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Ritu Shrivastava June 09 , 2014 PowerPoint Presentation
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Ritu Shrivastava June 09 , 2014

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Ritu Shrivastava June 09 , 2014

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  1. Summer Internship RituShrivastava June 09, 2014 Global Markets Information Classification:Internal

  2. Project Overview • Opportunities for Citibank in PSUs in India • Analyze the risk exposure of PSUs • Sector- wise analysis to find specific opportunities • Product development of an ELN based solution for ESOPs • Understanding ESOP policies offered by Indian Companies • Developing an ELN based solution for ESOPs and finding potential clients • Analyzer for FDI, ODI and ECB data • Developing a user interface for an easy access to FDI, ODI and ECB data 1 2 3

  3. Opportunities for Citibank in Indian Public Sector Enterprises 1 • Business Rationale • Citibank Global Markets is not currently very active with PSUs in India • PSUs are attractive from Global Market’s perspective as they have significant FX, Commodity and Interest Rate exposure • Relatively safer clients • Reputational advantages for Citibank

  4. Analyses of Foreign and Commodity Exposure of Top PSUs • Total Public Sector Units Analyzed= 93 • Maharatnas = 7 • Navratnas = 14 • Miniratnas(I)= 54 • Miniratnas (II)=18 • Divided them into three tranches based on their exposure • Tranche I -- Oil companies • Tranche II – Trading and Manufacturing Companies • Tranche III – Cluster of relatively smaller companies Commodity Exposure('000 crore) Commodity Exposure('000 crore) Forex Exposure ('000 crore) Forex Exposure ('000 crore) TRANCHE-II TRANCHE-III Forex Exposure ('000 crore)

  5. Sector-wise Breakup and Potential Opportunity for Citibank • Total foreign exposure of top public sector enterprises in India is Rs7,691 billion • Oil and Gas Companies cover almost 84% of this, followed by trading and manufacturing companies with 8% and 7% coverage respectively • Potential opportunity of USD 12.81 Million in FX space • Commodity exposure is sector dependent and needs further value chain analysis for estimation

  6. Sector Analysis

  7. Value Chain IOCL is the leader with 40% of the total exposure followed by BPCL and HPCL ONGC covers almost 98% of the total exposure MARKETING REFININIG EXPLORATION Commodity Hedging Commodity Hedging • No commodity hedging done FX Exposure and Hedging FX Exposure and Hedging • Relatively less import- export exposure • Significant External Commercial Borrowings • Usually do not hedge ECBs • Buyer’s Credit • Packing and Post- Shipment Credit • Significant External Commercial Borrowings • Hedge a small fraction of ECBs

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  9. Case Study: Bharat Petroleum Corporation Limited(BPCL) Risk Management Policy Objective: Maximizing Gross Refinery Margin Maximize • Imported: 75%, • Indigenous: 25% • Oil Supplying Countries • Middle East • Nigeria • Malaysia • Price: Linked to Argas and Platts benchmarks • Refineries • Mumbai Refinery • Kochi Refinery • Numaligarh Refinery • Bina Refinery *Source: Mr. Chandra Dev Singh, Head of Derivatives- Risk Management, BPCL

  10. Risk Management Policy Objective: Maximizing Gross Refinery Margin Maximize { Steps Followed Gross Refinery Margin(GRM) calculation on the basis of forward price curves and expected demand/supply of products and raw materials Threshold for GRM Hedgingis decided by the board in the beginning of the year. Usually this is equal to the fixed cost incurred to run the refineries. Refinery Hedging during the year is done by floating a tender to consortium of banks depending on the market view and the decided threshold Freight and Individual Product Hedging is also done depending on the transportation cost and export requirements respectively

  11. Threshold Trigger • For the current year BPCL has a threshold of 22% of their GRM • BPCL has not hedged anything in last 2 months as oil prices have remained range bound • Most of the Middle East Suppliers have their supply price floored at $100 USD/barrel. Unless this floor is hit, they believe there will be no expected turbulence in the oil market C

