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Standalone refineries performance review: 1QFY07 - Views on News from Equitymaster

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Standalone refineries performance review: 1QFY07
Aug 28, 2006

Supported by strong demand and high capacity utilisation, refineries across the globe have been witnessing a substantial turnaround in their fortunes in recent times. Their Indian counterparts however have not been able to do a repeat act on account of government intervention. As a consequence, growth in bottomline has been more subdued. In this article, let us analyse the performance of the Indian refining companies in general during 1QFY07. For this purpose our universe consists of Kochi refineries, MRPL, Bongaigaon refineries and CPCL. On cumulative basis, the standalone refining pack has registered a growth of 44% in the topline on the back of substantial increase in realisations. However, increased pressure on operating front combined with decline in other income and increase in interest expenditure lead to a subdued growth of 13% in bottomline. Discounts offered to OMC’s have lead to lower margins (YoY).

Financial snapshot…
(Rs m) 1QFY06 1QFY07 Change
Net sales 137,950 198,634 44.0%
Expenditure 126,007 184,644 46.5%
Operating profit(EBDITA) 11,944 13,991 17.1%
EBDITA margins(%) 8.7% 7.0%  
Other income 751 313 -58.4%
Interest expenses 936 1,122 19.9%
Depreciation 1,903 1,834 -3.6%
Profit before tax 9,856 11,347 15.1%
Tax 3,506 4,165 18.8%
Profit after Tax 6,350 7,182 13.1%
Net profit margin(%) 4.6% 3.6%  

What has driven the performance in 1QFY07?
Realisations drive topline growth: Sales registered a 44% 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 and 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 in India 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.

Also, the refineries worked at a higher capacity utilisation during FY06, thus substantiating the fact that topline was primarily driven by the growth in realisation. To put things into perspective, during FY06; MRPL’s capacity utilisation was more than 125%, while other refineries like Kochi refineries, Chennai petroleum also worked at healthy capacity utilisation levels of above 90%.

Discounts hurt margins: Standalone refineries had to provide discounts to the OMC’s for their product offtake. On the cumulative basis, standalone refineries had to provide discounts to the tune of Rs 4.6 bn (2.3% of the net sales). Excluding the impact of the same operating margins would have registered a growth of 50 basis points as against the actual decline of 160 basis points. Also, the other expenditure grew at a faster rate of 42% during the quarter, largely a result of losses due to depreciation of rupee vis-à-vis the dollar.

The ministry during 1QFY07 changed the pricing mechanism for petroleum products at the refinery-gate level. The shift was made from 100% import parity to trade parity (based on 80% import parity and 20% on the export parity). The move will reduce the GRMs of the refineries going forward as prices for exports are lower than that for imports (due to lack of tariff protection). Also, the custom duty on petrol and diesel was reduced from 10% to 7.5% thus putting further pressure on GRMs. During 1QFY06, KRL lost Rs. 231 m (2.4% of sales on an annualised basis).

Expenditure break up…
(Rs m) 1QFY06 1QFY07 Change
Consumption of raw materials 120,544.7 177,210.7 47.0%
as % of sales 87.4% 89.2%  
Staff cost 855.7 885.6 3.5%
as % of sales 0.6% 0.4%  
Other expenditure 4,606.5 6,537.3 41.9%
as % of sales 3.3% 3.3%  

Other income and interest expenditure spoils the play: Other income decline by as much as 59% during 1QFY07, while the interest expenditure increased by 20% during 1QFY07.

What to expect?
Oil marketing companies in a bid to diversify its business model and harness the benefits of synergies between its refining subsidiaries, are merging refineries with themselves. BPCL is merging Kochi refineries with itself, while IOC is doing the same with Bongaigaon refineries.

As far as the business prospects are concerned, the proposed shift in the pricing formula along with reduction in custom duty of petrol and diesel could adversely affects the margins going forward. If the international crude and product prices decline, the effect of the custom duty cuts will be even severe. Also, the refining margins during 1QFY07 were on the higher side due to larger than expected maintenance shutdown of the US refineries. Thus lower GRMs than the ones witnessed during 1QFY07 and hence lower profitability is likely to characterize the Indian refining industry in the coming months.

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