India Equity Research | Oil, Gas and Services Visit Note

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ESSAR OIL
Refinery capex on track; E&P upsides remain

We recently met the management of Essar Oil (ESOIL) to get an update on the September 14, 2010

company. Following are the key takeaways of our interaction:

Reuters: ESRO.BO Bloomberg: ESOIL IN

ƒ Gas sourcing contracts & Mangala crude to raise GRMs by ~USD 1/bbl
ESOIL is in the final stages of signing the GSPA to receive 0.6 mmscmd of KG-D6 EDELWEISS 4D RATINGS

gas (allocated by EGOM) for use in its Vadinar refinery. Since the company Absolute Rating BUY

requires 1.2-1.3 mmscmd of natural gas for internal use (post expansion of Rating Relative to Sector Outperformer

Phase 1 of refinery), it is looking to source additional 0.5 mmscmd from LNG. Risk Rating Relative to Sector High
While the company had started taking in Cairn’s Mangala crude Q1FY11 Overweight
Sector Relative to Market
onwards, the average crude consumption during August 2010 was 25,000 bopd. Note:
Currently, it consumes ~30,000 bopd of Mangala crude, which is expected to Please refer last page of the report for rating explanation

scale to 60,000 bopd after commissioning of the expanded refinery in March

2011. Both natural gas and Mangala crude are expected to increase refining
MARKET DATA
margins by USD ~1.0/bbl.
CMP : INR 130
52-week range (INR) : 175 / 104
Share in issue (mn) : 1,201.5
ƒ Refinery expansion on track; trial production commences in Raniganj block
M cap (INR bn/USD mn) : 176 /3,790
Refinery 1 (expanded capacity of 18 MMTPA) is expected to commence Avg. Daily Vol. BSE/NSE (‘000) : 4,880.4
production by March-April 2011. Two units have been delayed by 1-2 months,
but construction of the expanded refinery is broadly on track. Currently ESOIL is SHARE HOLDING PATTERN (%)

clocking operating GRMs (not including sales duty benefits) of USD 3.5–4.0/ bbl. Promoters* : 16.0

As per management, GRMs are expected to increase to ~USD 10/bbl post MFs, FIs & Banks : 1.8
commissioning of the expanded capacity. FIIs : 1.8

Others : 80.4
ESOIL has started trial production in the Raniganj CBM block (~18,000 scmd)
* Promoters pledged shares
with commercial production expected to commence from December 2010. ESOIL : 32.9
(% of share in issue)
is also bullish on its other E&P assets with good prospects emerging in its Nigeria
PRICE PERFORMANCE (%)
block. Management remains positive on sorting out issues related to Ratna PSC.
Stock Nifty EW O & G
Index

ƒ Outlook and valuations: SOTP at INR 186/share; maintain ‘BUY’ 1 month (2.4) 5.6 5.0
We have broadly maintained our earnings estimates and our estimated fair value 3 months 2.5 12.5 7.4
(SOTP at INR 186/share) after some minor adjustments due to the recent annual
12 months (13.6) 19.3 12.0
report update. The risk weighted estimate of E&P assets has been revised
upwards to INR 48/share after capturing the fair value from Raniganj and
Ratnagiri blocks only as other blocks are still in early stages of assessment. We
believe potential upsides from E&P assets may be even higher as clarity emerges
on these blocks—Nigeria, Assam, Mehsana, Rajmahal CBM. At CMP of INR 130,
the stock trades at 19.4x FY11E and 9.9x FY12E earnings. We maintain
‘BUY/SO’ rating on the stock.
Financials
Year to March FY09 FY10 FY11E FY12E
Net revenues (INR mn) 375,164 365,046 387,417 420,328
Revenue growth (%) 6,572.1 (2.7) 6.1 8.5
EBITDA (INR mn) 10,189 10,659 30,264 44,557
Net profit (INR mn) (5,135) 295 8,055 15,691
Share outstanding (mn) 1,202 1,202 1,202 1,202
EPS (INR) (4.3) 0.2 6.7 13.1
EPS growth (%) 1,147.0 (105.7) 2,634.2 94.8 Niraj Mansingka, CFA

