Crude oil prices have dropped more than 35 per cent since June, driven by multiple factors, including moderation in demand, increase in supply, strengthening of the dollar and unwinding of speculative long positions. This spells good news for the Indian economy as well as companies.
Since the Government has seized the chance and deregulated diesel prices, the subsidy burden will ease, helping to lower the fiscal deficit. The drop will also reduce India’s import bill, thus providing relief to the current account deficit. Since oil prices have a cascading effect on other goods, this is expected to help bring down inflation too. And falling inflation will give the RBI room to cut interest rates which, in turn, will give a leg-up to consumption.
Macros aside, falling crude prices will help corporate earnings too. The direct impact of this fall will be on upstream oil companies such as ONGC and Oil India that will now see their share of the subsidy burden going down. Companies that use crude or crude derivatives as inputs, such as manufacturers of plastic products, synthetic textiles, tyres and paints, will see margins expanding due to lower input costs.
Here are eight stocks that stand to gain from falling crude prices. The prices of some of these stocks might already have factored in the advantage from sliding crude. You can keep these stocks on your radar and pick them up when you get the opportunity.
Boost to bottomline ONGC, the public sector hydrocarbon exploration major, is among the big beneficiaries. Paradoxically, for a company that derives most of its revenue from crude oil, a price dip will help. That’s because ONGC’s net realisation — the final amount it gets for its products after providing discounts — should rise from the lows of the past few years. The subsidy burden that ONGC bears (through discounts to the oil marketing companies) is expected to reduce sharply. This is thanks to an expected sharp dip in the total fuel under-recoveries of oil marketing companies (OMCs) — Indian Oil, HPCL and BPCL — from selling fuels below cost.
The upstream companies ONGC and Oil India, along with GAIL, have been shouldering 40-50 per cent of the total under-recovery burden of the OMCs; the Government bears a chunk of the remaining burden. Among the upstream companies, ONGC provides the lion’s share (nearly 85 per cent) of the discounts to the OMCs.
The weakness in crude oil price, along with the monthly 50 paise hike in diesel prices since January 2013, neutralised under-recoveries on the fuel in September, and paved the way for price decontrol. So, under-recoveries on diesel – the largest so far - should be a thing of the past.
Domestic LPG subsidies should also reduce, with the Government reviving direct benefit transfers. Ergo, from nearly ₹1,40,000 crore in 2013-14, the total under-recovery burden should fall to about ₹85,000 crore in 2014-15 and to about ₹60,000 crore in 2015-16.
A dip in under-recoveries should improve ONGC’s net realisations, which over the last few years have been dented due to increasing discounts to OMCs. From around $56 a barrel in 2009-10, ONGC’s net realisation fell to a low of $41 a barrel in 2013-14. Even with lower crude oil prices currently, a lower subsidy burden should improve ONGC’s net realisation to about $55-60 a barrel. Crisil Research had estimated that lower under-recoveries will add about ₹10,500-12,000 crore to the profit of upstream companies in 2014-15 and another ₹7,000-7,500 crore in 2015-16.
A chunk of this will flow to ONGC. Even if crude oil prices move higher, with diesel under-recoveries done away with, ONGC’s net realisations should only improve. Besides, the recent increase in the price of domestic gas, though lower than expectations, should add about ₹4,700 crore to ONGC’s annual profit.
Smoother future ONGC’s smaller peer, Oil India, which bears about 10 per cent of the upstream burden from under-recoveries, should also be a key beneficiary of the dip in crude oil price. Its net realisation, due to much lower subsidy drag, should improve sharply from the low of $47 a barrel in 2013-14 and bolster the bottom-line. It helps that Oil India’s track record of increasing hydrocarbon production is better than that of ONGC. The recent gas price hike should also add about ₹600 crore to the company’s annual profit.
A colourful outlook Crude derivatives constitute about a third of the raw material costs for paint companies. Hence, a sharp fall in crude prices will lead to better gross margins for these companies. Raw materials for paint companies include titanium dioxide, additives, pigments, resins and solvents — most of these are crude derivatives. On an average, a 10 per cent drop in crude prices will improve gross margins by 200-300 basis points.
However, the actual benefit can vary across companies, depending on their product mix.
Asian Paints has a strong brand name and leadership position in the decorative paints segment. With early signs of a pick-up in the economy, real estate is also seeing signs of revival. Strong demand for decorative paints, driven by higher repainting demand and festive season, augurs well for Asian Paints. The company is the market leader in the segment, which contributes about 80 per cent to its total revenues.
The company’s focus on international operations (13 per cent of revenues), will also boost revenues.
Asian Paints has a good track record of performance. Over the last four years it has outperformed its peers in terms of revenue growth. Its revenues have grown by 17 per cent annually during this period. It enjoys a much higher operating margin (16.6 per cent) than its peers such as Kansai Nerolac and Berger (around 11-12 per cent).
Asian Paints has thus commanded a higher return ratio. The return on equity was 32.8 per cent in 2013-14.
The stock currently trades at 31 times, FY16 earnings, which is at a marginal premium to its peers. However, strong volume growth in the decorative paints segment, improvement in margins and a healthy 24 per cent growth in earnings annually over the next two years justify this premium and the stock can re-rate further.
Revving up Kansai Nerolac is a leading player in the industrial paints segment, catering mainly to the automotive segment. Among other paint players, Kansai has a larger exposure to the industrial paints segment, commanding more than a third of market share. The slowdown in the auto segment impacted the volumes for the company. This will change with the revival in auto volumes. Given its leadership position in the industrial space, Kansai is a good play on the recovery in the auto and capex cycle.
