Author: niveshaay@gmail.com

The company filed three applications to the Supreme Court related to import of GPC and CPC. Please find the attached file on the same highlighting the decision passed by the Supreme Court and its impact on the company.

Niveshaay Rain Industries Ltd. Company Update

Supreme Court allows import of Petcoke with some caveats : Relief for Aluminium and Calcining Industry

Please find the attached note on the same.

Niveshaay Update on Petcoke II

CHAPTER 1: TRUST DEFICIT
If someone painted India’s NBFC rout in the colors of Lehman crisis, we wouldn’t call it foul as there are uncanny similarities in the US sub-prime boom and India’s NBFC surge. Over a quarter of multi-baggers in the last five years would be an NBFC. These shadow banks have been witnessing spur in the growth in consumer lending space much faster than banks, particularly after the unravelling of NPAs can of worms.

But now, there is skepticism about the very ability of NBFCs to raise funds. With the cost of funds moving up, fears are growing that NBFCs, which are dependent on wholesale funding, will struggle to access capital. Borrowing costs have gone up with a rising yield and a widening current account deficit. Moreover, the RBI’s attempts to check decline in the rupee have driven out much of the liquidity in the market as the bank is sucking up rupees and selling dollars.

NBFCs raise funds mainly by issuing debentures & commercial papers and borrowing from banks. Despite a spike in systemic rates, their cost of funding has actually been falling as commercial papers became relatively cheaper. Many home finance companies (HFCs) migrated towards shorter-tenure borrowings in recent times, as the shorter-tenure borrowing became comparatively cheaper by about 100 basis points. But there lies the problem, as it has now created an asset-liability management (ALM) mismatch. Brokerage Emkay Global says 12 per cent of DHFL’s liabilities (nearly 17 per cent of market borrowings) are maturing in three months against 9 per cent of total assets (nearly 3 per cent advances).

About 50 per cent (NCDs-CPs) of NBFC borrowings are largely at a fixed rate, while over 35 per cent of bank borrowings get repriced on a quarterly or annual basis. As the share of bank borrowings begins to increase and borrowings with annual reset dates are expected to get repriced, retail NBFCs are expected to face increased pricing pressure in the second half of FY19, shrinking their net interest margins (NIM).

Since mid-September, rumours have been making rounds in the markets that there is already a systemic liquidity problem in the NBFC space. NBFC stocks have been on a free fall. A kind of contagion then spread to other financial stocks, and the benchmark indices crashed, creating bearishness all around. Some fund houses have already started cutting bond holdings, particularly from NBFCs, and are seeking to sit on cash, because of market uncertainty and apprehending a possible surge in redemptions. DSP mutual fund’s move to sell off DHFL papers also added to liquidity concerns over the commercial papers of NBFCs.

CHAPTER 2: DEFAULTS AND DOWNGRADES
On 21st June, IL&FS’s subsidiary IL&FS Transportation Networks (ILTN) defaulted on inter-corporate deposits and commercial papers worth Rs. 450 Cr. After the first default, between June and July, four of ITNL’s project special-purpose vehicles reported irregularities in debt servicing, showed an ICRA ratings note. “ITNL’s gross leverage (debt/EBITDA) remains high at 6.9 times and its interest coverage remains weak at 1.2 times”, said India Ratings in a note on July 25 while downgrading the company’s rating to BB from A.

Since IL&FS operates as an RBI registered “Core Investment Company”, its operations are restricted to investment in other group companies. Therefore, the health of its subsidiaries has a direct bearing on IL&FS’s own finances. For some of the outstanding debt instruments of the subsidiaries, IL&FS has guaranteed any shortfall in payments. In August, ICRA downgraded the long-term rating on Rs 4,475 Cr worth of debt securities from AAA to AA+ taking into account the “company’s elevated debt levels due to the funding commitments towards group ventures”.

