cals-refineries-bulls-perspective

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Price when posted: 30 Paise
Original posted on: March 31, 2011

Disclaimer:

• I am neither a trained financial analyst nor I come from the financial industry. Security analysis is my hobby and therefore it is possible that part of my work is either incorrect or incomplete. I thereby request the readers to exercise discretion.
• I own this stock and have recommended others as well.
• These are purely my thoughts and analysis based on the information available on public domain. There are many conjectures in the report. Viewers are requested to consult their financial advisors before taking any financial or non-financial decisions.
• I take no responsibility for any gains or losses.  

Company Background:

Cals Refineries Ltd. has plans to set up a total of 400,000 BPSD (20 MMTPA) of oil refining capacity on India’s east coast in the State of West Bengal, in phases, thereby emerging as the third largest oil Refining and petrochemical company in the Indian private sector.

Company Background

In 2007, Spice Energy bought this listed shell company that had discontinued its operations. This saved them a lot of costs that are typically incurred to start and list a company. A listed company is a must to issue GDRs.

In December 2007, the Company raised US$200 million through a GDR issue which is listed on the Luxembourg Stock Exchange.

Business Strategy

Cals’ strategy is to create an independent value-added integrated refining / petrochemical business with significant economies of scale and operational efficiency, producing world-class refining and petrochemical products with competitive domestic and international marketing strategy.

A refinery typically has a very long life. Many of the refineries that are operating in developed countries have become unviable because of the running costs in those countries. Relocating a refinery is not a new phenomenon. These projects have been carried out throughout the world and have given following benefits:

1. Significant cost savings when compared to Greenfield refineries.
2. Significant time is saved in executing the project.
3. The above two factors cause the ROE and ROCE of the projects to go up. In simpler words, they give the same cash flows as that of the new refineries for significant smaller investments.

Status of the project

After a lull of 3 years, the company is making rapid progress in recent times. The total cost of the project is about Rs 8100 Crores. Out of this they had already raised about 812 Crores in 2007. Kharafi Group is going to infuse 150 M USD (675 Crores) and Hardt has committed 418 M USD (1881 Crores). So, Close to 3375 Crores of equity has already been tied up. The annual report also talks about 3125 Crores of in-principle approval of Loans from a consortium of banks. With Hardt and Kharafi coming in, tying up the remaining amount now seem a possibility.

Hardt CEO has even joined the board recently. As per the company website, they are confident of achieving the Financial Closure for the project by September. Seeing Hardt actively participating in the project, achieving Financial Closure by September seems to be a very likely.

They are already in possession of the Land in Haldia and the project is going to be completed in 2 phases. The entire project is likely to be completed in 36 months with the first phase coming up in 15 months from the date of Financial Closure.

Key Milestones:

• 28 Mar 2011: Awarded LoI to Saipem S.p.A., Italy for Detailed Feasibility Report
• 15 Mar 2011: Signed Agreement with Hardt Group, Austria for Purchase of Two Refineries and Equity Investment
• 25 Nov 2010: Signing with Al-Kharafi Group for Equity Investment
• 17 Jun 2009: Cals Refineries signs MoU signed with Bharat Petroleum Corporation (BPCL) for off-take of products
• 13 Mar 2009: Additional 101 acres of land allotted (total 400 acres allotted till now) by Haldia Development Authority to CALS Refineries Ltd. for the upcoming refinery project
• 12 Feb 2009: Fiscal benefits and concessions received from Government of West Bengal
• 23 Jan 2009: Confirmation received from Haldia Dock Complex on availability of oil jetties at the Haldia port, capable of handling vessels for refinery’s operations with necessary Way Leave Licences & other approvals
•  26 Dec 2008: In-principle sanction received from West Bengal State Electricity Distribution Company Limited for power supply to the plant
• 17 Nov 2008: Agreement signed with British Petroleum (BP) for supply of crude & offtake of products (Gasoline & Diesel)
• 14 Dec 2007: Successfully closed GDR on Luxembourg Stock Exchange worth US$ 200 mn

Key People:

Deep Rastogi

Executive Chairman

Mr. Deep Rastogi is an entrepreneur with over forty years of rich experience in various businesses. These include manufacturing and marketing of laboratory and fine chemicals, manufacturing of printed circuit boards & solar products and exports of minerals & natural fibres for the construction industry. Currently his family has invested in an Oil & Gas and Infrastructure company implementing various projects, both domestically and internationally.

Prior to this, Mr. Rastogi led a chemical manufacturing & marketing company for over twenty five years. Over the years his acumen in developing international business relations made the company one of the largest business houses playing a key role in the development Indo-Russia economic relations.

