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Essar Oil: A lot of oil and no gas - Outside View by Luke Verghese
 
 
Essar Oil: A lot of oil and no gas

Brand Essar

The brand Essar was coined out of the names of the two founding brothers of the group - Shashi and Ravi Ruia. (The brothers Ruia apparently coined the brand in the late 1960s). Their first publicly listed company of the group was Essar Shipping, which was founded in 1945. Since then the group has over time grown exponentially to catapult itself into the 'A list' of top Indian business houses in the present sweepstakes. And helping them do so, and in no small measure at that, is Essar Oil. On full production, whenever that is, this company will have a name plate installed capacity to refine 18 m metric tons of oil per annum. (Presently the company's refining capacity at 14 m tons accounts for 8% of the present total refining capacity of 179 m tons.) The company's manufacturing unit is situated in Jamnagar District, and its oil fields are located at Mehsana, Gujarat.

Not lacking in color

The 20 years young Essar Oil does not lack in color. As matter of fact it boasts of all the shades of the rainbow, and some more. Where it lacks color is in the essentials. Namely, its inability to make a mark on its own as yet, inspite of the many complicated twists and turns that it has undergone, since the company was founded as a legal entity in 1989. The structuring of this sputtering company, and of the group that revolves round it, is a typical try and catch me maze. What exactly is the message, if any that the promoters are trying to send out by doing so, is very unclear, but not very comforting either. Just consider the following data. As at end March 2010, it had three holding companies - an immediate 'indirect' holding company called Vadinar Oil, Mauritius, an intermediate holding company above it, called Essar Energy Holdings, Mauritius, and followed at the top of the heap by an ultimate holding company called Essar Global Ltd. (Separately, there also appears to be two other similarly styled companies, Essar Energy Plc and Essar Energy Overseas Ltd. Where they fit in is not known, but the more the merrier it appears.) It also had one subsidiary, Essar Oil Vadinar, one associate company, Vadinar Power Company, 28 fellow subsidiaries (subsidiaries which are independent subsidiaries of the holding company) and another 22 companies, in which the promoters have significant influence. There are also 3 other companies - Hazira Steel 2, Imperial Consultants & Securities, and Essar Biofuels coming within the definition of group as defined by the MRTP Act, and which seem to be independent of the above mix. (It has a direct investment in only one group company, Vadinar Power Company Ltd.) It is of course another matter that the promoters may not even have a clue of the names of all these entities, and besides, what is one to make of this muddle?

It is quite obvious that such a 'mirch masala' situation also requires the special attention of a very competent person to keep track of the entire goings on of this humungous grouping. Hence it is not very surprising to see that the Finance Director of Essar Oil, Mr P. Sampath, is allowed a take home package not exceeding Rs 33 m per annum, while the managing director, Mr. Naresh Nayyar, has to make do with only Rs 20 m per annum. If my memory serves me right, it is the first instance that I have come across in the corposphere, in the recent past, where the junior gets a higher pay package, than the head honcho, perched in the corner office.

The fruit of its labors

So what does this company have to show for all its labors? In FY10 it consumed 13.5 m tons of imported crude oil valued at Rs 328.5 bn. This consumption produced 12.7 m tons of petroleum products, which when flogged in the market brought in Rs 424 bn of sales revenues into the kitty. (The figures for the preceding year are 12.9 m tons, Rs 360 bn, 12.1 m tons, Rs 418 bn. The conversion factor of crude into petroleum products at 0.9 is identical in both the years.) Exports of petroleum products contributed to a substantial 24% (29%) of overall net sales, with the balance being sold to PSU marketers. Whether these petroleum exports were more profitable than local sales is not known. It may well be out of pocket on this count though. (The company is apparently forced by circumstances to generate exports, to get the benefits on customs duty concession for capital goods imports.) What is known however is that, for some comic reason, it also bought finished goods of the value of Rs 17 bn and then sold it for an almost identical sum of money.