P/E (x) (30.4) 529.8 19.4 9.9 +91 22 6623 3315

EV/EBITDA (x) 23.9 22.9 10.5 7.9 niraj.mansingka@edelcap.com
ROE (%) (14.3) 0.7 14.2 21.2

Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited
 
Oil, Gas and Services

ƒ E&P highlights
• Raniganj E&P:

ƒ ESOIL has commenced trial production in the Raniganj block (~18,000 scmd)
with commercial production expected to commence from December 2010.

ƒ The gas pipeline from Raniganj-Durgapur (48 km) is nearing completion with a
small stretch of the pipeline under final stages of construction.

ƒ Capex of USD 327 mn for the block will be funded through debt and equity in the
ratio of 70:30 and financial tie up and closure has been achieved for the term
loan of phase I development.

ƒ Management also indicated that long-term contracts for the Raniganj block with
Phillips Carbon and other customers have either been signed or are in the
process of being finalised at a price of USD 6.5-9.5/mmbtu.

• ESOIL is bullish on its other E&P assets with good prospects emerging in its block in
Nigeria. Other blocks including Assam and Mehsana are undergoing preliminary
seismic tests and are under different stages of resource assessment.

• Management remains positive on sorting out issues related to the Ratna PSC.

ƒ Refining, marketing, and other highlights

• ESOIL has recently imported 1 LNG cargo from GSPC. The LNG was re-gasified at
Shell’s Hazira LNG facility. Cost of natural gas for the company was ~USD 9-
10/mmbtu.

• While the company had started taking in Cairn’s Mangala crude from Q1FY11,
average crude consumption during August 2010 was 25,000 bopd. Currently, ESOIL
consumes ~30,000 bopd of Mangala crude, which is expected to scale to 60,000
bopd after commissioning of the expanded refinery in March 2011. The company is
enjoying tax benefits of 3% (5% import duty less 2% CST) due to its off-take from
Mangala, which directly translates into a positive impact on GRMs. Further, ESOIL
benefits from lower working capital requirements and better pricing of Mangala
crude.

• Capacity of the captive power plant at Vadinar refinery has been ramped up to 380
MW from 120 MW earlier (both capacities include steam generation capacity). The
recent procurement of natural gas supplies will result in savings of ~15% in raw
material costs as the plant was running on FO/naphtha earlier. Savings from the
same will be ~USD 0.3-0.4/bbl. This capacity is expected to further ramp up to 890
MW in phase III and 1,200 MW in phase IV of expansion, respectively.

• Currently, 1,340 retail outlets are operational. As per management, the company
plans to increase the same to 1,700 outlets by end FY11. Currently, 80-85% of the
outlets are located on highways, which sell diesel. With limited clarity on diesel de-
regulation and petrol being deregulated, ESOIL plans to focus on opening new
outlets closer to urban areas. Despite oil marketing companies selling diesel at a
loss, ESOIL continues to make retail margins on sales of diesel.

• ESOIL is planning to raise capital at Essar Energy to significantly reduce the cost of
debt from ~10.5% currently.

ƒ Outlook and valuations: SOTP at INR 186/share; maintain ‘BUY’

We have broadly maintained our earnings estimates and our estimated fair value (SOTP
at INR 186/share) after some minor adjustments due to the recent annual report update.
The risk weighted estimate of E&P assets has been revised upwards to INR 48/share
after capturing the fair value from Raniganj and Ratnagiri blocks only as other blocks are
still in early stages of assessment. We believe the potential upsides from E&P assets may

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  Essar Oil

be even higher as clarity emerges on these blocks—Nigeria, Assam, Mehsana, Rajmahal

CBM.

