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CPCL: Hammered down! - Views on News from Equitymaster

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CPCL: Hammered down!
Nov 27, 2006

In this article, let us analyse the 2QFY07 & 1HFY07 performance of CPCL, a standalone refinery and a subsidiary of IOC.

Performance summary
The topline for the quarter grew by 21% YoY while the bottomline fell by whopping 51%YoY. The decline could be attributed to the lower tariff protection coupled with increased subsidy burden on the company. For the first half ended September 2006, the topline registered a growth of 29% YoY, while the bottomline fell by 18% over the corresponding period previous year.

Financial snapshot…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 54,586 66,069 21.0% 101,531 130,711 28.7%
Expenditure 50,678 63,689 25.7% 93,299.0 123,542 32.4%
Operating profit (EBDITA) 3,908 2,381 -39.1% 8,232 7,169 -12.9%
EBDITA margin (%) 7.2% 3.6%   8.1% 5.5%  
Other income 66 146 120.5% 237.60 215 -9.6%
Interest 425 468 10.1% 796.10 894 12.3%
Depreciation 589 586 -0.6% 1,175.10 1,172 -0.3%
Profit before tax 2,960 1,473 -50.3% 6,498 5,318 -18.2%
Tax 996 500 -49.8% 2,194 1,800 -18.0%
Profit after tax/(loss) 1,964 973 -50.5% 4,304 3,518  
Net profit margin (%) 3.6% 1.5%   4.2% 2.7%  
No. of shares (m) 149 149   149 149  
Diluted earnings per share (Rs) 13.18 6.53   28.89 23.61  
Price to earnings ratio (x) *         4.68  
* Based on annualised 1HFY07 earnings.

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 2QFY07?
Realisation driven growth: Company registered a crude thruput of 2.52 MMT in 2QFY07, a decline of 6% YoY. Thus, it was increase in realisations that led to increased sales during the quarter. Capacity utilisation was still good at 93% (on annualised thruput of 1HFY07). In our view, growth at the topline level has not been an issue for the refining sector as a whole, given the global crunch in refining capacity and robust domestic economic growth. The fact that the companies are forced to offer discounts on certain products hampers their ability to take advantage of the favorable refining cycle. The lower tariff protection also adds to the woes of the sector.

Margins slip: Operating margins of CPCL fell to 3.6% in 2QFY07 from 7.2%, registered in 2QFY06. This could be attributed to the fact that the gross refining margins (GRM’s) fell from US$ 5.68 per barrel to US$ 4.15 per barrel. The fall can be explained from the fact that CPCL’s discount on petroleum products to OMC’s stood at Rs 1.2 bn in the 2QFY07(1.8% of the net sales). Change in refinery gate pricing (which led to reduction in tariff protection) adversely impacted revenues to the extent of Rs 2.7 bn in 1HFY07(2.1% of the sales for 1HFY07). Operating margins declined from 8.1% recorded in 1HFY06 to 5.5% in 1HFY07.

Expenditure break up…
Particulars 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Consumption of raw materials 48,983.2 62,432 27.5% 89,911 120,252 33.7%
% of sales 89.7% 94.5%   88.6% 92.0%  
Staff cost 219.1 353 61.0% 440.3 597 35.7%
% of sales 0.4% 0.5%   0.4% 0.5%  
Other expenditure 1,475.3 904 -38.7% 2,882 2,692 -6.6%
% of sales 2.7% 1.4%   2.8% 2.1%  

Little support from strong other income: Other income during the quarter increased by 120% YoY, while the depreciation charges were flat. However, increase in interest expenditure by 10% YoY during the quarter coupled with weak operating performance lead to reduction of profitability at the bottomline level. Bottomline during the quarter decline by 51% YoY while declined by 18% YoY for the first half of the fiscal.

What to expect?
At the current price of Rs 221, the stock is trading at a price to earnings multiple of 4.6 times annualised FY07 earnings. Topline growth of the refining companies will be influenced by economic growth, while the profitability will be determined by GRMs internationally. Capacity utilisation for the company is higher and product offtake is never an issue for CPCL, owing to synergies with its parent IOC. On profitability front, GRMs in the benchmark Singapore markets have softened to an extent. However, we expect crack spread to improve going forward. This will improve the margins. Recently government has asked standalone refineries to discontinue discounts offered on sales of kerosene and LPG to OMCs. This is positive move for the sector, which had seen reduction in GRMs and lower protection. However, all the positives are factored into the current valuation, thus to that extent the returns from current prices are fairly limited.

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