1st MARCH 2007

PRICE
NO. OF SHARES
RECOMMENDATION

LKR 32.75
532,529,905
LONG TERM BUY

Reuters Code: LIOC.CM

Sri Lanka
Colombo Stock Exchange
Power & Energy

COUNTRY
EXCHANGE
SECTOR

SUMMARY

Lanka IOC Ltd. (LIOC) is owned 75% by the Indian Oil Corporation Limited, a Fortune 500 company
which, in turn, is owned by the Indian Government.
LIOC procured a twenty year Petroleum Products Licence on 22nd January 2004 which authorises the

company to Import, Export, Store, Distribute, Sell and Supply Petrol, Auto Diesel, Heavy Diesel
(Industrial Diesel), Furnace Oil and Kerosene, Naphtha and other mineral petroleum including Premium
Petrol and Premium Diesel but excluding Aviation and Marine Fuels and Liquid Petroleum Gas.

Company has recently announced plans to invest in a Lube Blending Plant and to offer Marine Bunkering
services, with over Rs. 1.8 Billion in Capital Expenditure.

LIOC is strategically positioned to benefit from possible oil exploration activities in Sri Lanka in the Long
Term.

FINANCIAL HIGHLIGHTS
2005/6
37,492
(1,722)
(3.23)
2.09
15.66

Turnover (Rs. Mn)

Profit After Tax (Rs. Mn)
Earnings Per Share (Rs.)
P/E Ratio @ 32.75 (x)
Dividend Per Share (Rs)
Price to Book @ 32.75 (x)
Net Asset Per Share (Rs.)

2006/7 E
38,188
(906)
(1.70)
2.35
13.96

2007/8 E
58,348
1,256
2.35
13.88
2.00
2.29
14.32

2008/9 E
92,687
4,266
8.00
4.09
2.00
1.61
20.33

PRICE CHARTS
LIOC Price Vs ASPI in 2006

LIOC Price & Quantity in 2006

36

36

2,900.0

34

2,700.0

6,000,000

34

5,000,000

32
30

32

4,000,000

30

3,000,000

28

2,500.0

2,300.0

28

2,100.0

26

2,000,000

24

26
1,900.0

24

1,000,000

Page 1 of 8

LIOC Price

12/2/2006

9/2/2006

8/2/2006

7/2/2006

6/2/2006

11/2/2006

Quantity

5/2/2006

1,500.0
4/2/2006

20
3/2/2006

1,700.0

1/2/2006

12/2/06

22

10/2/2006

Price

11/2/06

10/2/06

9/2/06

8/2/06

7/2/06

6/2/06

5/2/06

4/2/06

3/2/06

0
2/2/06

20

2/2/2006

22

1/2/06

EQUITY RESEARCH

LANKA IOC LIMITED

(LIOC)

ASPI

Amana Securities Ltd.

SECTOR OVERVIEW

International Petroleum Market

Despite increasing oil prices, the global demand for oil has continued unabated. This trend is expected to
continue with The International Energy Agency estimating crude oil demand in the year 2030 to be 115
million barrels a day, from 86 million barrels per day forecasted for 2007.
Independent estimates suggest that by the end of 2007, the price of Brent crude oil may be around US $ 65.
A key assumption in this estimate is that the geopolitics of Irans nuclear programme does not become too
volatile.
Other developments that could arrest the inexorable rise in oil prices are the increasing presence of Gas and
Biomass in meeting energy needs and Oilfield development projects straddling the globe. This should
restrain energy prices from skyrocketing, although short-term fluctuations could still persist.

Figure 1: Average Crude Oil Pric es ( Brent) in 2005 & 2006

80

Average crude oil

prices are shown
as closing prices
in New York.

75
US $/ bbl

70
65
60
55
50
45
Dec-06

Oct-06
Nov-06

Aug-06
Sep-06

Jul-06

May-06
Jun-06

Mar-06
Apr-06

Jan-06
Feb-06

Nov-05
Dec-05

Sep-05
Oct-05

Jul-05
Aug-05

Jun-05

Apr-05
May-05

Jan-05

Feb-05
Mar-05

40

Sri Lanka Market

The Petroleum industry in Sri Lanka comprises of three major segments: Importing of Crude Oil, Importing
of Refined Petroleum Products and Liquefied Petroleum Gas (LP Gas). The state-owned Ceylon Petroleum
Corporation (CPC) enjoys a monopoly in the import of crude oil. The import of Refined Petroleum products
is an oligopoly with CPC and LIOC sharing the market while the import of LP Gas enjoys a similar status with
Shell Gas Lanka Ltd. and Laugfs Lanka Gas (Pvt) Ltd. being the participants.
Table 1: Petroleum Products in Sri Lankan
Quantity Imported (MT000)
Crude Oil
Refined Products
L.P.Gas
Value of Imports (Rs.Mn)
Crude Oil
Refined Products

Page 2 of 8

2002

2003

2004

2005

2,280
1,344
137

1,995
1,168
141

2,201
1,644
148

2,008
1,823
149

40,404
27,781

41,708
39,179

61,434
61,298

77,795
88,767

Amana Securities Ltd.

