September 15, 2010

Highlights

Tech Revamp A Difficult Proposition

Storage The Biggest Problem

Indian Chlor-Alkali Industry: Molecular Change

SEPTEMBER 15, 2010

Chlor-Alkali Industry in India

T he global market has had a considerable impact on the Indian caustic chlorine industry. On the one hand, it has to deal with

chlorine, which is neither storage friendly nor amenable to easy disposal; on the other, it has to contend with a glut in caustic

soda in the market due to dumping by China and other Gulf countries.

In this article, we will focus on the caustic chlorine industry, which is part of the chlor-alkali industry. Chlor-alkali is the largest seg-

ment of the basic chemicals produced in India. It accounted for almost 70% of total production (of basic chemicals) during 2009-10.

The chlor-alkali industry in the country mainly produces caustic soda, chlorine and soda ash. The chlor-alkali segment witnessed a

CAGR of 1.43% over the 2003-2009 period, according to the Union ministry of chemicals and petrochemicals.

Both chlorine and caustic soda are indispensible lifelines

for many industries.

Caustic Soda

According to CMIE, growth of the caustic soda industry is

expected to accelerate to 11% during the June-September

quarter compared to 2% growth in the preceding quarter.

Caustic soda is mainly used in the:

textile industry

soaps and detergents industry

aluminium smelting

pulp & paper industry

Overall demand for caustic soda is crucially linked to the

end-use segments. The pulp & paper industry is the largest

consumer of caustic soda. According to CMIE, primary

aluminium production is expected to grow 17% in FY11

due to strong demand from the power, construction and

packaging industries. Demand for paper will be higher ow-

ing to an upturn in the manufacturing segment resulting in

higher consumption of packing paper and paper boards.

The July price of caustic soda stood at Rs 15.8 per kg, 5.4% lower compared to the previous month. Faced with rising cheap imports,

largely from China, Qatar and Saudi Arabia, the government

had imposed a safeguard duty of 15% on caustic soda imports

in December 2009. Safeguard duty is a temporary protectionist

measure, brought in for a limited time period to avert any dam-

age to the domestic industry from cheap imports.

The installed capacity for 2009-10 is 3.2 lakh tonnes and the

industry produced about 2 lakh tonnes in the same period. The

capacity utilisation was only 62% .

India imported about 2.8 lakh tonnes of caustic soda in 2009-

10. Cheap imports had reduced domestic production, resulting

in a fall in average capacity utilisation of manufacturers and,

hence, squeezing margins.

Higher expected demand from user industries (aluminium,

pulp & paper, textiles etc) and lower imports from Q1 FY11

(after the safeguard duty was imposed in December 2009) are

going to lend support to caustic soda prices in 2010-11.

Chlorine

SEPTEMBER 15, 2010

In India chlorine is treated as a byproduct of caustic soda. The main end-product use of chlorine is PVC (Polyvinyl Chloride), via the

intermediates ethylene dichloride (EDC) and vinyl chloride monomer (VCM). PVC is used to make rigid products — such as pipe and

conduit, window, fittings, roof tiles, fencing and automobile parts.

Liquid Chlorine is used as raw material/intermediate chemical for:

PVC and related products

Pesticides

Water and waste water treatment

Chlorinated paraffin wax

Dye and dye intermediates

However, there is more chlorine produced in India than there is demand. Chlorine production has been growing in line with the growth

of caustic soda manufacturing and has not been determined by the growth of the chlorine-based downstream industries. In contrast,

globally, caustic-chlorine industry is driven by demand supply of chlorine.

Globally major portion of the chlorine finds its way to the end-users, especially manufacturers of PVC. But in India the local market

for the end user is still not developed.

Industry Issues and Outlook

Power cost: The major input for in Chlor-alkali industry is power. The other raw material necessary for the production of caustic soda

is brine (a combination of salt and water) which is abundant and inexpensive. Energy costs represent 60% of the total cost of produc-

tion. The industry gets power in some of the states at as high as ` 5/unit. With such high power costs, industry finds it difficult to com-

pete in the international market.

