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Tuesday, January 8, 2008

gremach infrastructure : relook

Investors with a high-risk appetite and a three-four year perspective can consider exposure in the stock of Gremach Infrastructure Equipments and Projects (GIEPL).

While we had recommended that investors refrain from investing in the initial public offer, GIEPL's recent expansion in product portfolio and the subsequent entry into new business segments presents the case for a relook.

Addition of four onshore drilling rigs with plans to add36 more in three-four years, acquisition of controlling stake in coal mines in Mozambique and the booming market for equipment rentals suggest good earnings prospects.

At current market price of Rs 436, the stock is valued at 25 times its likely FY-09 per share earnings, assuming partial dilution of equity and deployment of a minimum of six rigs in FY-09.

This valuation is expensive; but Gremach's foray into the oil rig business and the robust demand prospects suggest strong growth.

Investors, however, can accumulate the stock in lots, given the volatility in the broad markets.
Rigging growth

GIEPL's foray into oil rigs holds immense potential. For one, it offers Gremach a share of the fast-growing onshore oil rig business, where there is a demand-supply mismatch, resulting in rising oil rig rentals. Rising rentals and better utilisation levels have shrunk the average payback period for oil rigs.

Second, the increasing number of onshore blocks in each phase of the NELP (New Exploration Licence Program) points to strong demand prospects. Drilling costs account for 20-25 per cent of the cost of developing an oil well and are showing an increasing trend.

Third, Gremach may also benefit due to the fewer players in the domestic market (Shiv Vani Oil — listed and John Energy — unlisted). Besides, unfavourable cost economics for overseas oil companies to set up onshore rigs in India is also a factor in favour.

Gremach has signed a MoU (memorandum of understanding) with Baoji Oilfield Machinery (BOMCO), subsidiary of China National Petroleum Corp for the delivery of 40 rigs, which includes 36 onshore and four offshore rigs.

The management expects to take delivery of the first rig in the first quarter of 2008 and another three within the current year.

However, effective contributions from the rigs may accrue by FY-09 only. Delivery of the remaining 36 rigs would be spread across the next three-four years. For this purpose, Gremach has floated a Singapore-based special purpose vehicle, Petrogrema Energy Pte, which would be a rental company for supply of rigs.

The company proposes to provide rigs to both Indian oil companies and global players in West Asia and US. This holds significance given the buoyant demand trends in overseas markets.

In this context, Petrogrema Energy's initial breakthrough in terms of obtaining a firm commitment from the state-owned oil company of Saudi Arabia, Saudi Aramco, and a few other oil majors in the Gulf, lends confidence.
Capex mode

The management proposes to invest about $1 billion towards its oil rigs business. In this regard, it has already raised FCCB (foreign currency convertible bonds) worth about $50 million from overseas investors and proposes to compensate for the rest from a mixture of debt, internal accruals and the proposed listing of its Singapore arm.

Despite the highly-leveraged nature of this business, it holds the potential to generate an IRR (internal rate of return) of about 36 per cent with a payback period of over 3-4 years.
Equipment business on a roll

With demand drivers in place, Gremach's equipment rental business has recorded sharp growth.

The change in revenue mix, skewed more towards owned-equipment than re-hired ones, on the back of a firm demand scenario have helped Gremach expand profit margins. Its margins for the half-year ended September 2007 expanded by 14.5 percentage points to about 27.4 per cent.
Entering coal business

Gremach has taken a 75 per cent controlling stake in 11 coal mines in Mozambique. This region falls in the Karoo basin, which is recognised as a prime hard coking coal area in Africa.

Given the global shortage in hard coking coal, these mines, expected to be rich in prime hard coking coal (about 200 million tonnes) could contribute significantly to Gremach's coffers in the long-term. Prospecting of these mines is expected to be complete by mid-2008.

The management proposes to use this acquisition to provide feedstock security to its group firm, Austral Coke & Projects (unlisted), which makes met coke. Our valuation, however, has not factored any contributions from this division.

Any positive results in prospecting in Mozambique, listing of Austral Coke & Projects and the likely setting up of SEZs (special economic zones) by Gremach could also be triggers for taking exposure in the stock.

On the flip side, delays in delivery of rigs or drilling projects and decline in rig rentals during this gestation period pose a downside risk to our recommendation.
 
 
 
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