  12. Commodity Solution- Oil and Gas 1 Refinery Margins: Increasing Refining Capacity Pointing to Weaker Margins • Refineries in India are rapidly increasing their refining capacities. • Changing landscape of the commodity market offers a favorable opportunity • “Deutsche Bank slashes commodity trading operations” – Financial Times, Dec 2013 • “Barclays has reduced its presence in commodities -- FT, Dec 2013 • CréditAgricoleand UBS have virtually closed their commodities businesses. – FT, Dec 2013 • “JPMorgan has put up for sale its physical commodities business” -- Reuters, May 14 Pardip: 15 MMT Ratnagiri9MMT Barmer9MMT Mumbai: 1.5 MMT Kochi: 6 MMT Revenue Estimation for Citibank • Refining capacity addition will exceed the incremental demand over 2014-2017, pointing towards weaker refinery margins

  13. Commodity Solution- Oil and Gas 2 • Freight expense is the second most important expense after crude oil for oil companies. Freight cost greatly fluctuates with the cost of shipping fuel, also known as Bunker fuel. • Oil companies are diversifying their oil imports and are planning to import more from West Africa and LATAM. This would imply more number of transportation days and higher risk exposure to freight cost • Citi Energy Risk’s Freight House of theYear Award – 2010” Freight and Bunker Fuel Hedging Norway Time between loading at major importing countries to unloading at Indian Refinery Azerbaijan Iraq Iran Kuwait Algeria Egypt Saudi Arabia Mexico UAE Sudan Yemen Nigeria Venezuela Brunei Colombia Cameroon Malaysia Congo Eq. Guinea Ecuador Brazil Angola Australia 6-7 Days 10-14 Days Up to 30 days

  14. Commodity Solution- Oil and Gas Freight and Bunker Fuel Hedging • BPCL currently hedges 15-20% of their freight cost • Citibank won “Energy Risk’s Freight House of the YearAward – 2010” • In 2008, we did a trade with State Trading Corporation on freight hedging Revenue Estimation for Citibank *Source: Ministry of Petroleum- Crude Oil Import Data 2012-13

  15. Commodity Solution- Oil and Gas Inventory Hedging- A good target for Repo Financing 3 Consideration • According to the RBI circular, hedging of inventory up to 50 per cent is allowed • IOCL hedges 5-10% of their inventory every year • Companies involved in inventory hedging can also be a good target for pitching Repo Financing Solutions • Inventories of LPG, Kerosene, Diesel, Jet Fuel, Petrol and Fuel Oil have to be maintained at numerous locations like Ports, Refineries, marketing depots, Airports etc. to ensure uninterrupted availability of products • OMCs carries inventories in the range of 10 MMT of crude oil/feedstock and products which are valued at Rs.25000 crores • Inventory Value= MIN (Acquisition Cost, Net releasable value), therefore inventory value fluctuates with the product price, which in turn can have a disproportionate affect on the profitability. Revenue Potential

  16. Foreign Exchange Oil and Gas Foreign Exchange Exposure • Suppliers from Middle East offer a credit window of 30days and do not really mind extending it to 60days • A usual operational cycle is also of 30 days (6-7 days transportation, 10-15 days processing and 6-7 days of marketing), hence it is almost a cash business for them • RBI has opened Revolving Credit Lines for IOCL, BPCL and HPCL. As a result, they have not availed any buyer’s credit since Sep 2013. Buyer’s Credit Packing and Post Shipment Credit • Limited export exposure so generally do not avail packing and post shipment credit. Nothing has been availed in last 2-3 years • Usually they hedge only a fraction of their ECBs depending on the mandate by Financial Risk Management Cell • HPCL has not hedged any of their ECBs after 2009 • If the FX market sees high volatility again in the future they might want to hedge ECB repayments ECB • According to the feedback, Citibank has been fairly competitive in forwards and spots but not in options and other derivatives. • For smaller foreign transactions they do not float a tender, instead call a top few banks. Though small in size these transactions add up to almost 500 Mio USD Recommendation *Source: Mr. AnupamPathak, Manager Treasury - HPCL

  17. Sector Analysis

  18. Trading Companies Trading Companies • Net foreign exchange exposure of public sector trading companies is Rs618 billion • MMTC is the leader with 38% market share followed by State Trading Corporation, PEC Ltd, MSTC and Shipping Corporation of India • However the financial health of most of the trading companies is a cause of worry • Out of the pool, MMTC and State Trading Corporation of India can still be explored because of their large FX exposure • PEC Limited is a relatively less popular name but they have an import-export exposure of Rs 9500 crore. Currently, DBS is the only foreign bank dealing with them.