However, most of the plants have installed their own captive power plants. The industry has been demanding that government should

allocate coal blocks on a priority basis for captive power plants and bring down import duty on all fuel oils and gas used for power gen-

eration from the current 5%.

There is also a demand that all taxes levied by state governments on captive

power generation and on the fuels used for power generation (such as, furnace

oil, LSHS, CNG & LNG) can be made VAT-able so that the final cost is free

from cascading effect.

Incentives for conversion of mercury cell plants to membrane cell plants:

Currently, 80% of the industry in India produces through the membrane cell

technology and the balance use the mercury cell technology. These plants using mercury cell technology needs to be converted to more

eco-friendly membrane cell technology. The conversion is highly capital intensive in nature and India is not equipped to provide this

technology indigenously. The sector is completely dependent on imports.

While new membrane cell plant is imported at 5% import duty, the spare parts still attract 7.5% customs duty plus countervailing duty

(please see InFocus dated September 1, 2010, for a definition of ―countervailing duty‖). The customs duty on spare parts used for main-

tenance of these existing plants can be reduced to make it a more viable option. The membrane cell plants are supposed to consume

less electricity, which will help bring down the cost of production and make the industry more competitive in the world market.

Usage of Chlorine:

Peculiarly, caustic soda is in demand in India but chlorine is not. Though Indian companies have excess chlorine, they can‘t even ex-

port it because of the major hazards associated with transportation. Chlorine also finds a place in the list of toxic and hazardous sub-

stances banned for transnational transportation under the Basel Convention on hazardous wastes. Serious questions of adverse health

and environmental effects of chlorine and chlorinated compounds have been raised. Both products — caustic soda and chlorine — are

used for very different end-users with differing market dynamics and it is only by rare chance that demand for the two coincides. The

increased cost of production due to power cost, high technology conversion cost and storage and disposal cost of chlorine can affect the

performance of the existing players in future.

Duty Structure

Excise

Duty Customs Duty

Caustic Soda 8% 7.50%

Chlorine 8% 5%

Soda Ash 8% 7.5%

SEPTEMBER 15, 2010

Metals: The Long Run Vision

Aluminium Makers Oppose Spot Pricing Of Alumina: The country‘s aluminium makers are against the proposal to shift to

spot pricing for alumina due to sluggish Chinese demand and sharp price fluctuations. They prefer the present method of price discov-

ery through long term contracts. (Business Standard, September 9, 2010)

PRU Analysis

Alumina is first derived from bauxite through a refining process and then converted to aluminium through electrolysis.

With the end of annual contracts for iron ore (the raw

material for steel), it‘s time for alumina refiners to take

a look at the prices for aluminium‘s raw material and

develop a pricing methodology that reflects the funda-

mentals.

Globally, alumina is traded mainly on contractual ba-

sis. Prices are usually set annually. Volume agree-

ments are also set for years in advance. About 95% of

the global alumina business gets settled through con-

tracts with the rest carried in the spot market. Histori-

cally, contract prices have fluctuated between 11.5%-

13.5% of the LME prices.

Market for alumina has been mainly controlled by

integrated players. The primary alumina buyers are

independent smelters and integrated aluminium com-

panies with smelting capacities that require alumina in

excess of the aluminium produced by their refineries.

In recent times, most of the alumina demand has been

coming from China.

When price of the base metal shoots up, miners and alumina producers gain if they switch to short-term contracts or spot pricing

system. At present, aluminium is around $2,050 a tonne on LME and alumina contract prices are in the range of $310-330 a tonne.

Shifting to a spot market regime and delinking alumina from aluminium prices on LME doesn‘t seem very viable.

It‘s difficult to separate alumina pricing from aluminium as its demand depends on the overall demand for aluminium.

