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MRPL: At the mercy of regulations! - Views on News from Equitymaster

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MRPL: At the mercy of regulations!

Nov 20, 2006

Introduction to results
MRPL, the refining subsidiary of country's exploration and production giant ONGC, announced its 2QFY07 results. During 2QFY07, it registered a growth of 30% YoY in the topline, while operating profits tumbled by as much as 64% YoY. The fall in bottomline came in at a much higher rate of 95%, despite the doubling of other income and a benign depreciation outgo. For 1HFY07, while topline grew by 23%, bottomline suffered a significant fall of 41%, again thanks mainly to 270 basis points drop in operating margins.

What is company's business?
MRPL, an ONGC subsidiary, is a refinery with an installed capacity of 9.69 million metric tonnes per annum (MMTPA). It accounts for 28% of the refining capacity in southern India (7.6% of India's refining capacity). MRPL's refinery was the first in India to produce Euro-III complaint diesel and Euro-II complaint petrol. MRPL is an excellent turnaround story. In FY03, it was a sick company. Post the ONGC acquisition, fortunes have turned around and it is now a profit-making entity. The reasons attributable for the same are crude sourcing through ONGC, higher capacity utilization, financial restructuring, lower fuel losses and healthy refining margins in international markets.

Financial snapshot…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 61,984 80,522 29.9% 117,729 145,219 23.4%
Expenditure 57,998 79,105 36.4% 109,206 138,698 27.0%
Operating profit (EBDITA) 3,985 1,417 -64.4% 8,523 6,521 -23.5%
EBDITA margin (%) 6.4% 1.8%   7.2% 4.5%  
Other income 78 182 132.1% 472 265 -43.9%
Interest 444 588 32.2% 928 1,166 25.6%
Depreciation 863 872 1.1% 1,794 1,726 -3.8%
Profit before tax 2,756 139 -95.0% 6,272 3,894 -37.9%
Tax 1,096 46 -95.8% 2,455 1,642 -33.1%
Profit after tax/(loss) 1,660 93 -94.4% 3,817 2,252 -41.0%
Net profit margin (%) 2.7% 0.1%   3.2% 1.6%  
No. of shares (m) 1,753 1,753   1,753 1,753  
Diluted earnings per share (Rs) 0.95 0.05   2.18 1.28  
Price to earnings ratio (x)*         33.6  
* Based on earnings of trailing twelve months.

What has driven the performance?
Realisation driven sales: MRPL registered a sales growth of 29% YoY. Since the results did not disclose the sales volumes, realisations could not be determined. Our understanding is that the growth in topline for MRPL was primarily due to better realisation over the previous fiscal (as was the case with other players). MRPL operated at a capacity utilisation of more than 125% during the previous fiscal, thus limiting further upside from volume growth. Thus, topline growth for the company was primarily due to better realisation over the previous fiscal.

Pricing procedure hurts margins: Inability to pass through the increase in raw material cost continues to hurt MRPL. The government froze the refinery transfer prices of the petroleum products, whereas the raw material cost over the same period increased significantly. The same can be substantiated from the fact that the raw material as a percentage of sales increased by as much as 720 basis points. MRPL had provided a discount of Rs 770 m (1% of the net sales of the quarter). Company also had to offer discount of Rs 335.40 m (0 .4% of the sales in the quarter) during the quarter on the sales of HSD to customers other than OMCs. If we exclude the impact of the discounts offered to OMCs and others, the operating margins stand at 3.1% during the quarter.

Also, the change in the pricing of petroleum products for the refineries has also negatively affected the profitability of the company. Due to the same, topline during 1HFY07 was lower to the extent of Rs 950 m (0.7% of the sales in the first half of the year). It lead to a reduction to the tune of Rs 1,120 m (29% of the reported PBT) at the PBT level for 1HFY07. The same would have improved the margins at the bottomline level to the tune of 40 basis points (assuming tax rate constant.).

Staff cost has also increased by 26% YoY on the back of annual incentives. This has also adversely impacted margins. Other expenditure during the quarter declined on the back of lower outgo on sales tax and excise duty.

Cost breakup…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Consumption of raw materials 55236.4 77504.1 40.3% 104567.6 134916.3 29.0%
as % of sales 89.1% 96.3%   88.8% 92.9%  
Staff cost 117.2 147.6 25.9% 234.4 273.5 16.7%
as % of sales 0.2% 0.2%   0.2% 0.2%  
Other expenditure 2644.7 1452.8 -45.1% 4403.9 3508.2 -20.3%
as % of sales 4.3% 1.8%   3.7% 2.4%  

Bottomline blues: The government withdrew the ‘Target Plus' export benefit scheme during the last fiscal, which affected the other income to an extent. During FY06, the benefit under the scheme was to the tune of Rs 1,366 m with no benefits from the current year. However, for the other income during the quarter 2QFY07, there was an exchange gain of Rs 95 m (52% of the other income during the quarter), leading to spurt in the other income. Increase in interest expenditure by 32% YoY also put some pressure on the bottomline of the company.

Performance over the recent past…
Particulars 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Net Sales growth (%,YoY) 31.5% 46.5% 38.7% 24.4% 16.1% 29.9%
Operating profits growth (%,YoY) 40.9% -4.7% -67.8% -87.9% 12.5% -64.4%
Net profits growth (%,YoY) 92.8% -1.5% -93.3% -109.5% 0.1% -94.4%
Operating profit margins 8.1% 6.4% 2.3% 1.0% 7.9% 1.8%
Net profit margins 3.87% 2.68% 0.28% -0.46% 3.3% 0.1%

What to expect
At the current market price of Rs 41, the stock is trading at a price to earnings multiple of 34 times trailing twelve months earnings. MRPL is currently operating at more than 100% utilization and new capacity is likely to come onstream by 2010, thus limiting any further production growth in the near term. Also, significant increase in the crude oil prices has resulted in change of subsidy sharing arrangement where the standalone refineries have to share the burden. If the crude oil prices rise, a greater amount of subsidy will be required to be shared by the standalone refineries. GRMs and profitability of standalone refineries are capped to that extent. Also, on a relative basis, valuation is a bit stretched as compared to other standalone PSU refineries.

The recent government nod to stop offering discounts to OMCs seems to have provided some respite for the standalone refineries. With this, MRPL has discontinued to sell domestic liquefied petroleum gas and kerosene under public distribution system (PDS) to state-owned oil marketing companies (OMCs) at a discount. Discounts to OMCs such as Indian Oil Corporation, Hindustan Petroleum Corporation and Bharat Petroleum have been stopped with retrospective effect from April 1, 2006.The OMCs have now agreed to make payment of full Refinery Transfer Prices (RTPs) towards sale of LPG and kerosene by it to them with effect from April 1 without deducting any discounts. The company had accounted for discounts of Rs 1428.8 m during the first two quarters of the current financial year, pending receipt of formal confirmation from OMCs, towards payment of full RTP without discount. These discounts will now be reversed in the third quarter resulting in a credit in the third quarter results. This move will provide some relief to standalone refineries, however regulatory risk still persists.

Thus, based on fundamentals and in light of current valuations and regulatory environment, we would like investors to excise caution at this point as the risk-to-reward ratio for investing in the stock is in the favour of risks.

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