On September 4, IL&FS again defaulted on a short-term loan of Rs 1,000 Cr from SIDBI (Small Industries Development Bank of India), while its subsidiary defaulted Rs 500 Cr of dues to the development finance institution. Following this, taking into account the liquidity pressure and over-leverage, ICRA downgraded IL&FS rating from AA+ to BB (junk or non-investment status) on 10th September and then to D on 17th September.

IL&FS long-term debt-to-equity ratio has risen to 3.08 times as of March 2018, compared to 2.60 times in March 2017. The group’s consolidated debt increased by Rs 11,211 Cr in financial year 2017-18 to Rs 91,091.30 Cr as of March 2018. With relatively high leverage, even selling strategic stakes in various projects/group companies had been inadequate to meet the further funding commitments to the group companies leading to an increase in the debt levels of IL&FS. In a letter to its employees, IL&FS claimed that if funds worth Rs 16,000 Cr stuck with concession authorities were released on time, it would not have landed in this mess, said a PTI report.

On Friday, 28th September, the RBI met large shareholders of IL&FS to decide on revival and capital infusion plans for the company. IL&FS’s investors include biggest Indian insurer LIC, top lender SBI, largest mortgage lender HDFC, Abu Dhabi Investment Authority and Japan’s Orix Corp.

On Saturday, 29th September, troubled Indian shadow bank IL&FS secured a lifeline after shareholders approved its plans to raise money through debt and equity. Stockholders voted in favour of IL&FS’s plans to raise as much as 15000 Cr rupees through a non-convertible debt issue, hike the firm’s borrowing limit by 40 percent to 35000 Cr rupees and increase its share capital to enable a rights offering
On 1st October, after all the drama, curtains went down when Government officials ousted IL&FS’s management and instituted a new six-member board including Uday Kotak and former head of the SEBI, GN Bajpai. Superseding the board of IL&FS, the government has pledged to ensure the beleaguered lender has the money to prevent further defaults.

The MF industry had more than Rs. 2,900 Cr exposure to IL&FS and its listed subsidiaries, said a Value Research report. NAVs of Mutual Fund Schemes were impacted by rating downgrades as well as defaults. AMCs exposed to such risk re-evaluated the impact on their NAVs and consequently provided for losses and devalued their NAVs considering the rise in credit risk & bond yields and fall in bond prices. And in this chain of events, cautious investors started exiting from mutual fund schemes having exposure to IL&FS, creating redemption pressure.

CHAPTER 3: COLLATERAL DAMAGE
In order to cater to such redemption pressures, DSP Mutual Fund was forced to sell NCDs, a short-term debt instrument, of DHFL worth Rs. 300 Cr at a higher yield of 11 per cent in the secondary market, as they didn’t find immediate buyers. This triggered a speculation that DHFL could be facing liquidity issues and there could be ratings downgrade in the HFCs. Even after DSP clarified the sale reflected its view on interest rates, rather than its credit view on a specific issuer, shares of non-bank finance companies (NBFCs) took a massive hit on 21st September, with DHFL and Indiabulls Housing Finance tumbling around 60% and 30% respectively in intraday trade. DHFL lost Rs 10000 Cr in the market capitalisation during the day.

If rumours were to be believed, in the wake of recent IL&FS papers downgrade, DHFL and Indiabulls Housing Finance could also find it difficult to meet their respective loan obligations going ahead leading to liquidity crisis. This contagion had a ripple effect and spread the panic to the entire NBFC space with Edelweiss Financial, Bajaj Finance, Shriram Transport Finance, M&M Financial Services & Indiabulls Housing plummeting. Ongoing crisis at IL&FS triggered the sell-off, as market feared that an ‘IL&FS-like’ situation might emerge across NBFCs.

As shares of the entire home-financing sector went into a tailspin, dragging the broader markets with them, the management of DHFL and Indiabulls Housing Finance clarified their stand on the issue and assured public investors that they do not face any liquidity crisis and are well placed to meet loan repayment obligations.

