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CPCL: Blown away

May 17, 2006

Performance summary
CPCL, a standalone refinery and a subsidiary of IOC, declared its results for the fourth quarter and fiscal ended March 2006. The topline for the fiscal grew by 49% YoY while the bottomline fell by 19%, which could be attributed to the spiraling of the crude price coupled with inability to pass on the price hike to the consumer. The performance in 4QFY06 is even worse, as the company’s operating and net profit margins fell by 67% and 86% respectively during the period.

Financial snapshot…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 43,626 55,082 26.3% 142,136 211,288 48.7%
Expenditure 39,463 53,716 36.1% 129,899 200,374 54.3%
Operating profit (EBDITA) 4,164 1,366 -67.2% 12,237 10,914 -10.8%
EBDITA margin (%) 9.5% 2.5% 8.6% 5.2%
Other income 468 180 -61.5% 760 418 -45.0%
Interest 586 480 -18.1% 1,567 1,740 11.1%
Depreciation 498 591 18.7% 2,094 2,358 12.6%
Profit before tax 3,548 475 -86.6% 9,336 7,234 -22.5%
Tax 1,041 121 -88.4% 3,364 2,424 -27.9%
Profit after tax/(loss) 2,507 354 -85.9% 5,973 4,810 -19.5%
Net profit margin (%) 5.7% 0.6% 4.2% 2.3%
No. of shares (m) 149 149 149 149
Diluted earnings per share (Rs) 32
Price to earnings ratio (x) 7.6

What is the company’s business?
Chennai Petroleum Corporation limited (CPCL), a subsidiary of IOC, is the largest refinery in southern India (with approx. 30% of installed capacity in the region). CPCL has two refineries, with a combined refining capacity of 10.5 Million Tonnes Per Annum (MMTPA) making it one of the largest and the most flexible refinery in South India. The 3 MMTPA refinery expansion project in 2004 increased the refining capacity of the company to 9.5 MMTPA. The expansion led to an increase in the secondary processing capacity from a modest level of 23% to 45% (of the expanded capacity).

What has driven performance in FY06?
Topline – Favorable prices: Apart from higher petroleum product prices, the fact that the company expanded the refining capacity in FY04 has also helped matters. Though actual volume sales is not clear, in terms of crude throughput, there was an increase of 16% YoY. In our view, growth at the topline level has not been an issue for the refining sector as a whole. The fact that the companies are forced to offer discounts on certain products hampers their ability to take advantage of the favorable refining cycle. We do not see any major policy changes that will benefit the sector in the short-term. In fact, if the government’s move to reduce import duty on petroleum products materialises, standalone refining companies will witness further contraction in margins.

Margins slip: Operating margins of CPCL fell to 5% in FY06 from 9% registered in the previous fiscal. This could be attributed to the fact that the gross refining margins (GRM’s) fell from US$ 5.33 per barrel to of US$ 4.37 per barrel. The fall can be explained from the fact CPCL’s discount on petroleum products to OMC’s stood at Rs 4.4 bn in the current fiscal (2% of the net sales).In 4QFY06, operating margins tumbled from 10% recorded in previous quarter to 2% in the current quarter. The discount provided by the company during the quarter to OMC’s was Rs 1.3 bn (2.5% of sales during the quarter).

Expenditure break up…
(%) of sales 4QFY05 4QFY06 FY05 FY06
Consumption of raw materials 86.0 94.1 87.3 91.7
Staff cost 0.7 0.6 0.7 0.5
Other expenditure 3.8 2.8 3.4 2.6

Other income effect: Weak operating performance, decline in other income (45% YoY), increase in depreciation expenses (13% YoY) and increase in interest expenses (11% YoY) led to a further deterioration at the bottomline. Other income in FY06 was lower by 45% YoY. Investors have to remember that in FY05 the company wrote back some excess provision and gained on foreign exchange fluctuations (Rs 328 m). Excluding the same, other income is down only by 3%. Also, if we were to exclude the one-time gains from the other income in FY05, the decline in net profit is 13% YoY.

What to expect?
At the current price of Rs 244, the stock is trading at a price to earnings multiple of 7.6 times FY06 earnings (the stock is trading at a price to book value of 1.8 times FY06 numbers). As we go forward, we believe that while the topline growth will be influenced by capacity utilisation, profitability will remain an issue. Until clarity emerges with respect to the government’s stance on the petroleum sector, we suggest investors to exercise caution.

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