  19. Trading Companies • India’s largest international trading company • Thehighest foreign exchange earner for India after oil refining companies • Citibank not a part of MMTC’s consortium of banks. Have uncommitted lines with them • MMTC will be importing 15Million tons of coal worth Rs 6000 crore this year to meet coal demands of power suppliers like NTPC • Stock in some of the commodities for sale due to which they also carry commodity risks Recommendation • With Rs 23,000 croreforex exposure, MMTC becomes an important PSU to focus on. • MMTC also offers good hedging opportunities as they hedge 100% of their foreign credits for non bullion trades • All trading companies have significant transportation cost exposure, hence freight hedging solutions can aslo be pitched here

  20. Sector Analysis

  21. Steel companies in India are worried about the import of Coking Coal • Major raw material for steel making process are Iron ore, coking coal and limestone Other Companies- Steel and Finance Other MajorCompanies Steel Companies (SAIL, RINL) Finance (Power Finance Corp., REC) • Most of finance corporations have long term liabilities and tend to hedge them using long term interest rate derivatives • Citibank is currently not very active in long term interest rate derivatives Steel Manufacturing Process • Steel Authority of India Limited (SAIL) • The raw material import expenditure of SAIL is Rs 12886 crore. • Iron Ore- Supplied through captive mines • Lime Stone and Dolomite- Captive mines and domestic suppliers • Coal - 75% of coking coal requirement is met through Imports • RashtriyaIspat Nagar Limited • RashtriyaIspat Nigam Ltd depends entirely on coking coal imports to meet its demand. Net imported coking coal in 2012-13 is Rs5000crore Iron Ore Coking Coal Limestone Inputs 75% of requirement met through imports (INR 12886 Cr in FY 13) Captive Mines and Domestic Suppliers Captive Mines Power Companies (NTPC, Power Grid) • Import of coal is a big cause of concern for power companies in India • Major foreign expense is linked to coal import 100% requirement met through imports (INR 5000 Cr in FY13) Captive Mines and Domestic Suppliers Captive Mines Most steel companies in India are worried about import of Coking Coal. Worth a USD 3 billion dollar opportunity

  22. Other Companies- Mining Mining Companies Dearness Allowance Inflation in India • As a labor intensive industry, most mining firms incur high employee expenses, exposing them to uncertainties in inflation • Coal India, the largest mining PSU, faces Employee Costs as the largest expenses, a large part of which is composed of Dearness Allowance Recommendation • Inflation Linked Bonds can be pitched as potential investment solution to Coal India Limited and other mining PSUs

  23. Other Companies- Various Other Companies Unexplored Sectors

  24. 2. Product Idea linked to Employee Stock Ownership Plan(ESOP)

  25. Stock Based Compensation Plans

  26. Stock Based Compensation Plans

  27. What areEmployee Stock Options and SARs? • ESOP is a right, not an obligation, to buy shares at a pre-defined price at a future date • Exercise price is fixed in the beginning and is usually below the spot price at issuance • ESOPs can be forfeited for non-fulfillment of certain conditions like leaving the company • SAR: Like ESOP, SARs benefit the holder with an increase in stock price but the settlement is through cash instead of equity Stages of ESOPs

  28. What are Employee Stock Purchase Plans(ESPPs)? • An employee stock ownership plan in which employees can purchase company shares at a discounted price • Employees contribute to the plan through payroll deductions • Exercise price is fixed in the beginning and is used to calculate the number of shares to be allotted • No capital protection in case stock price plummets ESPP Example: Company: ABC Limited Spot Price: Rs 100 • Employee XYZ receives compensation worth Rs 10 lakhs in the form of ESPP

  29. Design Consideration of Employee Stock Ownership Plans • Option valuation method • Taxation • Vesting Schedule • Exercise Price • Exercise Period • Legal and Regulatory Framework • Frequency of Issuance • Quantum of options 1 2 3 4 5 6 7 8

  30. Target Companies • Our Target • Employee Share Purchase Plan with secondary purchase • Employee Stock Option Scheme with secondary purchase • Stock Appreciation Right

