Sunday, October 25, 2009

Crude Prices - What to Buy and Avoid

Crude prices are once again on an upward spiral leading to fears about the impact on the margins of companies in various sectors. Analysts tracking markets say any further increase could lead to inflation rising at a faster pace. As a consequence,stocks in sectors like fertiliser, textiles, pharma, automobile, tyre, paints and aviation could be affected if the surge continues.

However, the strong rupee will act as a countervailing force which may ensure that their cost of raw material does not spin out of control. But should crude go beyond $100 a barrel from the levels of $80/barrel, there could then be some real cause for concern, feel analysts.

“Crude oil prices have more than doubled from their 52-week low levels. If the price of crude oil continues to increase and if the government decides to pass on the additional cost to consumers, it is expected to lead to an increase in inflation at a much faster pace compared to the anticipated level of 6% by March 2010. In an otherwise scenario, if the price increase is not passed on and the government bears the hike in the price of crude oil, then the fiscal deficit situation is expected to worsen further from the budgeted 6.8%. If the fiscal deficit figure, which is closely monitored by investors, rises beyond an extent then it can negatively impact the broader markets,” says Vishal Jajoo, research analyst of FCH Centrum Wealth Manager.

Oil prices have tumbled from the historic highs of more than $147 per barrel in July 2008 to about $32 per barrel in December because of the global recession, but have since risen on hopes of recovery. While the prices have still not gone to dangerous levels, they are not very far from it, say analysts. “While so far the direct impact has been limited, if prices retain this momentum, it could adversely impact companies’ profitability. The market is in a wait-and-watch mode,” said an analyst with a domestic brokerage.
The worst hit would be companies that rely on petro products either as feedstock or for meeting their energy needs. The list includes companies in sectors as diverse as tyres, cement, fertilisers & chemicals, synthetic textile, among others. In the tyre industry, for instance, bulk of the feedstock is derived from crude oil and its downstream products. The previous rally in crude oil prices resulted in a sharp rise in industry’s raw material cost and adversely affected the company’s profitability. In the past 3-4 years, industry’s raw material cost as a percentage of net sales jumped 600-1000 basis points to over 70% currently. A similar trend was visible in synthetic textile, fertilisers & chemicals industry.

Some of the leading firms that will be affected in the tyre industry include Apollo Tyres, MRF, Ceat and JK Tyre, among others. Among fertiliser companies, Chambal Fertilisers, Zuari, RCF and Nagarjuna Fertilisers will take the maximum hit. In the textile sector, the impact would be felt by companies like Century Enka, Vardhman Textile, Garware Wall-ropes and RSWM, among others. With its fortunes directly linked to international prices of aviation turbine fuel (ATF), stocks of Deccan Aviation, Jet Airways and Spice Jet could be another casualty of rising oil prices.

But some companies will benefit. Analysts maintain that investors should preferably invest in companies like ONGC, Reliance Industries and Cairn India, particularly if oil continues to explore higher levels. Some other sectors that would be positively impacted because of high crude prices are offshore services providers Great Offshore, Aban Offshore, Garware Offshore and ancillaries like Selan Exploration and Shiv Vani Oil. Shipping companies Varun Shipping, Shipping Corporation of India, GE Shipping and Essar Shipping, which carry crude, are also likely to benefit as demand will be higher.

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