L.P.Gas

3,773

4,502

6,095

7,573

The demand for petroleum products comes from the transportation sectors (50%) followed by power
generation (25%). The remaining demand (25%) arises from industries, households and other sectors.
In June 2006, the Government of Sri Lankan (GOSL) decided to remove price control mechanism, which was
introduced in 2002 and permitted CPC and LIOC to determine their own pricing strategies. This was a key
development, which saw sales of Super Petrol stagnate with 0% growth, while the sale of Diesel dropped 12%
year-on-year in real terms. However, part of the drop in Diesel volumes was attributed to the increasing use
of furnace oil for power generation.
Table 2: Domestic Sales (Metric Tonnes 000)
2004

2005

Petrol (90 Octane)

417

443

6.2%

Petrol (95 Octane)

20

20

0.0%

1890

1674

-11.4%

36

16

-55.6%

204

209

2.5%

Auto Diesel
Super Diesel
Kerosene

% Change YOY

Key Players

Ceylon Petroleum Corporation (CPC), since its inception in 1962, has thus far dominated the Petroleum
industry in Sri Lanka, with monopoly rights in petroleum imports, refining, export and distribution. The need
for reforming the industry was identified by successive governments, which eventually resulted in the
privatisation of some of CPC subsidiaries like Colombo Gas Ltd., Lanka Lubricants Ltd. and Lanka Marine
Services Ltd in the 1990s. Further reforms included selling CPCs 200 retail outlets. CPC retained ownership
of 262 filling stations of the countrys estimated 1100 outlets.
CPC also has a refining capacity of 2.2 million metric tonnes per annum. Caltex Lanka Lubricants, the Sri
Lankan arm of Chevron Texaco is the market leader in Sri Lanka in lubricants, with a market share in excess
of 80%.

COMPANY OVERVIEW

Parent Company

Indian Oil Corporation Ltd.(IOC) owns 75% of LIOC, with the Government of India owning more than 80% of
IOC. It is currently Indias largest company in terms of sales with a turnover of Indian Rupees 1,832 billion
(US$ 41 billion) and profits of Indian Rs. 49 billion (US$ 1.10 billion) for fiscal year 2005. IOC is also the
highest ranked Indian company in the prestigious Fortune Global 500 listing, having moved up 17 places to
the 153rd position in 2006. It is also the 21st largest petroleum company in the world. LIOC has a overseas
subsidiary in Mauritius as well.

Page 3 of 8

Amana Securities Ltd.

Indian Oil has set its sights on achieving US$ 60 billion revenues by the year 2011-12 from its current level of
US$ 41 billion. The road map to attain this milestone has been laid through vertical integration forward
into Petrochemicals and backwards into Exploration & Production of oil. It has also diversified into Natural
Gas. The globalisation of its marketing operations is expected to provide an additional impetus.

Core Business

LIOC procured a twenty year Petroleum Products Licence on 22nd January 2004 which authorises the
company to Import, Export, Store, Distribute, Sell and Supply Petrol, Auto Diesel, Heavy Diesel (Industrial
Diesel), Furnace Oil and Kerosene, Naphtha and other mineral petroleum including Premium Petrol and
Premium Diesel but excluding Aviation and Marine Fuels and Liquid Petroleum Gas. Subsequently, LIOC has
reportedly acquired licences to carry out offshore bunkering operation and to supply bulk fuel as well.
Almost 60% of the companys revenue during the last two years came from the sale of Auto Diesel while
another 30% came from the sale of Petrol (90 Octane).

Strategies

Currently LIOCs distribution network consists of 100 company-owned outlets, known as Company Owned
Dealer Operated outlets(CODO) and 53 outlets owned and operated by dealers known as Dealer Owned and
Dealer Operated outlets (DODO). Most of these outlets, reportedly generating 70% of the sales, are
concentrated in the Western Province. Ceylon Petroleum Corporation (CPC), LIOCs major competitor, has a
significant advantage over LIOC in its channel presence, which consists of around 262 CODOs and around
640 DODOs spread island-wide.
LIOC is focussed in increasing its channel presence and is seeking approval from the Sri Lankan authorities to
develop more than 300 sites island-wide, mainly on a CODO basis. This would obviously have a significant
impact on the companys revenue stream, if approved.
LIOC has an advantage over CPC due to its reportedly 10% lower operating cost. This is attributed largely to
inefficiencies at CPC, which is an inherent feature of many government enterprises. LIOC is poised to
exploit this in terms of a more competitive pricing structure.
LIOCs emerging market in lubricants carries a tariff advantage. LIOC is only liable for a 14.5% tariff based
on level of refining of the import, whereas its competitors pay a 28% tariff. LIOC has already exploited this
opportunity, gaining rapid market share (estimated at about 10%) by selling its Servo brand at discounts to
its competitors.
The parent company, IOC, is a key supplier of petroleum products to LIOC. The sales are made on a preagreed transfer pricing mechanism based on Singapore PLATTS. Both IOC and LIOC could use this
strategically to the greater benefit of the Group.