D. Sundararajan

Managing Director

Mr. Sundararajan started his career in Chennai in Small & Medium Enterprises and has since worked with major public & private institutions for more than 30 years. After a successful stint in Canara Bank he joined private sector in 1991.He has significantly performed outside the traditional role of CFO in organizations like Prag Bosimi Synthetics Ltd., ABG Heavy Industries Ltd., Fascel Ltd., and the Binani Group. Mr. Sundararajan has been highly influential in introducing best practices into his organization and has been effective in resource mobilization and its deployment. He has achieved several significant milestones in his career that include handling premium IPOs, implementing ERP, successfully turning around companies, enhancing investor relations and much more. Actively participated and led merger and acquisition activities and structured functional integration process at Idea Cellular Ltd. Mr. Sundararajan has significantly contributed in launch of mobile telephony in Gujarat for one of the operator and turning it to be a market leader in that State. He has helped a leading private life insurance company to set up business in 3 Indian states.

Mr. Sundararajan has completed his Bachelors in Applied Science from Madras University, where he also obtained a Master’s degree in Mathematics along with a Bachelors degree in Law. Furthermore, he is a Certified Associate from the Indian Institute of Bankers and an Associate from the Institute of Cost & Works Accountants of India.

Dr. Alexander Schweickhardt

Independent Director

Dr. Alexander Schweickhardt is a founding principal of HARDT GROUP and a member of the Executive Committee. He is responsible for communications and business development globally. He is also a member of the Investment Management Committee of HARDT GROUP Global Management AG which oversees investment management, strategy activities, and strategic asset allocation decisions.

Dr. Schweickhardt holds a Ph.D. in Economics and a PhD in Law from the University of Graz, Austria. Additionally, he is a frequent participant at roundtable discussions and a keynote speaker at International Conferences.

Standalone Valuation

It’s very raw method of valuing the company. But it is a good point to start with and includes factors like GRM, Oil Prices, Cost of Capital, Cost of Project, Days of Working Capital, Time to complete FC and time to complete the project.

Assumptions

Gross Refining Margin (in USD per Barrel) = $10

Output (in Lakhs Barrels per Day) = 2

Exchange Rate (Rupees per USD) = 45

Crude Oil Basket (USD Per Barrel) = $100

Working Capital (in Days) = -30

Cost of Capital= 15%

Cost of Project (In Rs Crores) = 8100

Debt Equity Ratio = 1.09:1

Expected number of Shares Outstanding (In Crores) = 3873

Time to Financial Closure (in Months) = 6

Time to Completion (after FC) (in Months) = 15

Calculations

Sales (In Rs Crores) = 36135

Gross Profit (In Rs Crores) = 3,285

Free Cash Flow (FCF) of all years (In Rs Crores) = 35,016

Present Value of FCF (In Rs Crores) = 28,008
Cost of Phase 1 (In Rs Crores) = 4050
Cost of Phase 2 (In Rs Crores) = 4050

Enterprise Value (In Rs Crores) (A) = Present Value of all Future Free Cash Flows = 28,008

Present Value of Debt (In Rs Crores) (B) = 4,224

Market Cap (In Rs Crores) (D) = (A) - (B) - Present Value of Cost of Phase 1 and Phase 2 = 17,335

Result:

Intrinsic Value of each share = Rs 4.48

If the refinery was ready TODAY,

Intrinsic Value of each share =  Rs 7.58

You can download the excel sheet (http://www.docstoc.com/docs/75878207/Cals-Refineries) where I have done the calculations. The output would obviously change as the input assumptions change. You can change the input and see how the output (Price per share) is affected.

 

Frequently asked questions

1. Is Rs 4.48 and Rs 7.58 the price target for the stock?
This is not the price target of the stock. It is the intrinsic value or the fair value of the stock as of TODAY.


2. Is it the fair value of the stock as of today even if the refinery is not ready?
Yes, it is a fair value for a refinery that is going to produce 2 Lakh Barrels per day and operate at a GRM of $10 per barrel and for whose project the FC will be done in 6 months from today and the actual production will start after 15 months, the fair value as of TODAY is Rs 4.48 (as arrived by the model).

This assumes that there are no execution risks or financial risks. You can read it like this. If say Reliance or any BIG player was to come up with this refinery for which the Financial Closure would be achieved in 6 months and production would start after 15 months, the market would have given it a price of Rs 4.48 TODAY.