  31. Indian Companies offering ESOPs • ABB • Aditya Birla Nuvo Ltd • Axis Bank Ltd • Bharti Airtel Ltd • Cairn India Ltd • Cipla Ltd • Colgate Palmolive India Ltd • Dabur India Ltd • Divi's Laboratories Ltd • DLF Ltd • Dr.Reddy's Laboratories Ltd • Federal Bank Ltd • Glenmark Pharmaceuticals Ltd • GMR Infrastructure Ltd • Godrej Consumer Products Ltd • Grasim Industries Ltd • HCL • HDFC Bank Ltd • Hero MotoCorp Ltd • Hindalco Industries Ltd • Hindustan Unilever Ltd • Housing Development Finance Corp. • ICICI Bank Ltd • Idea Cellular Ltd • IDFC Ltd • Indusind Bank Ltd • Infosys Ltd • ITC Ltd • Jaiprakash Associates Ltd • Jindal Steel And Power Ltd • JSW Steel Ltd • Kotak Mahindra Bank Ltd • Larsen & Toubro Ltd • Mahindra and Mahindra Financial Services Ltd • Mahindra and Mahindra Ltd • Ranbaxy Laboratories Ltd • Reliance Capital Ltd • Reliance Communications Ltd • Reliance Industries Ltd • Reliance Power Ltd • Shriram Transport Finance Comp • Siemens Ltd • Tech Mahindra Ltd • UltraTech Cement Ltd • Wipro Ltd • Yes Bank Ltd • Zee Entertainment Enterprises Ltd

  32. Impact of Employee Stock Ownership Plan on Companies Potential Merits Potential Demerits Dilution: Dilution of EPS if company issues new shares to meet ESOP obligation Valuation: The stock must be valued annually in order to establish the value of the stock for purposes of purchasing, allocating and distributing the stock in case of Employee Stock Option Fiduciary Liability: The plan committee members who administer the equity stock option plan can be held liable if they knowingly participate in improper transaction Availability of Financing: An ESOP can create serious cash-flow issues for a company, if a company borrows money to fund an ESOP, it will have to allocate significant future earnings towards repayment • Employee Loyalty: The company gains employees’ goodwill, loyalty and commitment • Employee Retention: Employee turnover rate is greatly reduced • Tax Benefits: Provides tax-favored corporate financing

  33. Impact of ESOPs on Employees Potential Merits Potential Demerits • Greater Participation: Employees gains greater participation in the company • Potential Benefits: Creates higher pay and benefits • Tax Benefits Downside Exposure: If the value of company does not increase, the employees will lose their potential benefit in case of ESPP Exposure to the fund availability of the company in case of re-purchase. In financially difficult times, a large shareholder can frequently be asked to accept a deferred payment plan instead of cash out Compensation Disparity: An individual employee is dependent on the collective output of all employees and management for a bonus Long term Horizon: Particularly attractive to long- term employees

  34. ESOPs- Trends in Indian Market • ESOP is predominantly the most preferred stock based compensation plan amongst Indian companies • ESOP policy is relatively more popular among IT sector companies followed by financial services and manufacturing • Multi-national companies consider ESOPs as a key mode of incentivizing their employees and usually have a well structured ESOP policy • Large conglomerates usually have a uniform ESOP policies across their businesses • None of the companies belonging to TATA group offer ESOPs • Most of the Reliance businesses follow similar ESOP policies

  35. Equity Linked Notes vs. Employee Stock Options (ESOPs)

  36. What are Equity Linked Notes (ELNs)? • Equity Linked Notes combine the feature of passive fixed income and active equity linked products. • ELD is a zero coupon bond, whose principal re-payment at maturity fulfills the capital guarantee. The initial discount to par is used to fund the equity linked payoff. Working of ELNs • An equity-linked debenture can be thought of as a combination of a zero-coupon bond and an equity option • ELNs also offer an option of customizing the equity linked payoff on the basis of investor’s requirement

  37. Price determinants of Equity Linked Notes • Equity Spot Level: The most important determinant of the option price. Payoff of an ELN is directly linked to the spot price, increase in the equity price makes the option more expensive. • Interest Rate Level: Interest rates affect the price of both options and bonds. Higher the interest rates, larger is the initial discount to par and more is available to spend on the equity option. • Dividend Yield: High dividend yield pulls down the forward, making the upside cheaper. Cheaper upside leads to the higher participation in payoff. • Volatility: Volatility is a key driver of option pricing. Higher the volatility, usually more expensive will be the option and lower will be the participation. • Volatility Skew: Volatility skew is the variation of implied volatilities with respect to the strike price of the option. Out-of-money options are quoted with the implied volatility smaller than those of at-the-money options and the opposite is true for in-the-money options 1 2 3 4 5

  38. Product Idea ELN for Employee Stock Option ELN for Employee Stock Purchase Plan Start: Company Company INR 100 INR 100 INR 100 Employee Maturity: Company Company INR 100 + Equity Upside INR 100 + Equity Upside Equity Upside INR 100 + Equity Upside Employee Employee

