Wednesday, March 16, 2011

What Cals Refineries' Tie-up with Hardt Group Implies

Cals Refineries (BSE: 526652) has announced that it has entered into agreements with Hardt Group GmbH, an international alternative investment firm, for purchasing two refineries, which is understandably for their Haldia Project's Phase-II. This new development has re-ignited the interest in Cals Refineries'  scrip which was trading low since the last couple of years.

The refineries are now owned by some Hardt associates. The two refineries are Cenco Refining Company's unit in Santa Fe Springs, near Los Angeles, and the Atas Refinery in Turkey's largest port city of Mersin. Both would require significant refurbishment, which Hardt has agreed to arrange before shipping. While Cenco is a 50,000 bpd refinery, Atas' capacity is around 1,00,000 bpd.

Earlier, in 2008, Cals had entered into an agreement to buy Bayernoil's Ingolstadt refinery through Lohrmann International, which when dismantled, shipped, and re-erected in Haldia, would form the Phase-I of the project. But the project had run into rough weather due to the financial meltdown of 2008-09, and only recently has been the project revived up through a planned $150 million investment from Kharafi Group of Kuwait. The financial closure (FC) for Phase-I is yet to happen.

Also Read: Cals Refineries Latest News on – SEBI, CCEA, FIPB, Hardt, EPCC, Bayernoil, West Bengal, SHP

The most interesting aspect about the new development regarding Phase-II is that the sellers of these refineries - which are some associates of Hardt - have agreed to be equity partners in the project, in return for the refineries. For this, Cals Refineries will be coming out with a GDR of $317 million, and the Hardt associates will be mainly paid through these GDRs, as also a cash payment of $100 million, but at a later date. 

Apart from its associates who own these refineries now, Hardt Group also is coming in as an equity participant in Cals Refineries, by subscribing for a $7 million or Rs. 31.5 crore preferential allotment which Cals plans to undertake. Signalling their active participation in the project, Hardt and its associates will be nominating two Directors in Cals Refineries' Board.

Hardt has a track-record in financing and arranging international refinery re-location projects, which is Cals' main strategy. 

One thing to note from the 'Progress of Project' report Cals filed in BSE regarding Hardt Group / their associates coming in as strategic investors, is that this is entirely about the Phase-2 of Cals Refineries' Haldia Project. Nothing has been mentioned about the ongoing Phase-1, especially about where the Kharafi deal stands, and where the arbitration with Lohrmann has reached. Maybe these will be filed soon under a separate progress report.

However, this report does mention that the total capacity of the Haldia Project would become 2,00,000 bpd, which should signal that Cals is confident of Phase-1 which is about relocating the 1,00,000 bpd Bayernoil, Ingolstadt refinery. But the question of whether there will be further cost overruns for Phase-I due to the ongoing arbitration with Lohrmann is still not clear.

If one takes even a basic look at Cals' numbers, there is no apparent reason why a company of Rs. 800 crore equity should trade at Rs. 250 crore market cap. The net worth is also intact at around Rs. 800 crore. Why it is so 'undervalued' is simple. Due to the unprecedented time/cost overruns, almost all of that equity has been spent already, but with no definitive outcomes still. Even more equity / debt is needed to salvage Phase 1. That is why their P/BV hovers around 0.30 times. Piled up on that is their contingent liabilities, which even though has come down from monstrous proportions, is still now at a sizeable Rs. 2800 crore odd. 

Now coming to deals like Kharafi and the recent Hardt, they are definitely significant positives for the company. It will no doubt amount to dilution, but without much dilution, nothing positive is going to happen in a big project like Cals Refineries. So, if we take a quick look at the upcoming dilution, it goes like this - $150 million from Kharafi + $100 million remaining for Phase 1 + $317 million for Phase-2 refineries + $7 million from Hardt = $574 million or Rs. 2500 crore. The original equity was around $200 million or Rs. 800 crore. 

Since there is no EPS to consider now, the focus will be on book value. Not that the EPS dilution is insignificant, but that its only implication is that there will be a limit to how high Cals Refineries' share price will shoot up during and after commissioning, because a refinery of Rs. 2025 crore equity (Phase 1) can't shoot up as high as a Rs. 800 crore equity-based refinery. 

Coming back to the NAV, if the multiple GDRs are all at face value of Rs. 1 (its dollar/euro equivalent / multiple), the post-issue book-value more or less remains the same at Rs. 1. But the crucial question is whether the market will rate it much beyond 0.3 times its book, with even all these developments. If not, the share price will be back to square one - that is, in the Rs 0.30s. 

However, two developments can provide a surprising upside here. One is Cals riding a string of short-term successes in milestones like Lohrmann case, Kharafi GDR, Phase 1 GDR, FC Progress etc, that will give market the confidence to rate it at least half its book-value, or three-fourths of its book-value, or even at its full NAV per share.

The second positive surprise that can happen is, Cals Refineries succeeding in issuing the GDRs at a reasonable premium to the face value of Rs. 1. Not that they can price it like an IPO, but even if they can price it at Rs. 1.5 to Rs. 3 (or its equivalent), there is possibility for a significant upside in the share price, much before commissioning itself.

One challenge before Cals for pricing the GDR even at Rs. 1 is the current market cap. If this can change due to a short-term rally, and it can hold the price around Rs. 1 comfortably, things become easier. But on the other hand, if Cals decides to do a totally different strategy to manage this challenge, like, say, equity reduction against accumulated losses, and then equity expansion through GDR, things become unattractive for long-term investors in the counter. But so far, no indication of such a drastic step has come from the company.

With the recent development, the Cals Refineries scrip has turned into a stock worth watching closely for further positive developments.

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