With a slump in demand for the metal due to tightening of the Chinese economy, shifting to spot market doesn‘t seem viable

for aluminium manufacturers.

According to National Aluminium Company, which exports about 45% of the alumina produced, shifting to a quarterly pric-

ing regime (like in the case of iron ore) seems difficult, as alumina can‘t be stored for long and needs a commitment of a con-

tract to be delivered.

However, gradual transition from contractual pricing to spot pricing will depend on the companies and industry as a whole.

Mining Cos Cut Output On Low Steel-Mill Demand: India‘s independent iron ore companies have cut output by 80% since

June due to uncertainty over exports and recovery in demand from domestic steel mills. (Business Standard, September 14, 2010)

PRU Analysis

Low grade iron ore is available only in Chitradurga and Tumkur districts in Karnataka. Up to 25 of the 90 operational mining com-

panies in the state export over 10 million tonnes of low-grade iron ore from these two districts. These miners have cut output by as

much as 80% since June this year.

Independent iron ore miners like Sesa Goa, MSPL, Bharat Mines and S K Modi have been losing out. They don‘t have steel pro-

SEPTEMBER 15, 2010

duction facility and sell the entire output to others.

There reasons for the fall in output are:

Government raised the royalty to 10% of the prevailing market price of the mineral from ` 27 a tonne about a year ago. The

cost goes up to around `125 per tonne post revision.

The world‘s largest steel maker and importer of iron ore, China, banned import of iron ore (with less than 60% of iron con-

tent).

Up to 80% of the iron ore exports from India are mainly low grade ore.

Most small steel mills in China have been closed or asked to trim output as the country has to meet the year-end power saving

target.

Meanwhile, as a fallout of the massive mining scam, Karnataka banned iron ore exports recently. The Indian steel industry is be-

lieved to have welcomed this ban as it ensures ample supply of iron ore to the domestic players.

There has been lot of talk recently about preserving the iron ore for future use in India. The Indian steel industry witnessed a period

of strong growth in 2003-07, with production and consumption increasing at a CAGR of 13% and 11% respectively. However,

recently demand picked up following a huge thrust in infrastructure development and robust growth in automobiles. The govern-

ment has set a target of 110 million tonnes of steel production by end 2019-2020, to cater to the robust domestic demand. Hence,

domestic consumption of iron ore is also expected to go up in tandem.

The ban on iron ore export has, ironically, led to a cut in production rather than the produce being diverted for domestic consump-

tion; the reason is that Indian steel makers either buy high grade iron ore or pellatise the low grade one. Also, companies like SAIL

and Tata Steel have captive mines. However, in the long run the ban will only benefit the country as its reserves will not get de-

pleted as quickly.

IIP: That Good Feeling Again

IIP Estimates For July 2010 Are Extremely Encouraging, Says FM: Union finance minister Pranab Mukherjee has said the

estimates of the index of industrial production for July 2010 are extremely encouraging. (Press Information Bureau, September 10,

2010)

PRU Analysis

The index of industrial production (IIP) rose to 330.8 in July 2010, up 13.8% compared to the year-ago month. This was way

above market expectations. Industrial output growth was expected to grow sluggishly -- in the 7-8% range -- in July, as it had

slipped to a 13-month low of 7.1% in June (later revised further downwards to 5.76%).

Cumulative growth for April-July 2010-11 stood at 11.4% over the corresponding period of the previous year. The high growth numbers are backed by strong performances by the manufacturing and mining sectors. Of the 17 industry groups,

up to 12 have shown YoY growth during July

2010 compared to the previous year.

Machinery & equipment has shown the

highest growth of 49.4%.

A robust 24.9% growth was also seen in

transport equipment & parts.

Rubber, plastic, petroleum and coal prod-

ucts rose 19.4%.

Jute and other vegetable fibre textiles

(except cotton) rose 19.3%.

