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Kochi Refinery: A mixed show

Apr 7, 2006

Considering the current government policy with respect to pricing of petroleum products, the performance of integrated refining players (with marketing presence) has deteriorated significantly. Prospects are also not looking good. In such a scenario, standalone refining majors have many things going in favor of them. Given the high crude prices and strong demand for petroleum products globally, gross refining margins have been favorable. In this article, we take a look at Kochi Refineries, one of the major standalone refineries in the country. A brief background: Kochi Refinery (KRL), a subsidiary of refining and marketing major, BPCL, is a standalone refinery operating in Kochi, Kerala, and has a 21% share of the installed refinery capacity in southern India. The company has an installed capacity of 7.5 million metric tonnes and crude for the refinery is arranged by BPCL, who also purchases a large part of its output. Some of the major outputs of KRL include LPG (liquefied petroleum gas), petrol, diesel, kerosene, naphtha, ATF and rubberized bitumen. KRL entered the petrochemicals sector in 1989, when the company's production facilities with a design capacity of 87,200 tons per annum of benzene and 12,000 tons per annum of toluene were commissioned.

Financial analysis: During the period between FY00 and FY05, KRL registered a CAGR growth of 17.8% in sales. However, on the back of improved profitability, the company's net profits have grown at a compounded rate of 29.1% during the period, thus outperforming the growth in the topline. Improved utilization ratios and higher refinery margins have helped the company post this strong performance on the net profit side during the said period.

Financial snapshot
1999-00 2000-01 2001-02 2002-03 2003-04 2004-05
Net sales (Rs m) 57,919 71,389 58,060 92,859 100,610 131,345
YoY growth 39% 23% -19% 60% 8% 31%
PAT 2,352 1,095 688 4,560 5,551 8,421
YoY growth -30% -53% -37% 563% 22% 52%
Profitability ratios
EBDIT margin 6.7% 4.4% 5.9% 9.8% 10.6% 10.3%
EBIT margin 5.6% 3.0% 4.0% 8.5% 9.4% 9.4%
Net profit margin 4.1% 1.5% 1.2% 4.9% 5.5% 6.4%

The fact that KRL has its refinery close to the coastal region has helped the company enjoy location advantages in terms of freight cost, which has been aided the margin improvement over the years. As the merger/ amalgamation of KRL along with BPCL is announced this will bring a larger company into picture, which can harvest the fruits of economies of scale. Thus there will be operational and financial synergies, which will aid KRL as well as BPCL.

In the last five years…
(000's MT) FY00 FY01 FY02 FY03 FY04 FY05
Capacity 7,500 7,500 7,500 7,500 7,500 7,500
Capacity utilisation 104.4% 100.3% 90.6% 101.1% 104.7% 105.7%
Source of crude…
Imported - processed 4,983 4,336 4,072 4,576 5,614 5,803
% of total 63.6% 57.7% 59.9% 60.4% 71.5% 73.2%
Indigenous - processed 2,847 3,184 2,725 3,004 2,239 2,121
% of total 36.4% 42.3% 40.1% 39.6% 28.5% 26.8%
Total 7,830 7,520 6,797 7,580 7,853 7,924
% change -4.0% -9.6% 11.5% 3.6% 0.9%

In refining, cost of raw material (Crude) and freight accounts for as much as 95% of the total expenditure. Thus, the Rs 623-crore single point mooring (SPM) project of Kochi Refineries Ltd (KRL) is likely to be good move for KRL. This conventional method would help the company save around Rs 400 m or roughly 3% of FY05 sales. Currently, the company receives crude oil from Bombay High as well as from other countries at the Crude Oil Terminal (COT) of Cochin Port Trust using crude tankers with the capacity up to 70,000 tonnes. This results in higher transportation costs to KRL, especially when securing crude from far-off countries like Nigeria. By using Very Large Crude Carriers (VLCC), the company hopes to benefits from economies of scale (primarily, freight costs).

Among the concerns, lower level of refining sophistication is one of the disadvantages of KRL. KRL's refinery does not have the capacity to handle sour and heavy crude. Considering the crude price scenario, complex refineries that can handle various mix of crude are likely to have better gross refining margins. Besides, India has been a product surplus economy for a long time now and given the expansion plans of domestic refineries in the next five years, the surplus is likely to increase significantly. With demand for petroleum products expected to grow by 3% to 5%, refineries are likely to increase exports (a relatively low margin business). More importantly, not all products can be exported. Subsidy sharing is also a negative factor (in 9mFY06, KRL's subsidy share was Rs 2,100 m or 2.5% of net sales).

The stock currently trades at Rs 185 implying a price to earnings multiple 7.0 times trailing twelve months earnings. In 3QFY06, due to the fall in GRMs and higher subsidy share, the company posted a net loss. With the proposed merger with the parent company, BPCL, we believe that the company will benefit from economies of scale (sourcing of crude as well as marketing of petroleum products). As far as BPCL is concerned, post the merger, we believe that the company will save on third-party purchases of resale. Perhaps this is the major positive from the merger.

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