3. Then what does the current price of 30 paise indicate? Will the refinery not come up?
If the market is certain that the refinery will NOT come up, the price would be 0. So, Cals is trading somewhere in between. So you can apply probability concepts and come at a figure. Right now market is giving it 7% chance of coming up with a refinery. If your belief is more than that, you associate a bigger price to the stock.

Market does not think objectively. That is, it would not think like say the chance is 7% so let us give it a value of 0.30. It reflects the collective thinking of people. In a way, it is the measure of fear. The transactions happen because of difference in beliefs. If because of some reasons, your belief is higher than that (you believe that the project is more certain), you will be very comfortable buying and holding at the current price.

4. Will the price not go more than Rs 7.58?

Rs 7.58 represent the fair value of the stock if the refinery was ready today. Stocks hardly ever trade at fair value. They either undertrade or over trade. They reflect the pessimism or optimism in the economy. Besides that, the sudden spurt in demand also can make a stock more valuable. It is not uncommon for a stock to see a high of about 4 to 5 times its fair value. So, I will not be surprised to see a price of Rs 25 and then coming back to trade somewhere near its fair value !!!

5. I am worried about equity dilution?

Many people seem to be worried about the equity dilution (the fact that they are issuing more GDRs and thereby diluting the equity). The fact is that with the equity they have currently, the project cannot be completed and without the project, the value of the current equity is next to zero (it is actually trading at levels next to zero). Raising fresh money through Debt and Equity is necessary. Debt is not easy to raise without sufficient equity.

If you do not want the equity to be diluted, the only option is to go for RIGHTS issue wherein the existing shareholder has an option to subscribe to more shares. With the stock trading at 30 paise, do you think anyone will subscribe to the RIGTHS ISSUE? I do not see an alternative to what the management is doing. With the GDR coming up, the project becomes a certainty and thereby the current shareholders would get the worth for their investment.

6. Why are the mutual funds not buying it? When will they buy?

This is the question many have asked me. To understand this you need to understand how institutions work. They manage public money so they work under strict rules. Their performance is measured with respect to the benchmark indices (nifty) and other funds. This means that they do not need to give superlative returns. They only need to give above average returns. On the other hand, they are answerable to many people (senior managers, investors, regulators) if anything goes wrong. Their job, compensation, promotion, etc everything depends on this. So, they would not invest in a company like Cals whose project is not yet operational. Whereas they would not mind investing in the same company at Rs 15/- with a target of Rs 25/- as it still gives them a return of 67% which is phenomenal (which can earn them a hefty bonus and a promotion even at that level). In fact, I will not be surprised if many of those analysts/fund managers own this stock in their personal portfolio.


7. I have been holding this stock for 3 years and I have not seen any progress. I am frustrated.

In fact, when they came in we all knew that they were a startup. Their plans were hit by recession. Recession hits the new companies harder as investors do not commit fresh money to projects.  So they got punished. The stock fell from about Rs 12.82 (The intraday high was Rs 128.2 when the face value was Rs 10, now the face value is Rs 1).

It’s a journey. When a company travels from planning stage to production stage, the stock also travels from very low value to high value. As an investor you must realize that there will be intermediate stations. We are all sitting in that train and are seeing stations pass one after another. I feel (looking at the stations we have passed) that the company is in the right direction and will reach the destination. Therefore the stock will also travel from current levels to the levels corresponding to its true worth.

Few other stocks that have made this journey,

• ABAN OFFSHORE – Rs 6.00 Rs to Rs 5393
• KS OILS - 0.50 paise to Rs 142
• MERCATOR LINES - 0.40 paise to Rs 184
• PANTALOONS RETAIL- Rs 2.23 to Rs 875
• JAI CORPORATION- Rs 16 to Rs 1079
• Essar Oil – Rs 3.7 to Rs 342
• Kwality Dairy – Rs 28 to Rs 1552

8. If the company is so positive, why are the promoters not buying all the shares?

The promoters simply do not have so much money. This project requires about Rs 8100 Crores. They are a small group and cannot be expected to have so much cash.

They must be spending a lot of money to attract the Foreign investors and on consultants. The cash (and therefore the debt) that they have infused, they got them converted to preference shares. They are subscribing to more preference shares now. I think they have invested to their maximum possible capabilities. This shows their confidence.


9. Why is Hardt deal so important?

Rs 8100 Crores is needed to start the project. Right now only 800 crores has got committed to the project. Without the remaining money, the value of current 800 crores is ZERO. A part of the money will be raised as LOANS and remaining as equity. If fact, banks will first ask the equity to be tied up. And equity will not be tied up if the debt is not guaranteed. So, one is waiting for the other. This is where Hardt becomes important. They have even joined the board. This shows their commitment to the project and it will now be easy to get others on board.

