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War winners and losers
BS Smart Investor Team | March 24, 2003
If the war turns out to be a long-drawn affair it could impact some sectors considerably.
Steel and engineering companies could gain due to Iraq's reconstruction, but technology companies may suffer due to slow decision-making by American corporations.
Metals: The biggest beneficiary of the US-Iraq conflict may turn out to be domestic steel manufacturers. As part of its preparation for war, the US government has instructed steel manufactures in America to considerably reduce their exports to countries like China and build up inventories for the expected post-war reconstruction work in Iraq.
This is music to the ears of domestic steel companies as US companies have been exporting around 1.5 million tonne per month of high grade steel to China.
"Currently, Indian manufacturers account for less than five per cent of the total steel imported by China. But their contribution could rise as domestic companies like Tata Steel and Jindal Iron & Steel would try to fill in at least part of this void created by US steel companies," feels Bhavin Chheda, research analyst, Pioneer Investcorp.
This apart, the rise in demand from the overseas market could result in another price hike by domestic manufacturers.
On the flipside, the sharp rise in fuel prices will push up transportation and manufacturing costs and this is expected to adversely impact margins if the steel producers are not able to fully pass on the extra cost to customers.
There is no significant impact on other metals like aluminium, copper, zinc and nickel.
Heavy engineering: The heavy engineering sector may be a major beneficiary of the war, if it prolongs. This is primarily pitching on the fact that they may be able to garner additional business on account of Iraq's post-war reconstruction.
Analysts, however, are not optimistic on Indian companies getting a significant share of reconstruction activities. They highlight the fact that post the Gulf war in 1991, only one order came to India.
This was bagged by BHEL under the 'food for oil' programme, because of which it constructed a power plant in Iraq.
They say that even this was bagged at a time when the chances of an Indian company getting a share of the reconstruction activity was much better than it is today.
Especially since the power sector in US is in a recessionary phase. So this might lead to aggressive bidding by foreign companies, resulting in a squeeze on margins.
Technology: US sneezes and the Indian information technology industry catches a cold. This is the kind of effect US markets have on domestic software services companies.
And rightly so as domestic firms generate around 75-80 per cent of their revenues from US.
Though the long-term impact of war will largely depend on how quickly the US is able to achieve its objectives, domestic software companies are already feeling the heat of delays in decision making by US clients.
Industry officials admit that large US corporations have been postponing major outsourcing decisions in the past couple of months.
Moreover, with the outbreak of war many clients may postpone their visits to vendor premises. Both these will further elongate the sales cycles and add to the marketing expenses of software services companies.
In the recent past also a similar trend was noticed when the tension between India and Pakistan had flared up after the terrorist attack on Parliament in December 2001.
Worse still, a prolonged war could unsettle the staggering US economy even more and companies may choose to lower capital spends further.
Apart from this, analysts are concerned about the possibility of the US-Iraq war playing on the minds of Infosys' management while providing growth guidance for the next fiscal.
The annual guidance by Infosys is seen as an important event for the entire universe of tech stocks on domestic bourses.
Thus, if Infosys decides to take a conservative view, it could impact investor sentiments at tech counters considerably.
Export-oriented industries: With shipping freight rates set to go up and the war premium also inching higher, importers across the board may just decide to defer their imports. Worse still, if the war is prolonged, there could be order cancellations as well.
Export-oriented units may actually witness losses or see their receivables pile up. Notably, commodity exports such tea, textiles and gems and jewellery could be hard hit.
Tea could be one of the worst affected commodities as tea manufacturers were depending on newer markets such as Iraq and other Middle East countries to make up for the fall in demand from traditional markets such as Russia and Europe. In fact, sales to Iraq under the 'food-for-oil' programme had tripled to 40.25 million kg last year.
Similarly, analysts say ready-made garment manufacturers such as Arvind Mills and Raymond and cotton yarn producers like Nahar Exports and Mahavir Spinning, who have considerable exports, could be adversely impacted as they may see some cancellations or order deferments.
Another industry where exports play a significant role is pharmaceuticals. Most home-grown companies such as Ranbaxy Laboratories and Dr Reddy's thrive on exports.
However, analysts don't see any adverse impact on the industry. They say medicines are essential and war is unlikely to alter demand.
In fact some of them see a spurt in demand for medicines, especially, anti-infectives, as war casualties begin to mount.
Shipping industry: Though freight rates have been rising due to the increase in fuel prices and war premiums, the shipping industry sees no reason to panic as any increase in costs will be passed on to customers. However, there are other reasons for worry.
The London War Risk Committee has listed 29 ports where a war risk premium ranging from 0.01 to one per cent will be levied on the value of cargo transported. Indian ports of Kandla and Mumbai are amongst those 29 ports listed.
The freight rates on oil tankers from the Persian Gulf region too have gone up substantially in the last few days.
However, if the war continues on a sustained basis, they say cargo volumes are likely to see a dip and this will hurt business.
Volumes have already been hit by the lack of movement of ships to Iraq and its neighbouring countries as insurers were unwilling to extend insurance to these regions.
Hotels: The hotel industry was beginning to show signs of recovery from a long sluggish phase. In the last few months inbound traffic movement was increasing and flights in and out of the country were fully booked.
But unfortunately, the US-Iraq war could undo all the positive developments very soon.
To begin with, air travel fares are expected to increase on account of an increase in insurance premiums and re-routing of flights to avoid war-affected areas.
Industry sources say that about 10 per cent cancellations have already taken place and cancellations may reach as high as 60 per cent if the war drags on for an extended period. This could spell disaster for the Indian hotel industry.
On slippery ground
Oil prices spiralled on the eve of the Gulf war only to collapse by half soon after it broke out. But this time around, it was somewhat different. In the run-up to the US war with Iraq, oil prices spiked to $35 per barrel.