Besides, the market forces have not been very friendly to the company in FY10. Inspite of paying 12.6% less at Rs 24,336 for each ton of crude that it consumed, and realizing only a 5% drop in the gross value of petroleum products that it sold at Rs 31,932 per ton, it was not enough to bring any succor to the bottom-line. The profit before interest, depreciation, and taxes, grew only slightly to Rs 1.9 bn from Rs 1.2 bn in the preceding year. What gave the gratuitous lift to the EBITDA figure was the sharply higher 'other income' at Rs 872 m (Rs 183 m). Putting it all down to simple arithmetic, what happened in the latter year is that higher excise charges, of all things, ate into margins. Excise levies took away Rs 5.1 bn against Rs 3.7 bn in the preceding year, leaving the company out of pocket. It is as simple as that. Going by this data, this is one refining company that appears to have very little leeway. Given the capital intensive nature of its operations (a year end gross block of Rs 13.8 bn), and the simultaneous need to go in for large helpings of debt capital (a year end debt of Rs 10.3 bn), the net bottom-line after provision of interest and depreciation, just about made it into black ink, against a liberal splash of red ink in the preceding year.

Cranking up capacity

The company is in the throes of cranking up refining capacity to 16 m tons initially and then to 18 m tons. With the expected gold plating of capacity, (the terminology that the company uses is optimizing refinery operations) it will be able to refine a lot more crude for sure for example in FY10 the capacity utilization was 129% of its 10.5 m ton capacity. The ongoing expansion is coming in at some cost. It has capital work in progress at year end of Rs 4.3 bn, and estimated amount of contracts on capital account not provided for at a humungous Rs 21.4 bn. Funding this unprovided for capex is going to call for all the dexterity that it can conjure up, as the company is as yet not generating sufficient cash flow from operations, to contribute its mite. The net cash that it generated from operations was insufficient to pay even the interest dues in FY10. As a part solution to wriggle out of the muddle, the company issued additional equity capital to the tune of 164 m shares of Rs 10 each, after the close of the FY10. That resulted in the paid up equity base rising to Rs 13.6 bn from Rs 12 bn in the preceding year. (At end FY10, the promoters held an 88.5% stake in the paid up equity). The first phase of expansion to 16 m tons is expected to go on stream in August 2011.

Backward Integration

Separately, and as a part of its backward integration programme, it is exploring for oil either on its own or through several joint venture companies, or so one opines. It has six exploration JVs ranging from Gujarat in the West, to West Bengal and Assam in the East, and Myanmar. The company's 100% interest in the two Myanmar blocks have been transferred to yet another company styled Essar Exploration and Production South East Asia Ltd. Its exploration venture in Gujarat is handled by Essar Exploration and Production Gujarat, while the West Bengal venture is handled by Essar Exploration and Production Ltd. Significantly, Essar Oil has no capital stake in any of these drilling ventures. According to the notes the company's interest in proved and probable reserves is 358,000 metric tons. The information on the crude oil front is not exactly forthcoming, barring its statement that it will be processing the Mangala crude in the current year.

It will be very interesting to see how this company pans out in the near future, regardless of the encouraging noises that it makes in this respect. The management is forecasting gross revenues of Rs 390 bn for the current year, running, depending on the international price of petroleum products. That is to say a revenue inflow which is lower than what it achieved in FY10. More interesting is how it will fund the full capacity addition given the present straitjacket that the company is in.

PLEASE NOTE THAT I AM NOT A SHAREHOLDER OF THIS COMPANY

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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1 Responses to "Essar Oil: A lot of oil and no gas"

Vineet

Jan 3, 2011

Pure work of fiction.. the numbers just dont add up.. a simple look at the annual report of Essar oil would have been sufficient to get the numbers correctly. Seems like for some personal reasons, Mr. Varghese is more interested in bashing a company who is trying hard to recover from a very difficult phase and have just started to make profits, than to present facts and carry an impartial analysis.

Disappointing article..

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Equitymaster requests your view! Post a comment on "Essar Oil: A lot of oil and no gas". Click here!
 

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