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Kochi Refineries: Merger pangs... - Views on News from Equitymaster

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Kochi Refineries: Merger pangs...

Jul 25, 2006

Introduction to results
Kochi Refineries, a standalone refinery and subsidiary of oil marketing and refining major, BPCL, has declared its 1QFY06 results. Topline for the company registered a growth of 148% YoY, on the back of substantial increase in realisations. However, margins were under pressure due to higher crude oil prices. Increased pressure on operating front combined with decline in other income and increase in interest expenditure lead to a subdued growth of 43% in bottomline.

Financial snapshot…
(Rs m) 1QFY06 1QFY07 Change
Net sales 22,022 54,631 148.1%
Expenditure 20,006 51,811 159.0%
Operating profit(EBDITA) 2,016 2,820 39.9%
EBDITA margins(%) 9.2% 5.2%  
Other income 126 92 -27.0%
Interest expenses 66 90 36.4%
Depreciation 304 312 2.6%
Profit before tax 1,772 2,510 41.6%
Tax 607 850 40.0%
Profit after Tax 1,165 1,660 42.5%
Net profit margin(%) 5.3% 3.0%  
No.of shares(m) 139 139  
Diluted earnings per share 8.4 12.0  
Price to earning ratio.(x)*   6.9  
* Based on trailing twelve months earnings.

What is the company’s business?
Kochi Refinery (KRL) is a standalone refinery operating in Kochi, Kerala, and has a 21% share of the installed refining capacity in southern India. The company has an installed capacity of 7.5 million metric tonnes (MMT) and crude for the refinery is arranged by BPCL, who also purchases a large part of its output. KRL is planned to be merger with its parent company, BPCL and company will cease to have its individual existence.

What has driven performance in 1QFY07?
Realisation driven Topline growth: The topline of the firm registered a whopping 148% increase on the back of soaring crude oil and product prices internationally. To put things into perspective, during FY06, price of Dubai crude went up by 46% YoY, Brent crude went up by 38% YoY, On the product side, diesel prices internationally were up 38%, Motor spirit prices (Petrol) went up by 75%. LPG prices went up by 66% and kerosene prices went up 75% in FY06. (Product prices are in their respective benchmark markets.)

Also, demand for petroleum products during the quarter ended June 2006 was significantly higher than the previous year. The demand for petroleum products increased by 3.9% as against 2.1% YoY reduction in the first quarter of last year mainly due to higher demand growth for aviation turbine fuel, diesel and gasoline. The consumption of high-speed diesel (HSD), which accounts for more than a third of the total consumption of the petroleum products, registered a growth of 7.7% during the quarter as against the reduction of 1.3% YoY during the previous quarter. MS (petrol) demand also grew at a faster pace of 7.2%, while LPG demand grew by 2.7% YoY. KRL, by virtue of being a leading refinery in the country seems to have benefited from such a positive trend in both prices as well as products. As per our view, issues on the demand side of the petroleum products does not exist, as demand has a positive correlation with GDP growth rate and it will continue to be robust. However, realisation is a major concern. The discounts by the standalone refineries to the OMCs can hurt realisation and operating performance going forward.

Expenditure speeds past realisations: Growth rate in the expenditure has surpassed the growth rate in revenues. This has placed a pressure on the margins to an extent. To put things into perspective, consumption of raw material (which accounts for 91% of the total sales) has grown by 159% YoY. Moreover, discounts to OMC to the tune of Rs 1.4 bn (3.5% of net sales) have also impacted the operating performance. Thus the discounts itself shaved off 2.3% of operating margins (as margins excluding the impact of discounts are 7.5% as against actual 5.2% during the quarter). Important parameter for analyzing the performance of the refining industry, GRMs, have declined from US$ 7.5 per barrel to US$ 5.4 per barrel for the company.

Along with the recent price hike of petrol and diesel, the ministry also changed the pricing mechanism for petroleum products at the refinery level. The shift was made from import parity to trade parity (based on 80% import parity and 20% on the export parity). Thus the move will reduce the GRMs of the refineries going forward. Also, the custom duty on petrol and diesel was reduced from 10% to 7.5% thus putting further pressure on GRMs. However, the effect of the same is not going to be substantial, as the increasing crude oil prices will offset for it to an extent, in terms of pricing at the refining gate level. During 1QFY06, KRL lost Rs. 231 m (2.4% of sales on an annualised basis) due to shift from import parity to trade parity for the period of just 15 days as the move was implemented by the refinery post 15th June.

Expenditure break up…
  1QFY06 1QFY07 Change
Consumption of raw material 19315.0 49926.0 158.5%
as a % of sales 87.7% 91.4%  
Staff Cost 261.0 264.0 1.1%
as a % of sales 1.2% 0.5%  
Other expenditure 430 1621 277.0%
as a % of sales 2.0% 3.0%  

Other income and interest expenditure also hurt bottomline: Other income for the quarter declined by 27%. The interest expenditure for quarter increased by 37% YoY and this put further pressure on the bottomline of the company which increased by 42% YoY.

Performance over the recent past…
(Rs m) 1QFY07 4QFY06 3QFY06 2QFY06 1QFY06
Sales growth(YoY) 148.1% 29.7% 20.7% 19.7% N.A
Operating profit margins 5.2% 0.4% N.A 7.7% 9.2%
Net profit margins 3.0% N.A N.A 4.4% 5.3%
Net profit growth(YoY) 42.5% N.A N.A N.A N.A
NA=Not Applicable due to negative values

What to expect?
At the current price of Rs 130, the stock is trading at a price to earnings multiple of 7 times FY06 earnings. The merger of the company with BPCL has been finalised and the proposed swap ratio for the deal is 9:4 (four shares of BPCL for every nine shares of KRL). If merger takes places the value derived by KRL shareholder will be 44 shares of BPCL per 100 shares of KRL. BPCL is currently trading at Rs. 315. Thus at current market prices, Rs 130 in KRL will become Rs 140 in BPCL. As far as the long term is concerned, a KRL shareholder will now be exposed to both the marketing as well as refining side of the business and consequently to the regulatory risks associated with the marketing business.

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