  39. Equity Linked Notes Asian Call Option Tenor(T): 3 years Capital Protection: 100% S[0]: Closing price of the stock on the Start Date S[T]: Average of closing price of the stock on annual observation dates PF: Participation in the upside Payoff: At maturity Citibank pays : (1+ PF * Max(0, S[T]/S[0]-1)*Notional Invested

  40. Equity Linked Notes vs ESOPs Potential Merits over ESOPs Potential Demerits over ESOPs • Capital Guarantee: Employee exposed to only the upside of the stock • Diversification: Significant potential of diversifying both in terms of underlying and the payoff profile in case of ELNs • No Dilution: Nodilution of EPS due to issuance of new shares • No Valuation Required: No need to value the stock annually to meet ESOP obligations • No Liquidity: No liquidity crisis as in the case of purchase of shares under ESOP policy • No Legal obligation: NoIssue of fiduciary liability Credit Risk: Company is exposed to the Issuer risk of Citibank for principal re-payment Tax: No significant tax benefits in case of ELNs Cost: Costlier than ESOPs in some cases

  41. F&O Liquidity Analysis of Companies with ESOP policy • Given the low liquidity of long tenor options in Indian F&O market, Citibank can issue ELNs for following highlighted companies Liquidity  Liquidity  Liquidity 

  42. Example: HUL Employee Stock Option Scheme

  43. ELN on Hindustan Unilever Limited (HINDUNILVR) Asian Call Option Participation on Upside 1:1 participation in the upside Tenor(T): 3 years Capital Protection: 100% S[0]: Closing price of the stock on the Start Date S[T]: Average of closing price of the stock on annual observation dates PF: Participation in the upside Payoff: At maturity Citibank pays (1+ PF * Max(100%, S[T]/S[0]))* Notional Invested Underlying: HINDUNILVR Strike: 100% Tenor: 3years Participation(PF) = 105% Asian Call Option allows buyer to capture market upside on annual observation dates as in the case of ESOPs

  44. ESPP and ELN Performance Comparison Company: Hindustan Unilever Limited Spot Price: Rs 563.00 Date: May 2014 • Employee XYZ receives compensation worth Rs 10 lakhs in the form of stock based compensation. ESPP Equity Linked Notes

  45. Scenario Analysis # 1A Bearish Market Start Date[0]: May 2014 Stock Price [0]: Rs 563.00 Maturity[T]: May 2017 Stock Price[T]: Rs 506 Payoff Comparison * In case stock depreciation, employee ends up losing his capital in ESPP while in ELN his capital is protected

  46. Scenario Analysis # 1B Bullish Market Start Date[0]: May 2014 Stock Price [0]: Rs 563.00 Maturity[T]: May 2017 Stock Price[T]: Rs 619.00 Payoff Comparison * In case of stock appreciation both ELN and ESPP yield same returns

  47. Exercise Flexibility European Exercise/ High participation American Exercise/ Low Participation ELN ESOP Bermudan Call Monthly/Quarterly/ Annual Observation • Citi Markets equity desk can offer Shout Options to give flexibility to lock in the equity payoff when employees want to exercise European Call American Call High Exercise Flexibility Low Exercise Flexibility

  48. Annexure I Considerations of Employee Stock Ownership Plan

  49. Design Consideration of Employee Stock Ownership Plans • Option valuation method • Taxation • Vesting Schedule • Exercise Price • Exercise Period • Legal and Regulatory Framework • Frequency of Issuance • Quantum of options 1 2 3 4 5 6 7 8

  50. Option valuation method 1 Option 1: Intrinsic Value Method Option 2: Fair Value Method • Intrinsic Value = Max( Equity Price –Exercise Price) • Commonly used method for accounting purpose • Fair Value = Amount for which the option can be exchanged between knowledgeable, willing parties in an arms length transaction • Computed using an option-pricing model like Black Scholes, Binomial valuation methods • Required for disclosure and accounting purposes Taxation 2 Tax impact on employees Tax impact on Company • Perquisite at the time of exercise: Amount of FMV at the time of exercise less the exercise price is taxed • Capital gain at the time of sale of shares: Net sales consideration lessFMV as on date of exercise is taxed • Long or short term capital gain would depend on period of holding of the asset • Company is responsible for Tax Deduction at Source (TDS) on the perquisite value of ESOPs