ESOIL’s GRMs are likely to improve going forward on better refining outlook (expected
uptick in global refinery utilisation as product demand growth may be better than
refinery capacity additions), increased complexity and benefit of gas/Mangala crude.
Further, upstream (especially CBM) activity by the company has been rising and
monetisation of the Raniganj gas block (expected by Q3FY11) will diversify revenues.
With multiple triggers lying ahead, we remain positive on re-rating of ESOIL.

At CMP of INR 130, the stock trades at 19.4x FY11E and 9.9x FY12E earnings. We
maintain ‘BUY’ recommendation on the stock and rate it ‘Sector Outperformer’ on
relative return basis.

Table 1: Change in earnings estimates

Revised estimates Previous estimates (% Change)
FY11E FY12E FY11E FY12E FY11E FY12E Reason
Estimates
Revenues (INR mn) 387,417 420,328 396,337 427,443 (2.3) (1.7) Broadly maintained
EBITDA (INR mn) 30,264 44,557 29,939 45,942 1.1 (3.0) same as above
Group PAT (INR mn) 8,055 15,691 8,071 15,877 (0.2) (1.2) same as above
Diluted EPS (INR) 6.7 13.1 6.7 13.2 0.1 (1.1) same as above
Source: Edelweiss research

Table 2: March 2011 SOTP value of INR 184/share

Existing refinery
post-expansion Mar-11
(INR mn) (INR/share) Notes
1-yr forward operational EBITDA 35,925 Excluding the sales tax benefit
EV of operational assets 233,514 194 At industry multiple of 6.5x
NPV of income tax benefit 10,947 9 7 year tax holiday
NPV of E&P assets 57,439 48 Risk-weighted estimate
Value of investments 2,030 2 At book value
NPV of sales tax deferral 5,778 5 Still remaining at year-end
EV of firm 309,708 258 Sum of parts above
Net debt 128,929 107 Debt net of cash and CWIP
Equity value of firm at year end 180,778 150 EV - Net debt
Equity value of firm (Mar-2011) 180,778 150 Discounted at Ke till FY11

Parameter Value
Equity value of refinery 2 (Mar-10) (INR/share) 142
Risk-weightage for refinery 2 execution (%) 25.0
Fair value of firm (INR/share) 186
CMP (INR/share) 130
Upside (%) 43.1
Source: Edelweiss research

Edelweiss Securities Limited 3

 
Oil, Gas and Services

ƒ Company Description
ESOIL is one of the major arms of the Essar Group, and currently has operations
primarily in refining and marketing of petro products. Historically, the company had a
business of oil exploration rigs, which it has exited. ESOIL aims to be a vertically
integrated entity, and has therefore embarked on acquisition of upstream assets.
However, its core business remains refinery-centric, for which the company has
ambitious expansion plans.

ESOIL has a 10.5 MMTPA, 6.1 NCI (Nelson Complexity Index) refinery at Vadinar, near
Jamnagar in Gujarat. The refinery started trial production in mid-FY08, and FY09 was its
first full year of operations. ESOIL has interests in the upstream sector as well, and aims
to transform into a true integrated oil and gas entity through forays into the E&P
segment. It has interests in blocks in India (both E&P and CBM), and some assets lying
with other group companies of ESOIL are pending approval for transfer to ESOIL.

ƒ Investment Theme
• Mega expansion in refining to complete as industry recovers from overcapacity

• Twin fiscal benefits increase attractiveness of returns for investors

• Expanded high-complexity refinery to outperform peers on multiple fronts

• Robust demand despite concerns of economic slowdown provides comfort on offtake

• Resilient marketing model to benefit further from auto fuel pricing deregulation

