Reports indicate that BPCL will pick up a stake in Essar Oil through the preferential allotment route. As the public-sector giant wishes to acquire a minimum of 26 per cent in Essar Oil in addition to its current holding, any other route would require an open offer. With this, BPCL would own about 35 per cent of the stand-alone refinery (an open offer is required at 15 per cent). Therefore, it may seem that no direct benefit will accrue to Essar Oil shareholders. However, if BPCL picks up stake, the company will no longer be viewed as a Ruia company but as a company in which BPCL has material stake and this will be reflected in its discounting. The infusion of funds will result in lower interest cost and will be a marginal compensation for the huge equity dilution. The dilution will be at a time when the refinery is about to go on stream. This would no doubt benefit the shareholders, but not to any great extent.

Irrespective of whether the scrip gets better discounting, the outlookfor the debentures would change drastically. Essar Oil debentures were downgraded by credit monitoring agencies twice last year. The ratings assigned to the Rs 5.65-billion non-convertible debenture (NCD) issue and the Rs 2-billion NCD issue were downgraded to "C" (meaning delay in payments) from BB+ (insufficient safety) in April. Earlier, there was a downgrade in October 1998. In spite of the fact that we do not have an active secondary market for debt, the downgrade of ratings saw the value of debentures slipping from Rs 80 to less than Rs 57.

Incidentally, these 14 per cent debentures to be redeemed in year 2003 now bear a yield in the range of 55-58 per cent. If a strong company picks up a stake in the firm, there is little chance that it would default in interest payments. Even if the capital on investment in the debenture payment does not appreciate, investors still have an interest yield of 24.5 per cent at a price of Rs 57 (subject to the fact that interest payments are timely).

Crisil officialssay that nothing much has changed fundamentally for them to re-rate the company. The important parameters such as cost escalation and delay in commissioning of the refinery remain. In addition, earlier, the company had contemplated using a 70:30 mixture by weight of light and heavy crude but now plans to use sweet murban crude, as the installation of the coker unit is delayed. Further, there are uncertainties relating to the expected surplus situation of the refinery products and those relating to tariff protection recommeneded by the Nirmal committee.

The other issue is also whether the infusion of capital would be to fund the loss or to achieve financial closure of the escalated project cost. If it is the latter, then one can expect that finally the refinery would be commissioned at the earliest and production would start, generating cash flow for the company.

It is still early days for anyone to predict when the refinery would break even and generate profits. But if the company manages to put itsrefinery on stream in the next fiscal, the company can make profits at the gross level, which would ensure interest payments, suggesting that the biggest beneficiary of BPCL initiatives to take a stake in Essar Oil would be the debenture holders of the company.

Inventory valuation

The revised Accounting Standard (AS)-2 on inventory valuation, effective from April 1, 1999, makes it mandatory to either use the first-in-first-out (Fifo) or the weighted average method. AS-2 has become mandatory by default -- it was never made mandatory by the institute and though the revised AS 2 is mandatory with effect from April 1999, because of the newly inserted Section 211(3C) of the Companies Act, even the existing AS-2 is mandatory.

Since the valuation of inventory has significnat impact on the taxable income, the CBDT has been urged to allow the companies to defer the one-time tax liability arising as a result of switch over from Lifo for a period of three to five years. Unless the CBDT takes appropriateaction, companies will opt for a qualification rather than comply with AS-2.

Section 211(3B) of the Companies Act requires that in the event of non-compliance with accounting standard(s), the company shall dislcose the deviation from the standard, the reason for the deviation and the financial effect as a result.

The very reason why AS-2 was not made mandatory by ICAI was the unwillingness of the CBDT to consider the point which is being made now. Though ICAI has taken the initiative, unless the CBDT sees sense, it will be a meaningless step taken by ICAI. In any case, virtually all large-size companies either use Fifo or the weighted average method for valuation of inventory and, as a result, the CBDT hardly stands to gain by way of a huge one-time tax. The sooner good sense prevails, the better. Interestingly, the permitted method for calculating production overheads will be absorption costing (the cost of inventories is determined by including the share of variable and fixed costs). However, likeGujarat Ambuja does, companies will be allowed to include interest for valuation of inventory subject to a qualification.

Sugar imports

There appears to be no end to domestic sugar manufacturers' woes. While it is true that spot prices of sugar in the international markets have begun to firm up, it appears to be merely a temporary phenomenon. Fresh estimates indicate a world sugar surplus of over 5 million tonnes in the 1998-99 crop year. Both Thailand and Brazil have produced much more than was expected. As a result, a further price weakness is likely in the coming months. This is clearly evident from the fact that though spot prices have firmed a little, futures prices continue to be unaffected. Any hopes that the domestic sugar industry had regarding a decline in the imports of the sweetener have, thus, been dashed to the ground.

(With contributions from Manish Saxena, Urmik Chhaya & Sarad Saraf)