the previous year was Rs 402 crore, net profits are up 33.25 per cent.
• Sales for the quarter included about Rs 1,327 crore from trading activities. This is probably the first time a trading component has creeped into ONGC's profit and loss account.
• Operating margins were down to 50.06 per cent from 58.79 per cent while net margins declined to 22.42 per cent from 27.13 per cent. However, if one excludes the trading sales of Rs 1,327 crore clocked during the quarter, margins are only a shade lower.
• Global crude prices continue to be firm. Bonny Light Crude traded at around $36 per barrel during the first quarter of this year compared to $29 for FY04. A stronger domestic currency, however, deflated the gains.

Crude prices are expected to remain firm for the rest of the year. Analysts expect the company to end the year with earnings of around Rs 76 per share. At current prices of Rs 716.30, the share is trading at 9x FY05 earnings, making it a reasonably good buy.

M&M
Farm sector leads growth

Mahindra & Mahindra reported a strong performance for the June quarter wherein its revenues grew 41.87 per cent to Rs 1,423.17 crore while its PAT zoomed 144.47 per cent to Rs 103.9 crore. While the company's automotive division continued to witness robust growth in volumes, it was the farm equipment segment which propelled the overall growth.

Interest savings and an improved operating performance buoyed margins. Operating margins witnessed a 233 basis points rise while net margins rose over 300 basis points.

• Revenues from the farm segment witnessed a 70.70 per cent growth to Rs 445.33 crore. The company improved its marketshare in tractors to 27.5 per cent from 25.7 per cent in the year ago period. Tractor exports grew 20.1 per cent.
• Revenues from the auto segment witnessed a 31.69 per cent rise to Rs 964.98 crore while volumes grew 60 per cent. Utility vehicle (UV) sales, the mainstay of the company's automotive division, grew 29 per cent.
• The three-wheeler segment grew 29.5 per cent in volume terms and the company's marketshare in the segment climbed to 38.5 per cent from 29.1 per cent.
• Raw material costs jumped 45 per cent while staff costs and other expenses grew 15.77 per cent and 19.39 per cent respectively. However, as a percentage of sales, staff costs and other expenses declined 1.95 per cent and 2.21 per cent respectively.
• Interest outgo plummeted 89.61 per cent to Rs 1.76 crore from Rs 16.96 crore in the corresponding quarter last year.

Analysts say margins would have been even better if it wasn't for higher steel prices. The stock is currently trading at Rs 451.70 at a P/E of 12.78. Analysts say though valuations look attractive prima facie, the pace of growth may not sustain on a long-term basis.

In addition, lesser-than-adequate monsoons so far may also impact volumes growth, especially in the farm equipment division. Analysts expect an EPS of Rs 37 for FY05.

HPCL
Rising refining margins boost profits

HPCL posted results that were better than analysts' expectations, with a net profit growth of 57.18 per cent despite a sharp fall in other income. The key earnings driver was rising refining margins, though marketing margins suffered. Sales grew 10.69 per cent to Rs 13,660 crore.

• Gross refining margins for HPCL's Mumbai refinery was $5.3 per barrel, up from $3.1 per barrel in the corresponding previous quarter.
• Crude throughput during the quarter was 3.08 mt compared to 3.52 mt in the previous quarter. However, market sales, including exports, were up 5.75 per cent at 4.96 mt compared to 4.69 mt.
• Gross marketing earnings, according to analyst estimates, are down by 74 per cent.
• Inventory gains amounted to Rs 170 crore against a loss of Rs 450 crore.
• Other operating expenses increased 40 per cent, partly offsetting gains from the growth in the volume of sales and from inventories and refining margins.
• Subsidies on LPG and kerosene for the current quarter have been provisionally accounted for at one-third of the subsidy rates approved by the government.

Analysts expect refining margins to be strong in ensuing quarters, while marketing margins are expected to be better on the back of the pricing autonomy for oil marketing companies announced by the government recently. "The stock is trading at 5.3x FY05E earnings and 1.2x FY05E book value, and offers an attractive dividend yield of 6.7 per cent. We recommend a buy," says S Varatharajan, oil analyst, Motilal Oswal.