X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Identifying a refinery stock: Do's and Don'ts - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Aug 11, 2003

    Identifying a refinery stock: Do's and Don'ts

    It is often said that the dynamics of the world economy are often altered due to the crude oil price movement. As a result, the dynamics of companies operating in this sector are very different. Here in this article, we deal with key factors that impact the performance of petroleum products companies.

    Profile
    Petroleum products can be broadly classified as kerosene, diesel, petrol, naphtha, aviation fuel (ATF) and liquefied petroleum gas (LPG). As the name itself implies, crude is 'refined' into various usage based products or distillates. Without going into much complexity, the three broad classifications are heavy distillates (furnace oil and bitumen), middle distillates (diesel, kerosene, aviation fuel) and light distillates (LPG and petrol). This is how most of the companies in India classify products in their balance sheets. Margins are higher in middle and light distillates.

    Globally as well as in Indian markets, government has a vital role to play in internal policies and external diplomatic relationships. This is because crude oil involves diplomatic relationships on the sourcing front and outgo of foreign exchange. On the other hand, the government also plays a key role in fixing excise duties on petroleum products. Moreover, it also deals with basic requirements of industries and public in general.

    Revenues
    Revenues are a function of volumes and realisations. Lets look at the volumes side first.

    Volumes
    Volumes in case of oil sector are linked to economic growth. Why? Economic growth, as you know, is linked to the performance of the agriculture, industrial and services sector. When growth gains momentum, demand for petroleum products tends to increase and vice versa, as it is a source of energy. This is not just restricted to the industrial side but also from the retail market (more units of cars and CVs sold, higher is the demand for fuel).

    • The industrial side
      Demand for petroleum products is relatively inelastic to change in prices. In case of industrial, the key user segments are fertilizer (naphtha or natural gas), utilities (naphtha or natural gas) and aviation (ATF). Any increase in power capacity, growth in tourism sector and better agricultural sector performance has a positive impact on petroleum companies. Hence, one should keep abreast of developments in these user segments. However, alternate sources of fuel like natural gas may adversely affect volumes growth.

    • The retail side
      On the retail sector, demand drivers are primarily linked to income levels at the hands of people. Higher income growth will lead to a rise in automobile demand as well as usage of LPG. On the auto sector front, diesel accounts for an estimated 40%-45% of total consumption. Kerosene and petrol account for 8% and 13% of consumption respectively.

    Realisation
    One cannot however, ignore the realisation angle. Earlier before deregulation in 2002, the government fixed prices of petroleum products. Prices were cross-subsidised. While petrol prices were higher compared to the actual cost, kerosene, diesel and LPG were sold at lower rates. But with the dismantling of APM (administered price mechanism), prices of these products are now linked to international crude prices. What this means is that whenever crude prices go up, petrol and diesel prices will mirror the trend. Though LPG and kerosene continue to be subsidised, the government has decided to remove the subsidy in a phased manner.

    As mentioned earlier, government has an active role to play in this sector. Hiking diesel and petrol prices is a politically sensitive issue, which could affect the vote bank of any ruling party. In this context, prices of LPG, diesel and kerosene are not based on reality. Government intervention and policies play a major role in determining the prices and hence one should be aware of these developments.

    Expenses
    Since the prices of crude oil (major raw material) are linked to international prices, one must be aware of the prevailing prices internationally. Crude oil price is known to be very volatile (has moved from a low of US$ 10 per barrel to a high of US$ 147 per barrel) and is a function of demand and supply and also various geo-political situations. This apart, currency fluctuations alter the cost significantly.

    Key parameters to look into...
    Consider key things that one should look while analyzing the companies in the sector.

    • Refining capacity: To set up a 1 MT plant, an investment of Rs 10 bn is required. Of course, the cost goes down if one goes in for a higher MT plant. So, it is a very capital-intensive industry and therefore, barriers to entry are high. Besides, with environmental regulations expected to become stricter, watch out for the company's status on this front. Higher contribution from light and medium distillates is beneficial. Higher the refining capacity, higher the chances of altering product mix to derive more revenues. Though branding is possible, petroleum products are largely a commodity.

    • Integration benefits: Another key aspect is to note whether a company is integrated forward (distribution), backward (crude oil exploration) or a standalone player (only refining). Standalone players have less bargaining power, as products have to be sold to consumers through an external distribution network. Integrated players have an upper hand.

    • Distribution network: Petroleum products are usually sold through retail outlets that offer lot of leveraging opportunity for a company. Look out whether the company owns most of the outlets or it is franchise based. It costs Rs 20 m to set up a retail outlet and if a company owns a major part of the distribution, it can be valued accordingly. By leasing out part of its distribution, a marketing company can maximize revenues (like ATMs).

    • Valuations: Since it is a commodity sector, valuations should be in line with the economic growth in the long-term. But some companies get lower valuations due to the PSU status. But if a player in integrated, valuations tend to be on the higher side. Price to earnings and price to book value are useful tools.

    And last but not the least, the management's past track record. Though the government owns some companies, watch out whether the management has been proactive in branding the product and new capacity expansions. But government intervention is still a reality and therefore to that extent, caution has to be exercised.

    Click here to identify stocks from other sectors.

    Related Links for Energy Sector: Quarterly Results NEW | Sector Analysis Report | Sector Quote | Over The Years

     

     

    Equitymaster requests your view! Post a comment on "Identifying a refinery stock: Do's and Don'ts". Click here!

      
     

    More Views on News

    GAIL: A Good Show (Quarterly Results Update - Detailed)

    Mar 27, 2017

    GAIL (India) Ltd has announced results for the quarter ended December 2016. reported 9.4% year on year (YoY) decline in sales, while bottom-line grew 45.4% YoY.

    ONGC: Higher Realisations on Crude Support Performance (Quarterly Results Update - Detailed)

    Mar 17, 2017

    ONGC has announced results for the quarter ended December 2016. The company has reported 9.2 % year on year (YoY) growth in sales, while bottom-line grew 197% YoY.

    Oil India Ltd: A weak quarter (Quarterly Results Update - Detailed)

    Jan 24, 2017

    Oil India Limited announced results for the quarter ended September 2016. The company has reported an 6.5% and 7.8% Year on Year (YoY) decline in sales and net profit respectively during the quarter.

    GAIL: A Robust Quarter (Quarterly Results Update - Detailed)

    Dec 3, 2016

    GAIL (India) Ltd has announced results for the quarter ended September 2016. The company has reported 16 % year on year (YoY) decline in sales, while bottom-line grew 180% YoY.

    ONGC: Lower Write-offs Support Performance (Quarterly Results Update - Detailed)

    Nov 3, 2016

    ONGC has announced results for the quarter ended September 2016. The company has reported 10.3 % year on year (YoY) decline in sales, while bottom-line grew 6.3% YoY.

    More Views on News

    Most Popular

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE OIL & GAS


    Aug 22, 2017 09:30 AM

    S&P BSE OIL & GAS 5-YR ANALYSIS

    COMPARE COMPANY

    MARKET STATS