Page 4 of 8

Amana Securities Ltd.

It is somewhat ironic that, following the liberalisation of pricing by the GOSL, LIOC embarked on a premium
pricing strategy targeting what it perceived to be discerning customers. This resulted in the company
losing volumes during the second quarter of 2006/7. LIOC has since aligned its prices to CPC, regaining lost
ground.
LIOC is also expecting to increase its product offering to the market and to diversify its sources of income
(See Future Prospects)

Grant/ Subsidy

Until June 2006, both CPC and LIOC sold petrol at what was perceived to be a subsidised price, based on an
agreement with the GOSL. From January 2004 to March 2006, LIOC had accrued Rs. 7.7 billion in subsidy
receivable from the GOSL. However, this was based on the initial agreement where the Government agreed
to pay a mark-up of 5% on the cost, which was subsequently revised to 1.5% in June 2006. The resulting
losses, amounting to Rs. 2.1 billion, were written off during the financial year 2005/6. On 5th of January
2007, LIOC accepted Rs. 5.16 Bn. as the settlement of the balance, with Rs. 700 million in cash and Rs. 4.46
billion in 2-year government bonds carrying a coupon rate of 11% p.a. Therefore, a further write-off of Rs.
440 million may be incorporated for the financial year 2006/7. There could also be a further write-off in
terms of disallowed input VAT on this amount.

Key Risks

LIOC, controls the strategic China Bay tank farm, located in Trincomalee and which has 99 tanks, each with
a capacity of storing 12,000 kilolitres. In 2006, only 15 of these were operational. LIOC spent Rs. 22.7
million to refurbish this tank farm during the Financial year 2005/2006 with further Investments envisaged.
However, Trincomalee is a strategic location for the countrys security forces and the LTTE rebels. Severe
escalation of violence could cause damage to the property and hamper LIOCs aims of making Trincomalee
an important industrial site.
Approvals that are pending from regulatory authorities is another possible risk that could impact on LIOCs
future plans. Currently, LIOC needs to get approvals for its expansion of retail outlets and to expand into
related services like selling aviation fuel and refining petroleum.
Entry of a third player, which has been expected for sometime, seems to have been stalled, at least for the
time being. However, the risk of increased competition from the potential entry of new players cannot be
ignored.

PERFORMANCE ANALYSIS
LIOC reported the biggest ever loss of Rs. 1.721 billion on the Colombo Stock Exchange (CSE) for the
financial year 2005/6. Rs. 2.1 billion written off on the subsidy receivable contributed more than 120%
towards it. A further write off during the financial year 2006/7 is expected to be in the range of Rs. 440500 million. LIOC is exempted from Income Tax up to 2013.

Page 5 of 8

Amana Securities Ltd.

Table 3: Key Ratios

Financial year ended

2003/4

2004/5

2005/6

7.26%
2.94%
3.98%

9.07%
7.10%
6.83%

6.09%
-3.44%
-4.59%

49.25%
10.52%
0.39%
136.56%

138.30%
84.36%
15.94%
101.58%

105.55%
78.10%
5.17%
110.38%

12.4%
5.2%
12.4%

18.7%
9.3%
16.1%

-20.6%
-9.8%
-19.6%

Profitability
Gross Margin
Operating Profit Margin
Net profit Margin
Liquidity / Solvency
Current Ratio
Quick Ratio
Long Term Debt/ Equity (Book)
Total Debt/ Equity(Book)
Management Effectiveness
Return on Equity (Book)
Return on Assets
Return on Investments(Book)

Revenue

The revenue during the last three financial years grew at an average rate (CAGR) of 61%. Key contributors to
the revenue were sale of Petrol-90 Octane (60%) and Auto Diesel (30%). LIOCs sales volumes grew on
average (CAGR) 19% during the last three financial years, with the quantity of Petrol-90 Octane growing at
31% and Auto Diesel growing at 21%.