On the other hand, wood & wood products and

furniture & fixtures declined 9.4%, while beverages, tobacco & related products declined 2.1%.

Use-Based Classification of IIP (Base 1993-94=100)

July-10 % YoY

growth

Apr-July

2010

% YoY

growth

IIP 330.80 13.76 315.40 11.45

Basic Goods Index 251.20 5.15 253.50 6.37

Capital Goods Index 620.70 63.00 491.32 35.57

Intermediate Goods Index 325.80 9.11 315.75 9.71

Consumer Goods Index 340.40 6.74 335.05 8.69

Durables Index 597.40 22.14 562.88 26.38

Non-durables Index 281.20 0.54 282.57 2.13

Source: CSO, DhanBank PRU

SEPTEMBER 15, 2010

Capital goods recorded the maximum growth during the month. However, it must be noted that the growth figure in this sector has

seen wild swings – from exuberance to slumps -- almost every quarter. While the month-on-month growth in capital goods has

moved in step with IIP, its variation from the average has been far higher than IIP. While the capital goods segment has been rising rapidly, growth in intermediate goods has been slower. Also, a moderate increase

in production of consumer goods indicates slower growth in consumer demand for non-durables.

Also, growth in capital goods cannot be taken as a reason to rejoice growth in investments. Because the core infrastructure sector

has been growing at a far slower pace, with cement production being the weakest. Also, credit growth in the economy has been

under 20%.

The Central Statistical Organisation has also revised the June IIP figure downwards by 130 basis points to 5.8% (1st revision) and

that for April 2010 under the second (final) revision. Thus, analysts expect a revision in the July figure as well. Thus, the provi-

sional figure must be taken with a pinch of salt.

Telecom-Power: Symbiosis

Power Grid Eyes Telecom Tower Biz To Boost Revenues: State-owned Power Grid Corp of India (PGCIL) plans to expand its

telecom business by leasing out transmission towers to firms such as Bharti Airtel, Vodafone Essar and Bharat Sanchar Nigam. (Mint,

September 9, 2010)

PRU Analysis

India, the world‘s second largest mobile phone market, is also among the fastest growing. While the number of telecom subscribers

is rising rapidly, average revenue per user (ARPU) is falling. Tele-density in India is also low, particularly in rural areas. So if tele-

com providers need to expand their base, they need to tap the vast potential in rural India. This requires a reliable infrastructure set-

up involving huge costs.

Given the current scenario, where telcos have invested huge amounts in buying 3G and broadband spectrum, pumping money into

new infrastructure, such as telecom towers in rural areas, will be a stressful proposition. It is in such a situation that PGCIL has

offered them a timely ride on its back.

Passive infrastructure that includes steel towers and antennas, among other components, is one of the most important elements of a

mobile phone network and a critical area of operation for telecom companies.

SEPTEMBER 15, 2010

According to ICRA‘s estimates, passive infrastructure accounts for 60-70% of the total cost of setting up a wireless network.

PGCIL plans to enter the telecom tower business by leasing out its towers to telecom providers. Telecom operators can put up a

maximum of three antennas per tower. Given the advantage it has in terms of reach in semi-urban and rural areas, the company

believes this move will increase its revenues by `400 crore within eight years.

The telecom industry is estimated to require around 93,000 more towers to meet the growing demand in the next five years. And

PGCIL has a nationwide network of 1,50,000 towers, with 70% of them located in semi-urban and rural areas. It initially plans to

lease out only around 10% of them.

Other players in the telecom tower business include Indus Towers (with 100,000 towers, or nearly a third of India's 330,000 tow-

ers) and GTL Infrastructure. PGCIL will enter a business led by Indus Towers, a JV of the three largest telecom service providers,

Bharti Airtel, Vodafone Essar and Idea Cellular.

Examples of industries that give a piggyback ride to other industries include Indian Railways (telecom cables along train tracks)

and gas pipelines (cables along the pipeline network).