• Exploratory upsides and CBM monetisation to add value

ƒ Key Risks
• Project execution risk for refinery 2

• Recessionary demand attenuation leading to overcapacity and muted GRMs

• Rupee appreciation may harm refining realisations

• Marketing segment’s growth may be constrained due to regulatory disparity

• Signing of PSC for Ratna E&P block

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  Essar Oil

Financial Statements
Income Statement (INR mn)
Year to March FY08 FY09 FY10 FY11E FY12E
Net revenues 5,623 375,164 365,046 387,417 420,328
Raw material costs 5,944 342,030 342,509 347,447 365,793
Gross profit (321) 33,135 22,537 39,970 54,534
Employee expenses 23 969 975 981 988
Other expenses 156 21,977 10,903 8,725 8,990
Operating expenses 179 22,946 11,878 9,706 9,977
Total expenditure 6,123 364,975 354,387 357,153 375,771
EBITDA (500) 10,189 10,659 30,264 44,557
Depreciation & amortisation 25 6,549 7,283 7,500 9,500
EBIT (525) 3,640 3,376 22,764 35,057
Interest expense 61 10,915 11,809 12,695 16,762
Other income 145 1,837 8,719 - 1,319
Profit before tax (441) (5,437) 286 10,069 19,614
Current tax (24) - (9) 2,014 3,923
Deferred tax (6) (321) - - -
Other taxes 1 19 - - -
Total tax (29) (302) (9) 2,014 3,923
Core profit (412) (5,135) 295 8,055 15,691
Profit after tax (412) (5,135) 295 8,055 15,691
Profit after minority interest (412) (5,135) 295 8,055 15,691
Equity shares outstanding (mn) 1,174 1,202 1,202 1,366 1,366
EPS (INR) basic (0.4) (4.3) 0.2 5.9 11.5
Diluted shares (mn) 1,202 1,202 1,202 1,202 1,202
EPS (INR) fully diluted (0.3) (4.3) 0.2 6.7 13.1
CEPS (0.3) 0.9 6.3 11.4 18.4
DPS - - - - 1.0

Common size metrics (% net revenues)

Year to March FY08 FY09 FY10 FY11E FY12E
Cost of goods sold 105.7 91.2 93.8 89.7 87.0
Operating expenses 3.2 6.1 3.3 2.5 2.4
EBITDA margins (8.9) 2.7 2.9 7.8 10.6
Depreciation & amortisation 0.4 1.7 2.0 1.9 2.3
Interest 1.1 2.9 3.2 3.3 4.0
Net profit margin (7.3) (1.4) 0.1 2.1 3.7

Growth metrics (%)

Year to March FY08 FY09 FY10 FY11E FY12E
Revenues 18.6 6,572.1 (2.7) 6.1 8.5
EBITDA 0.4 (2,139.0) 4.6 183.9 47.2
PBT (19.2) 1,133.8 (105.3) 3,423.0 94.8
Net profit (39.0) 1,147.0 (105.7) 2,634.2 94.8
EPS (39.0) 1,147.0 (105.7) 2,634.2 94.8

Edelweiss Securities Limited 5

 
Oil, Gas and Services

Balance sheet (INR mn)

As on 31st March FY08 FY09 FY10 FY11E FY12E
Total equity capital 13,420 13,092 23,713 13,822 13,822
Reserves & surplus 22,587 22,729 23,023 53,067 67,166
Shareholder's equity (A) 36,007 35,820 46,737 66,890 80,989
Secured loans 91,341 94,192 94,706 129,727 118,063
Unsecured loans 6,812 6,126 8,831 20,633 66,816
Total debt (B) 98,153 100,317 103,537 150,361 184,879
Deferred tax liability (C) 315 (6) (6) (6) (6)
Sources of funds (A+B+C) 134,475 136,132 150,268 217,245 265,862
Gross fixed assets 5,517 133,647 138,025 216,738 221,073
Depreciation 1,216 7,589 14,932 22,432 31,932
Net fixed assets 4,301 126,058 123,094 194,307 189,142
Capital WIP 132,903 19,139 43,188 19,168 62,147
Total fixed assets (A) 137,204 145,197 166,281 213,475 251,289
Investments (B) 1,031 1,031 2,030 2,030 2,030
Inventories 48,909 22,509 39,694 38,076 40,087
Accounts receivable 8,034 11,654 20,333 21,579 23,412
Cash and cash equivalents 10,028 11,746 13,508 7,660 8,281
Loans and advances 8,010 9,123 6,947 6,953 6,986
Other current assets 545 4,199 3,307 3,874 4,203
Current assets (C) 75,526 59,231 83,789 78,143 82,970
Accounts payable 79,156 69,074 101,603 76,153 70,152
Other current liabilities & provisions 130 253 228 250 275
Current liabilities & provisions (D) 79,285 69,327 101,832 76,403 70,427
Net current assets (E) (3,759) (10,096) (18,043) 1,740 12,543
Uses of funds (A+B+C+D+E) 134,475 136,132 150,268 217,245 265,862
Book value per share 31 30 39 49 59