CHAPTER 4: THE SIDEKICK: BANKS

1. YES BANK
Shares of YES Bank have plunged around 45 per cent this month. The RBI had curtailed the 3-year term extension that the board had sought for Rana Kapoor, also one of the promoters, to January 31, 2019, and asked the bank to find a replacement. The scrip dropped further on Friday after reports that Madhu Kapur, wife of late Yes Bank co-founder Ashok Kapur, sold around 0.04 per cent of her stake in the bank in the open market on September 21.

The lender has been facing challenges in the form of doubts over bad debt and uncertainty over leadership since the RBI’s order. In a BSE filing, YES Bank clarified, “Over the past few days, some unfounded speculations regarding the bank’s asset quality have been brought to its notice. In this context, the management clarifies that the asset quality continues to be stable. The bank has a liquidity coverage ratio of 101 per cent as on September 30, 2018, which is 11 per cent points in excess of the minimum regulatory requirement of 90 per cent.”

The National Stock Exchange (NSE) had earlier sent a notice to the lender, seeking its response to allegations that Kapoor’s family office was running a parallel lending or investing business by compromising the interest of YES Bank. However, YES Bank vehemently denied any dealings with the Three Sisters Family Office, which is run by the bank’s founder CEO Rana Kapoor’s three daughters.

On account of the RBI’s action, CARE Ratings said, various debt instruments issued by the Bank, which were upgraded to AAA with a stable outlook from AA+ on July 5, 2018, now carry a rating of AAA credit watch with developing implications. Instruments include-Infrastructure Bonds, Lower Tier II Bonds, Tier II Bonds (Basel III), Additional Tier I Bonds (Basel III), Upper Tier II Bonds and Perpetual Bonds (Basel II).

2. BANDHAN BANK
RBI’s licensing norms require a private sector bank to bring down its promoter shareholding to 40 per cent within three years of operations. But Bandhan Bank was not able to bring down the shareholding of nonoperative financial holding company (NOFHC) to 40 percent as required under the licensing condition and hence general permission to open new branches stood withdrawn and the bank can now open branches only with prior approval of RBI. Also the remuneration of the MD & CEO of the bank stood frozen at the existing level, till further notice by RBI.

On 1st October, Shares of Bandhan Bank Ltd hit a lower circuit of 20%, their biggest single day decline since listing. Brokerage ICICI Securities reduced its target multiple on the stock from 6 times earlier to 4.7 times FY21E book. It said the stake sale may be highly EPS and RoE dilutive. The brokerage has however retained its buy rating citing robust growth, healthy margins and low cost to income. In the short-term, the stock could hover at a corrected level until there is clarity from management.

3. KOTAK MAHINDRA BANK
Kotak Mahindra Bank fell over 12% on Monday, its biggest fall in nine years, after analysts feared a similar action after the bank failed to reduce its promoter holding last month. Kotak Mahindra Bank has to pare its promoter stake to less than 20% in the next three months. Uday Kotak, vice chairman and managing director of the Kotak Bank, currently holds a 30.03% stake in the bank. The RBI in August rejected its proposal to issue non-convertible preference shares to reduce promoter holding.

NIVESHAAY’S VIEW:
The combination of confusion and panic emanating from above events has led to sharp fall in NBFCs, HFCs and finance Stocks. Liquidity concerns emerging from NBFC news have concerned many investors on the financial position of Small & Midcap Companies. We continue to hold well managed companies, not having liquidity concerns and find ourselves fortunate to not have any exposure in NBFCs currently. But we plan to add them as markets have thrown this opportunity and also that the overvaluation in a lot of quality companies have corrected and is expected to stabilise over the coming 4 to 5 months, which gives us a comfort on the downside protection with a good upside potential. These times of panic are opportunities in disguise to deploy lump-sum capital. We are more bullish than ever at such attractive valuations.

We have been getting queries from many people after the notification issued by the government on banning the use of Petcoke and there are many messages floating around various circles regarding the same. Many people are not sure how would it affect the business of Rain Industries Ltd.

We would try to throw some light on the issue as we have been in touch with many industry experts including Petcoke importers, Calciners and aluminum plants.