Source: ICRA

SEPTEMBER 15, 2010

Tourism: Entry Barrier

Decline In Number Of Foreign Visitors In August: With less than a month left for the Delhi Commonwealth Games, statistics

show that foreign tourist arrivals in India in August has declined as against July this year. (Reuters, September 8, 2010)

PRU Analysis

The number of foreign tourists that arrived in

the country in August 2010 dipped to 3.82 lakh

compared to 4.52 lakh in July. However, on a

YoY basis, the number was higher by 9%. Arri-

vals during the January-August 2010 were

34.67 lakh, with a growth of 9.7 % as com-

pared to a decline in the year-ago period. Foreign exchange earnings (FEE) from tourism

in India was $992 million, up 16.6% as com-

pared to the year-ago month. The growth rate in

FEE in rupee terms in August 2010 was 12.3%

higher than August 2009. Due to the rupee‘s

appreciation, rupee earnings from arrivals grew

at a slower pace than dollar earnings.

October-March is generally the peak season for

Indian tourism. Besides, India is going to host

mega sporting events like the Commonwealth Games in October 2010 and the ICC Cricket World Cup in February-March 2011.

These events are expected to attract a larger number of foreign tourists. About four lakh foreign tourists are expected to visit Delhi

during the 12-day Commonwealth Games.

Whether the number of tourists will match up to expectations or not, the hotel industry is on the revival path. Aggregate net sales of

the industry grew 16.1% in the June 2010 quarter. Over 70% of the companies reported higher sales during the quarter. Higher oc-

cupancy levels and improved average room rates are driving this growth.

Auto: Eying The Future

Maruti Lines Up Rs 1,925-Cr Investment For Sixth Plant: Maruti Suzuki plans a fresh investment of `1,925 crore in its pro-

posed sixth plant that will help the firm produce an additional 2.5 lakh cars by 2013. (The Economic Times, September 8, 2010)

PRU Analysis

Maruti Suzuki, India‘s biggest car maker, is seeing unprecedented growth in demand for its cars at a time when its market share

has dropped below 50% (in 2010) for the first time in over two decades. Competition is strengthening with many small cars

launched by such global giants as Volkswagen, Ford, and Nissan, even as demand for its own models burgeons. The company,

however, faces severe capacity constraints.

To tackle the rising demand and manage competition, Maruti has planned a sixth plant at Manesar, around five kilometer from

Gurgaon, Haryana.

Maruti‘s total current capacity: 12 lakh units

Three plants at Gurgaon with a total annual capacity of 8.5 lakh units

Plant at Manesar with annual capacity of 3.5 lakh units

SEPTEMBER 15, 2010

Additional capacity creation:

In February 2010, the fifth plant at Manesar was announced with annual capacity of 2.5 lakh units. It will be ready by January

2012 and will involve investment of `1,700 crore.

The sixth plant with an annual capacity of 2.5 lakh units will be constructed along with the fifth plant at Manesar. It will entail

an investment of `1,925 crore and is likely to be ready by end FY12 or early FY13.

The existing plants at Gurgaon and Manesar will also undergo capacity enhancement. After all this, Maruti‘s total annual capacity

will touch 17.5 lakh units. As per SIAM, Indian car sales are set to hit 30 lakh units by 2016. If all these plants become operational

as planned, Maruti could increase its market share back to over 50%.

The company will further invest `2,500 crore in an engine plant and an R&D centre at Rohtak, Haryana. All these investments will

be funded by Maruti‘s internal accruals. Its cash reserves stand at around `7,000 crore.

Retail: Another One Takes A Bow

Shriram, TPG Capital To Buy Vishal Retail For Rs 100Cr: Debt-laden Vishal Retail has said its board has approved the sale

of its retail trading business to Chennai-based Shriram Group and the wholesale business, institutional sales and franchise operation to

private equity company TPG Capital. (Hindu Business line, September 14, 2010)

PRU Analysis

Vishal Retail operates 170 stores across India under brands such as Vishal Megamart, Vishal Retail and Vishal Fashion Mart. After

reporting operating losses for six consecutive quarters, it has finally decided to sell its core retail business to Shriram Group and

wholesale business, institutional sales, and franchise operations to TPG, a private equity investor. The total deal value is estimated

to be `100 crore.