Kansai also has strong brands in the decorative paints segment such as Impressions. The company has increased its revenues from this segment over the past years and now derives about half of its revenues from this space. Repainting demand will continue to drive growth for this segment.
The company’s sales have grown 17 per cent annually over the last four years. Improvement in auto sales and strong demand for decorative paints should see 18-19 per cent revenue growth over the next two years. There is also scope to improve its margins on the back of a pick-up in industrial volumes, sanguine raw material prices and operational efficiencies. Earnings are expected to grow by 28-30 per cent annually over the next two years.
At the current price the stock is trading at 27 times FY16 earnings. Strong earnings growth led by revival in auto sales and better operating margins offer ample scope for re-rating.
On the fast track Although natural rubber constitutes 40-50 per cent of the raw material for the tyre industry, crude oil derivatives such as carbon black, synthetic rubber and nylon tyre cord fabric also go into the making of tyres. A drop in crude prices will be an additional sweetener for tyre companies which have already seen operating margins expand to double digits in the last few quarters due to a steady fall in natural rubber prices.
JK Tyre and Industries, whose operating margins touched about 11 per cent in FY14, is well-placed to gain from these factors. Besides cheaper raw materials, recovering commercial vehicle sales and the trend of rapidly increasing radialisation in CV tyres (about 25 per cent currently) favour the company. JK Tyre is the market leader in radial tyres for trucks and buses with about 35 per cent share. Radial tyres add value to the product mix as these are priced higher and bring better margins.
Over the next one-two years, improved cash flows from strong demand, utilisation of additional radial capacity being installed and low input costs are expected to bring down the debt to equity ratio from about two times now. With many tyre stocks running up between two to five times in the last one year, JK Tyre also provides some valuation comfort.
Unlike most others, it is still at a discount to bigger players such as Apollo Tyres, trading at about nine times trailing 12-month consolidated earnings.
To reap higher margins State-owned fertiliser maker GSFC, whose operating profit margin declined by almost 3 percentage points in 2013-14 after prices of key raw materials such as benzene increased sharply, may heave a sigh of relief now. Thanks to the fall in crude prices, the global price of benzene — a key raw material for the company’s flagship chemical product caprolactam — is beginning to cool off. From the June 2014 peak of $1,420 a tonne, the price of benzene (Korea) has fallen by over 18 per cent to $1,160 a tonne now. To manufacture one tonne of caprolactam, about a tonne of benzene is required. In 2013-14, GSFC produced 84, 856 tonnes of caprolactam; its sales accounted for 18 per cent of total revenues.
Even as benzene prices declined sharply in the last four months, the price of caprolactam saw a marginal 6 per cent fall to $2,150 a tonne. Benzene imports accounted for almost 25 per cent of GSFC’s raw material cost in 2013-14. Moderation in benzene prices by $50 a tonne will add about ₹20-30 crore to GSFC’s operating profit.
Caprolactam, which is used to manufacture automobile tyre cord, should benefit from an increase in discretionary spend, once the global economy returns to the growth path.
In addition to better margins for its chemicals’ segment, higher fertiliser sales in 2014-15 following a reduction in inventory with dealers and availability of phosphoric acid from the Tunisian joint venture Tifert should add to GSFC’s profits. Capital investment of over ₹2,000 crore over the next one year in facilities such as the 1,650-tonnes per day di-ammonium phosphate plant and nylon 6 plant should drive the company’s long-term growth.
A promising package An FMCG company may seem an unlikely candidate to benefit from lower crude oil prices. But petroleum derivatives form the raw material for packaging — tubes, bottles, covers, Styrofoam, and so on, for diapers, detergents, shampoos, cosmetics and perfumes.
Colgate Palmolive India is one of the key beneficiaries of lower packaging costs, which form a fourth of total raw material consumed. Colgate dominates the toothpaste (57 per cent market share) and toothbrush (43 per cent market share) segments that are ‘essential’ in nature and swallow up a small share of consumer wallets. This has allowed it to grow sales at a healthy clip of 12-15 per cent in the past several quarters, though volume growth is starting to wear thin from the March 2014 quarter.
It also fought off competition from Hindustan Unilever (Pepsodent and Close-Up) and P&G (Oral-B). But the higher ad spend and promotion this entails — it has inched up to 18 per cent of sales by the June 2014 quarter from the 11-12 per cent it used to average — shaved off operating margins. However, lower other expenses propped up margins. With packaging and plastics turning cheaper, Colgate now has more room for ad spend besides bettering its profit margins.
Building on economic revival Companies engaged in plastics are among the biggest beneficiaries of sliding crude prices, being derivatives of crude oil polymers. Sintex Industries is among the largest listed plastics players with a diverse product portfolio to boot, in both international and domestic markets.
Custom-moulded plastics for segments such as defence, aerospace, automotives and such form 44 per cent of its revenues. Another 46 per cent comes from building products for pre-fab structures, monolithic construction and storage tanks. The pre-fab segment and custom moulded products are the biggest growth drivers, with annual growth of 18 and 16 per cent, respectively, in the past four years. The two segments also sport better profit margins.
Raw material costs have been moving higher over the years to reach 61 per cent in 2013-14. For the first half of the current fiscal, they crept higher to 62 per cent of sales. Lower forex and other expenses helped operating margin improve to 16 per cent. Respite on the raw material front, a pick-up in construction demand for low-cost housing, and a revival in industrial growth can boost the fortunes of Sintex. The company also has a portion of revenues coming in from cotton textiles and infrastructure.
(By Anand Kalyanaraman, Bhavana Acharya, Nalinakanthi V, Parvatha Vardhini C, Radhika Merwin)