Free cash flow

Year to March FY08 FY09 FY10 FY11E FY12E
Net profit (412) (5,135) 295 8,055 15,691
Add: Depreciation 25 6,549 7,283 7,500 9,500
Add: Deferred tax (6) (321) - - -
Add: Others 62,737 0 - 0 0
Gross cash flow 62,344 1,092 7,578 15,555 25,191
Less:Changes in working capital (13,952) (8,055) (9,708) 25,631 10,181
Opertaing cash flow 76,296 9,148 17,285 (10,076) 15,010
Less: Capex (91,782) (14,367) (28,426) (53,314) (45,147)
Free cash flow (15,485) (5,219) (11,141) (63,389) (30,137)

Cash flow metrics (INR mn)

Year to March FY08 FY09 FY10 FY11E FY12E
Operating cash flow 76,296 9,148 17,285 (10,076) 15,010
Financing cash flow 12,781 2,442 3,220 48,464 32,926
Investing cash flow (91,604) (14,542) (29,366) (54,694) (47,314)
NET CASH FLOW (2,527) (2,952) (8,861) (16,305) 622
Capex 91,782 14,367 28,426 53,314 45,147
Dividends paid - - - - (159,244)

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  Essar Oil

Profitability ratios (%)

Year to March FY08 FY09 FY10 FY11E FY12E
Gross profit margin (5.71) 8.83 6.17 10.32 12.97
EBITDA margin (8.9) 2.7 2.9 7.8 10.6
ROACE (0.4) 2.7 2.4 12.5 14.6
ROAE (3.3) (14.3) 0.7 14.2 21.2
ROA (0.3) (3.8) 0.2 4.4 6.5
Current ratio 1.0 0.9 0.8 1.0 1.2
Quick ratio 0.3 0.5 0.4 0.5 0.6
Cash ratio 0.1 0.2 0.1 0.1 0.1
Receivable turnover (x) 1.1 38.1 22.8 18.5 18.7
Inventory turnover (x) 0.1 9.6 11.0 8.9 9.4
Payables turnover (x) 0.1 4.6 4.0 3.9 5.0
Receivables (days) 318 10 16 20 20
Inventory (days) 2,551 38 33 41 39
Payables (days) 3,650 79 91 93 73
Cash conversion cycle (days) (780) (31) (42) (33) (14)
Debt-equity (x) 2.7 2.8 2.2 2.2 2.3
Debt/EBITDA (196.4) 9.8 9.7 5.0 4.1
Adjusted debt/Equity 2.7 2.8 2.2 2.2 2.3
Long term debt / Capital employed (%) 73.0 73.7 68.9 69.2 69.5
Total debt / Capital employed (%) 132.2 124.6 136.7 104.4 96.0
Interest coverage (x) (8.7) 0.3 0.3 1.8 2.1

Operating ratios (x)

Year to March FY08 FY09 FY10 FY11E FY12E
Total asset turnover 0.0 2.8 2.5 2.1 1.7
Fixed asset turnover 1.8 5.8 2.9 2.4 2.2
Equity turnover 0.2 10.4 8.8 6.8 5.7