Firstly, we would like to bring to your notice that the matter is not new which is being discussed and the ban was already announced by the Honorable Supreme Court wide its order dated 26^th July, 2018. The implication of the same was explained by the company in detail in its Concall and the same was highlighted by us in our update of the quarterly numbers.

The management of the company on the call had highlighted that they already have 3 months inventory of the raw material. It also mentioned that it expects a favorable order soon as not allowing imports can disrupt the whole value chain of aluminum in our country including the production of the government of India undertaking, Nalco Ltd.  The loss to the smelters and the government would be much larger in quantum than to the Calciners like Rain who also have global operations and India business would be contributing just 15 % to their profits.

 The following is our understanding of the matter:

• The court in its order had intended to ban use of Petcoke as a fuel and not as a feedstock. Rain uses anode grade Petcoke as a feedstock only and not as a fuel.
• The court has set a deadline for representation to be made and studies to be made and would be deciding on the matter by 1^st October, 2018. Given the stakes involved of the aluminum industry and that of the undertaking of the government enterprise itself i.e Nalco ltd, it seems less likely that the court would decide otherwise and Rain has sufficient quantum of material available till that time.
• Rain Industries has already made a representation by its lawyers and the next hearing is scheduled on 22^nd August,2018
• People in the industry say that the refiners in India are not capable of producing anode grade coke and 95 % of the anode grade coke required by Indian aluminum smelters is imported hence there is no alternative to import.
• Aluminum smelting cannot happen without use of anodes, which use Calcined Petcoke as a raw material. Hence, there is no alternative to manufacture aluminum without the use of anodes, which require Calcined pet coke.
• Companies like Rain still have global operations hence the impact would be in the range of 12% to 15% of their profits in extreme situation versus the other Calciners who have just Indian operations. Their whole business would go for a toss if the ban were to be permanent.
• Rain has 3 months of inventory already available at its plants as was highlighted by the company in its Concall.
• Rain facility is state of the art facility in Vizag with a Zero discharge plant and having fully compliant environmental practices, hence it has the strongest case in the industry to get the permission.

In our understanding of the whole situation the following are the risks and opportunities emanating from the current situation:

Risks

1. The Government doesn’t allow the imports even after representation.

The chances of such an outcome are almost close to negligible, as it would disrupt the whole aluminum manufacturing industry in India.

2. The Government takes much longer time than 3 months to give approval.

In this scenario, the Calciners including Rain Industries start to suffer as their production starts taking a hit and their short term profitability gets impacted.

3. The Government allows the aluminum smelters to import CPC directly from China and other countries to survive :

Such a decision would make the whole Calcining industry to shut down and create a dependence on foreign imports completely of a commodity which is very important for the aluminum industry. Given the stance of the government in fact to impose anti-dumping duties and discourage imports it’s really tough to believe why would it want to encourage imports in this case where the Calciners are not even using petcoke as a fuel which is the major concern of the government and the Supreme Court.

Opportunities:

1. The government sets norms of importing and stricter compliance:

This can emerge as a big long term opportunity for Rain as it being the leader and already compliant as per the global standards, it would be able to gain market share as many small Calciners would not be able to comply or they would be required to install pollution control equipments at their plant hence increasing their CAPEX and OPEX which Rain doesn’t need to as it already has that. Also the upcoming new plant of Rain next year would get higher utilization rates very soon due to such a development.

2. This move may even trigger consolidation in the industry :

Already struggling with high working capital requirements and unavailability of calcinable petroleum coke, the small players might be further discouraged to continue operating by themselves in a tough regulated environment; instead they may decide to merge with bigger Calciners.

3. The prices of CPC may shoot up in the short term :

As the ban on imports creates a short supply but bigger Calciners like Rain and Goa Carbon have few months of inventory on their hand and they might benefit from the short supply. The ability to do that would be limited as most of them have medium term contracts due to which they would not be able to change the prices abruptly.

All in all our assessment is that the only concern is the timing of the allowance by the Court on the subject matter and the norms which are fixed by the government for the same rather than weather the imports would be allowed all together or not.