The Vishal Retail board has approved the proposal and the company will conduct a postal ballot to seek shareholders‘ approval.

The results will be announced on October 25. The deal does not include Vishal‘s freehold properties in Hubli, Kolkata, Dehradun

and Jabalpur.

The `100-crore valuation for the deal has been found to be lesser than what was expected by the market. A sum of `75 crore will

be received upfront and the balance via bonds with yield to maturity of 7.5%, redeemable in five years. The sale proceeds will

partly meet the huge debt outstanding of `730 crore with banks such as SBI, HDFC Bank, HSBC and ING Vysya Bank. These

banks were also part of the company‘s debt restructuring exercise.

How did Vishal Retail land in this trouble?

It had raised `110 crore in June 2007 through a public issue that was oversubscribed 81 times, just before markets crashed. The

company expanded aggressively, funded by short-term loans. This strategy cast a shadow on the company when consumer senti-

ment hit rock bottom following the worldwide financial crisis. Sales fell and losses mounted in 2009, causing multiple bank de-

faults and forcing the company to go for corporate debt restructuring.

What’s in Store?

The company will be bailed out and this will prevent it from joining the category of Subhiksha, which had to put up shutters when

it couldn‘t manage the debt taken to finance aggressive roll outs of stores at the peak of the retail boom.

In almost two years of its struggle, Vishal Retail tried to take some corrective measures such as shutting down loss-making stores,

warehouses, manufacturing facilities and downsizing its employee base. This deal is the last resort as it has been trying to scout for

a strategic buyer for some time now.

Post deal, Vishal Retail may have to look for other avenues for business opportunities as its core business -- retail trade -- will be

controlled by Shriram. Vishal Retail will not be able to get into similar businesses due to the non-compete agreement with the buy-

ers.

SEPTEMBER 15, 2010

FMCG: The Underdog’s Day

Bimaru States Provide Oxygen To FMCG Firms: Once considered the laggards in economic growth, the Bimaru states are now

looked at as productive markets for fast-moving consumer goods (FMCG) companies. (Business Standard, September 8, 2010)

PRU Analysis

The acronym Bimaru stands for ‗Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh‘. These states used to pull down the overall

average GDP growth of India. But now some of these states, especially Bihar, have started registering impressive growth rates,

albeit on a low base.

Interestingly, these states are now hogging the limelight in the plans of FMCG

majors.

Emami, for instance, has revealed that these states contribute 35-45% of its

total sales. Godrej Consumer Products says 17-18% of its total sales come

from these states. Godrej spends 66% of its total advertising and promotional

expenses on regional areas. Dabur has registered double digit growth in these

states in FY10. It launched special, rural-focused sales initiatives across eight

states – UP, Punjab, MP, Bihar, Chhattisgarh, Maharashtra, West Bengal, and

Gujarat.

Wipro Consumer Care & Lighting is increasing focus on these states as the

rural economy of these states is doing well and road infrastructure is also im-

proving. This infrastructural improvement will go a long way in helping FMCG majors penetrate these markets.

Factors which are driving FMCG sales are:

Younger population which wants to try their products instead of locally made ones

Higher brand loyalty in rural areas

NREGA leaving more money in the hands of consumers

Per capita incomes of Bimaru states have started growing at rates matching the national average

Up to 40-60% of FMCG companies‘ growth is driven by rural areas; hence, the Bimaru states hold a lot of potential. An inclusive

growth agenda will help these states improve their contribution to FMCG sales. Therefore, most FMCG majors are expecting better

growth from these states.

SEPTEMBER 15,

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