Du pont analysis
Year to March FY08 FY09 FY10 FY11E FY12E
NP margin % (7.3) (1.4) 0.1 2.1 3.7
Total assets turnover 0.0 2.8 2.5 2.1 1.7
Leverage multiplier 10.0 3.8 3.5 3.2 3.3
ROAE % (3.3) (14.3) 0.7 14.2 21.2

Valuation parameters
Year to March FY08 FY09 FY10 FY11E FY12E
Diluted EPS (INR) (0.34) (4.27) 0.25 6.70 13.06
Y-o-Y growth (%) (39.0) 1,147.0 (105.7) 2,634.2 94.8
CEPS (INR) (0.3) 0.9 6.3 11.4 18.4
Diluted P/E (x) (379.0) (30.4) 529.8 19.4 9.9
P/BV (x) 4.2 4.4 3.3 2.7 2.2
EV/Sales (x) 42.6 0.6 0.7 0.8 0.8
EV/EBITDA (x) (479.4) 23.9 22.9 10.5 7.9
EV/EBITDA (x)+1yr forward 23.5 22.9 8.1 7.1 7.1

Edelweiss Securities Limited 7

 
Oil, GasRATING & INTERPRETATION
and Services

Company Absolute Relative Relative Company Absolute Relative Relative

reco reco risk reco reco Risk
Aban Offshore HOLD SU H Bharat Petroleum REDUCE SU M
Corporation
Cairn India HOLD SO M Chennai Petroleum HOLD SP H
Corporation
Essar Oil BUY SO H GAIL (INDIA) BUY SO L
Hindustan Petroleum Corporation REDUCE SU L Indian Oil Corporation REDUCE SU M
Indraprastha Gas BUY SO L ONGC HOLD SU L
Petronet LNG BUY SO L Reliance Industries HOLD SO M
Shiv Vani Oil & Gas Exploration BUY SO M
Service

ABSOLUTE RATING
Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria
Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe
within the sector

RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING
Ratings Criteria
Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

8 Edelweiss Securities Limited

  Essar Oil

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021.
Board: (91-22) 2286 4400, Email: research@edelcap.com

Vikas Khemani Head Institutional Equities vikas.khemani@edelcap.com +91 22 2286 4206

Nischal Maheshwari Head Research nischal.maheshwari@edelcap.com +91 22 6623 3411

Coverage group(s) of stocks by primary analyst(s): Oil,Gas and Services

Aban Offshore, Bharat Petroleum Corporation, Cairn India, Essar Oil, GAIL (INDIA), Hindustan Petroleum Corporation, Indraprastha Gas,
Indian Oil Corporation, Chennai Petroleum Corporation, ONGC, Petronet LNG, Reliance Industries, Shiv Vani Oil & Gas Exploration Service

Essar Oil EW Indices

210 1,280

180 1,160
(INR)

150 Buy Buy 1,040

120 Buy Buy

920

90
800
Mar-10
Dec-09
Sep-09

Jan-10

Sep-10
Oct-09

Jun-10

Aug-10
Nov-09

Apr-10
Feb-10

Jul-10
May-10

11-Sep-09 11-Mar-10 11-Sep-10

Essar Oil Ltd. EW O & G Index Nifty

Distribution of Ratings / Market Cap Recent Research

Edelweiss Research Coverage Universe Date Company Title Price (INR) Recos
Buy Hold Reduce Total 02-Sep-10 Oil & Gas Monthly Update;

Rating Distribution* 109 52 12 177

* 4 stocks under review 20-Aug-10 IGL Going strong 320 BUY
Visit Note
> 50bn Between 10bn and 50 bn < 10bn
19-Aug-10 Petronet Spot volumes to pick 112 BUY
Market Cap (INR) 108 54 15 LNG up momentum;
Visit Note

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