But after OPEC's decision to release excess capacity to make up for the shortfall, if any, after the Vienna meet on March 11, the pressure eased and prices fell to $33 per barrel. So when war broke out, expectations that it would be a short one pushed prices lower to $28 per barrel.
However, as days pass and if the market turns sceptical and feels that the war may last longer, concerns about a supply shortage could crop up again, driving prices higher. The medium-term outlook is still not clear and analysts fear that an increase in crude prices is a distinct possibility.
Oil prices are just as fickle as any other commodity's, despite the industry being the strongest oligopoly in the world. And as things stand today, the demand-supply situation points to rising oil prices.
The demand for oil has been surprisingly strong despite global economy being on a weak footing. The statistics arm of America's energy department, the Energy Information Administration has reported that oil stocks at the end of February stood at 16 per cent below their levels a year ago, and 12 per cent below the average for the past five years.
On the other hand, the supply side has been fragile. Iraq happens to be the second largest supplier of oil in the world, with a daily production of 2.5 million barrels per day and proven reserves of 100 billion barrels. The prospect of Iraqi exports coming to a halt, is, therefore, quite scary.
Not only that, the Venezuelan oil sector is just recovering from a workers strike launched in early December. As per official figures, the country slashed crude production from around 2.9 million barrels per day in November to an average of two million barrels per day.
But international agencies say that the unofficial figures are significantly lower. The EIA reckons it will be late May or June before the output recovers to pre-strike levels. Besides, the energy watchdog of OECD countries International Energy Agency, has estimated that Venezuela has permanently lost around 400,000 barrels per day of production capacity. Oil analysts also point that the impending election in Nigeria next month may impact oil supplies.
Even though OPEC officials have been reassuring the world that they will ensure a stable supply by utilising available excess capacity, experts suspect that it may not be able compensate for the loss entirely.
The excess capacity available with OPEC countries (excluding Iraq and Venezuela) is estimated to be around 2.5-3 million barrels per day, which may be enough to compensate for the loss on account of Iraq, but nothing more.
The bigger worry, however, is whether the war will damage Iraqi oilfields -- and for how long. A US defence official is reported to have said that there was some evidence that Saddam Hussein might be planning to cause extensive damage to Iraq's oil infrastructure.
With its cup of woes overflowing, the price of Brent crude spiralled to hit a 2-year high prior to the war only to fall back. But fundamentally, nothing has really changed, and prices may inch up once again say analysts.
Apart from the threat of a rise in crude prices, domestic oil companies have more to worry about. The deregulation of oil prices effected in April 2002 hasn't really meant pricing freedom for oil marketers.
"In effect, oil companies have been bearing the brunt of rising oil prices as they have been unable to pass on the high product prices to customers," says Satyam Aggarwal, oil analyst, Motilal Oswal Securities.
Product prices are still lower than import parity prices. Consider this: crude price was ruling at around $21 a year ago and the price of petrol and diesel was pegged at Rs 27.54 per litre and Rs 17.09 per litre during that time in Delhi.
Currently, crude prices are up by more than 40 per cent (at $30 per barrel), while petrol and diesel prices at Rs 33.79 per litre are Rs 21.21 per litre are up only by 22 per cent at 24 per cent, respectively.
If crude prices move higher, it could get worse. Petroleum minister, Ram Naik indicated in a press conference last week that oil PSUs may not pass on the entire price hike to customers.
He said public sector oil companies had earlier taken a commercial and conscious decision not to increase prices of these fuels to international levels.
The adverse effect of this could show up in the forthcoming quarterly results of oil companies, unless oil prices fall and companies are able to sustain prices at the current level thereby recouping part their earlier losses.
Besides, refining companies have also been forced to hold a high level of inventory to due to war-related uncertainties. Currently most public sector companies are carrying two months inventory compared to less than a month's inventory that they carry normally.
Usually companies stock about 10-15 days of crude oil and about the same level of petro products, totalling about one month's inventory.
Since September, however, public sector companies have upped their capacity utilisation levels to keep their tanks full.
Holding this additional inventory costs an additional investment of Rs 2,000-3,000 crore (Rs 20-30 billion), meaning a cost of about Rs 200-300 crore (Rs 2-3 billion) if this is financed at an interest cost of 10 per cent.
Besides, oil companies have been burdened with higher duty in this Budget -- an additional cess of Rs 0.50 per litre of petrol and diesel and Rs 50 per tonne towards the National Calamity Contingency Duty on domestic and imported crude oil.
Though oil companies have sought a relaxation in the excise duty on petro products and a reduction in the import duty of crude, there has been no supportive action from the ministry of finance yet.
"The additional cess, plus the cost of holding additional inventory will only exert more pressure on oil companies' bottomline," says Aggarwal.
Also, the government is yet to take a call on the amount of subsidy available on kerosene and LPG, and companies continue to incur losses on account of these subsidies.
Based on the current product price, the estimated loss to BPCL is around Rs 180 crore (Rs 1.80 billion) and for HPCL around Rs 230 crore (Rs 2.30 billion).
In the last one year, inflation has risen from 1.9 per cent to 4.6 per cent due to sustained increase in oil prices. In all likelihood the government may not be fully in favour of another round of upward revision in fuel prices.
Possible rise in crude oil prices, and the inability of companies to pass on this escalation in the form of high product prices, may dent the profitability of oil companies in the forthcoming quarters.
The only exception to this rule will be the crude producer in the country Oil & Natural Gas Corporation which sells crude oil at import parity prices.A one dollar hike in crude price means an accrual of Rs 850-900 crore (Rs 8.5-9 billion) to its bottomline. On the contrary, if crude prices continue to fall, albeit less likely, and oil marketers are able to sustain product prices at current levels, they may be able to improve their refining margins.