Figure 2: Average Revenue Increase (CAGR)

Table 4: LIOCs average price per litre

2003
2004
2005
Super Petrol
50.20
62.04
71.21
Lanka Petrol
46.88 59.41
68.40
Auto Diesel
28.19
40.83
54.72
Super Diesel
26.21 39.34
60.47
Kerosene
24.89
38.80
53.35
Lubricants
90.18
95.99
111.42

CAGR
19.10%
20.80%
39.33%
51.89%
46.39%
11.16%

Lubricants

Kerosene

Super Diesel

Auto Diesel

Lanka Petrol

Super Petrol

-40.00%

-20.00%

0.00%

20.00%

40.00%

60.00%

% Growth

During the first nine months of 2006/7, revenue has dropped 13.3% compared to the same period last year.
This decline is attributed largely to the drop in sales volume, in the aftermath of its previously adopted
premium pricing strategy and the decision of the management to discontinue sales, albeit temporarily.

Margins

The gross profit margin has dropped from 9% in 2004/5 to 6.09% in 2005/6. The gross margin for the nine
months up to 31st December 2006 is less than 1%. This is attributed to increasing oil prices that has
escalated the cost of sales.

Operating profit margin, which was a healthy 7.1% in 2004/5, turned a negative 3.4% in 2005/6 due to part
of the subsidy receivable write-off as losses and the VAT disallowed on the subsidy. The operating margin

Page 6 of 8

Amana Securities Ltd.

80.00%

for the nine months up to 31st December 2006 was negative 2.6% as compared to negative 5% for the same
period last year. Reduced Other Operating Income and the subsidy write-off, amounting to Rs. 303
million, contributed to operating losses during the first three quarters of 2006/7.
Net margin, which was around 6.83% in 2004/5, fell to negative 4.6% in 2005/6 due to higher Interest Costs.
The operating margin during the last nine months reduced further to negative 6.4%. Major contributor this
decline is the finance cost, which increased by 164%. The company also relied on extensive external
financing due to the non-payment of the subsidy.

FUTURE PROSPECTS

Lubricant Market

The lubricant market is estimated to be selling around 45,000 kilolitres annually and growing at a rate of
around 8-10%. Based on these estimates, the companys market share would be around 13%. LIOC already
enjoys a tariff advantage in the lubricants segment, as described above in the Company Overview
Strategies section. To exploit this advantage further, LIOC plans to invest US $ 5 million on a lube blending
plant by 30th June 2007.
LIOC is planning to export substantial part of the output, especially to Bangladesh, Malaysia and Mauritius.
This may be a strategic decision by the parent company since its already exporting to Malaysia and
Mauritius. The company is expected to target a two-fold increase in its market share by 2008/9.

Marine Bunkering

LIOC plans to expend US $ 10 million by May 2007 in order to diversify in to marine bunkering services.
Once operational, it could refuel ships at Colombo port, tapping one of the worlds busiest trade routes.
According to initial estimates, the refuelling market is worth around US $ 700-800 million. Currently Lanka
Marine Services Ltd. a subsidiary of John Keels Holdings, and Lanka Maritime Services Ltd., are the key
players in marine refuelling.

Others

LIOC is also looking at Aviation fuel and LPG Imports as viable sectors in the long term. LIOCs parent
company, IOC, is expected to bid for oil exploration projects in the North-Western coast of Sri Lanka, which
is in close proximity to India.

FORECASTS

Revenue

We forecast the revenue of the company to grow by 35% year on year till 2008/9. This also takes into
account a possible drop of up to 80% in volume 2006/7. We expect at least a 23% increase in volumes for the
next two financial years with the gradual expansion of the distribution network.

Page 7 of 8

Amana Securities Ltd.

Margins

We expect the company to report a loss during 2006/7, of around Rs. 906 Million. This is due to a drop in
gross margins, and a further subsidy write-off anticipated at Rs. 480 million.

Capital Expenditure

Company plans to invest Rs. 1.8 billion in two major projects, i.e. in Lube Plant and for Marine Bunkering as
detailed above. However, some portion of this amount may be only for working capital requirements.
Company also plans to develop over 300 retail outlets.

VALUATION

Free Cash Flow

We have used Capital Asset Pricing Model (CAPM) in calculating the share value on the discounted cash flow
basis, adjusted appropriately to capture the cost of both Debt and Equity. Based on the forecasts, the Free
Cash Flow value is in the range of Rs. 40 to 43 per share.

Price Earnings

The stock is trading at 13x on its 2007/8 earnings and 4x its 2008/9 earnings.

Price to Book Value

LIOC is trading at 2.2x on its 2007/8 net book value and 1.61x on its 2008/9 net book value.

Based on the above valuation we recommend a Long Term Buy.

CONTACT US
Amna Securities Limited
550, R.A. De Mel Mawatha
Colombo 03
Sri Lanka
Telephone: 94 11 5552556/7
Fax: 94 11 5552553
Email info@asl.lk

Page 8 of 8

Amana Securities Ltd.