10. Why are Hardt and Kharafi paying Rs 1 per stock when they can buy the same at 30 paise in market?

 
Somebody needs to bring in fresh money so that the project is taken forward. And more so, they believe that they can earn much more than their investment of Re 1 per share.
 
Kharafi Group is committing 150 M USD (Rs 675 crores) and Hardt is committing 418 M USD (Rs 1881 Crores). These groups are typically not interested to make small profits. They think big. They typically target returns of about 50 to 100 times their investment. Of course, they work very hard for that and have to operate the company in best possible way to achieve their targets. They are confident of their abilities to operate the company and therefore do not mind paying Re 1 per share.

11. The promoter holding is very less, this cannot be a good stock.

I once again bring you to the project cost. A small group acting as a promoter cannot be expected to finance such a huge project. It is very common to see small promoters being funded by venture capitalists (VCs). The VCs then list the company in stock exchanges once they are of considerable size. Listing the company before it is stable can backfire because the market may not give it the valuation it deserves or the risk appetite of the market participants could be low. This means that the promoter of the company gets lesser overall stake than they might actually deserve.

In the recent past, the promoters have increased their stake from 0.11% to 2.32%. They have proposed to subscribe to more preference share and thereby taking their stake to 2.93%. Apart from this, they currently hold 13.66% more through GDR.


12. Can the low promoter holding be beneficial to the shareholders?

In a way yes. The promoters cannot take any major decisions themselves as they do not have the majority. They will have to keep coming back to shareholder for approval. Take for example, companies like Infosys, L&T or ICCI Bank. The promoter holding in all of these is very low but the board is very strong. Therefore, a lot would depend on the composition of board.

It is important that some chunk of shares are held by a few large investors and they have a say in the board. We are seeing Hardt becoming a member of the board with immediate effect. This will ensure that the promoters are acting in the best interest of the shareholders.

13. What is the progress with Lohrmann Case?

 As per the updates on the Delhi High Court's website (http://delhihighcourt.nic.in/), the case seems to be moving towards out of court settlement.

14. When stock is trading at 30 paise and GDR is being issued at face value, there seems to be an arbitrage opportunity.

 Yes. The new GDR is going to be issue at face value. So their price is Euro equivalent of 1 Re / No of shares per unit of GDR. A lot of  GDRs got converted to shares in India last year. The GDR bucket can be replenished. So, there seems to be inherent arbitrage opportunity. Therefore before the new GDRs are listed and are available to trade, the price of the stock is expected to cross Re 1 (atleast) so that no such arbitrage opportunity exist.

15. Will Hardt and Kharafi try to sell their holding at Re 1 or Rs 2.

When a huge sell order comes the price drops suddenly. So the seller cannot sell at the price he plans to. The other choice he has is to sell slowly. But when someone holds about 500 to 1000 times more than the average traded volume, imagine the time it will take him to exit from his position.

Last year, the GDR was issued for 200 M USD. Whoever held the GDR tried to sell it in the Indian market and the price came down from Rs 12.8 to 25 paise. This happened to liquidate 70% of the GDR then which comes to 140 M USD and it took them 2 years to liquidate.

So, Hardt and Kharafi must have thought million times before agreeing for the GDR. They know very well that if they try to sell it immediately, they will not be able to liquidate. And this time we are talking about more than 670 M USD. So as and when they want to exit, they have to sell their stake to another strategic investor and not dump it in the market. As long as their stake is not dumped on the market, we have no problem.

In many ways that GDR being issued this time is very different from the one issued earlier. Last time, the GDR holders did not choose to identify themselves. Apart from that the GDR that is being issued to Hardt has a lock-in period of 1 year (a lock-in for GDR is a rare occurence) and 3 years for the preference shares.


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Other Questions:
1. Do you own this stock?

Yes, I own this stock.

2. I am impressed with your analysis. I will take a loan and buy this stock.

It is not a good practice and I certainly do not encourage it.


3. I am going to sell all my other shares and buy this one.

A single stock portfolio is an extremely risky affair. This stock can only be part of your well diversified portfolio. That too in small amount and that too if and only if you have an apetite for risk.

4. I dont believe in all this. I am going to exit my holdings at the earliest.

You are invaluable to this market. Unless there is a seller, people who are bullish on the stock cannot buy at all. A difference in perception is what makes the trade possible.

5. Are there any risks?

This project and therefore the company face all the risks that a startup faces.