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Essar Oil Limited
Taking the big leap 8 March 2011
Investment summary
We initiate coverage on Essar Oil Limited (EOL) with a BUY recommendation
and a target price of INR171/share. We expect refinery margins to remain
strong for the next 2-3 years led by strong diesel demand and recovery in light
heavy spreads. Vadinar refinery expansion is thus expected to come at the
right time of investment cycle, benefitting EOL. Company's foray into CBM
and commencement of production at Raniganj would provide significant early
mover advantage. Furthermore, signing of PSC agreement for Ratna R series
field and progress on exploration process in other prolific E&P blocks (both
domestic and international) are likely to act as future catalysts for growth.
Capacity expansion comes at the right time of investment cycle
EOL's Vadinar refinery expansion, from 14mmtpa to 20mmtpa, comes at the
right time of refinery investment cycle. Post expansion, EOL would benefit from:
i) larger refinery at competitive capital cost; ii) product slate biased towards
higher value-added products; and iii) improving light-heavy differentials. We
expect EOL to post a clean GRM of USD7.4/bbl and USD8.3/bbl in FY12e
and FY13e, respectively (excl. sales tax benefit).
CBM - early mover advantage
EOL's CBM portfolio comprises of five blocks with total 2P reserves of 201bcf
and prospective best estimate resource of 5.5tcf. Raniganj is the only producing
CBM block currently. EOL joins the league with GEECL and ONGC of being
the only players to start CBM production in India, thus providing early mover
advantage to EOL. We assign an NPV value of INR39bn (INR29/share) for
its Raniganj block implying a resource multiple of USD5.2/boe. We assign a
significantly lower resource multiple of USD1.2/boe for the Rajmahal CBM
block due to early stages of exploration. EOL has another 4.4tcf of unrisked
resource in place, where exploration activity is yet to commence, and thus, not
accounted in our valuations.
Option values - to act as future catalysts
Signing of PSC agreement for Ratna R-series field will help unlock an option
value of INR23/share. We employ DCF methodology to value the field implying
a valuation of INR46/share but currently assign a 50% valuation weight to
our valuations. Progress on diesel price de-control would also enable EOL to
capitalise on its strong retail network.
Valuation and outlook
We recommend a BUY on EOL with SOTP-based target price of INR171/
share implying a potential return of 53% from current levels.
Refining and marketing divisions has been valued at INR213bn (INR156/share)
using DCF methodology. We have assumed expansion of Vadinar refinery to
18mmtpa by 1HFY12e and to 20mmtpa by 2HFY13e. Our valuations also include
sales tax deferral benefit of INR91bn implying an NPV benefit of INR10/share.
We value EOL's Raniganj CBM block at INR39bn (INR29/share) using DCF
methodology, implying a resource valuation of USD5.2/boe. Our valuation
comprises both Phase-1 and Phase-2 development.
We value Ratna and R-series field at INR62bn (INR46/share) using DCF
methodology implying a resource valuation of USD20/bbl. We however assign a
50% valuation weight to our DCF valuations as we await signing of PSC agreement
for the block. We are currently assuming INR2,625/ton of cess and 10% of royalty
in our valuations for the block.
Rajmahal CBM block is valued using a resource multiple of USD1.2/boe, significantly
lower than that derived for Raniganj CBM block due to early stages of exploration.
For the Nigerian block, we currently account for only oil reserves in our valuations.
Resource valuation includes 2C net oil reserves of 11MMbbl and 50% of prospective
oil resources of 49MMbbl. We assign a resource multiple of USD4/boe implying
a valuation of INR5/share.
Key macro risks to our earnings forecasts and ratings
Domestic or global economic slowdown may dampen refining demand and thus
impact our refinery margin assumptions.
Volatile crude and oil product prices may affect refining margins and earnings.
Delays in commissioning of Vadinar expansion project could affect our throughput
assumption and valuation.
Regulatory delays in signing of PSC agreement for Ratna R series field beyond
1QFY12e could impact our DCF assumptions for the field.
Volatility in foreign exchange may increase costs of key feedstock (crude oil), which
is denominated in US dollars.
Any adverse regulatory change with respect to direct or indirect taxation may
affect our earnings and DCF estimates.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Essar Oil Limited
Taking the big leap 8 March 2011
Investment summary
We initiate coverage on Essar Oil Limited (EOL) with a BUY recommendation
and a target price of INR171/share. We expect refinery margins to remain
strong for the next 2-3 years led by strong diesel demand and recovery in light
heavy spreads. Vadinar refinery expansion is thus expected to come at the
right time of investment cycle, benefitting EOL. Company's foray into CBM
and commencement of production at Raniganj would provide significant early
mover advantage. Furthermore, signing of PSC agreement for Ratna R series
field and progress on exploration process in other prolific E&P blocks (both
domestic and international) are likely to act as future catalysts for growth.
Capacity expansion comes at the right time of investment cycle
EOL's Vadinar refinery expansion, from 14mmtpa to 20mmtpa, comes at the
right time of refinery investment cycle. Post expansion, EOL would benefit from:
i) larger refinery at competitive capital cost; ii) product slate biased towards
higher value-added products; and iii) improving light-heavy differentials. We
expect EOL to post a clean GRM of USD7.4/bbl and USD8.3/bbl in FY12e
and FY13e, respectively (excl. sales tax benefit).
CBM - early mover advantage
EOL's CBM portfolio comprises of five blocks with total 2P reserves of 201bcf
and prospective best estimate resource of 5.5tcf. Raniganj is the only producing
CBM block currently. EOL joins the league with GEECL and ONGC of being
the only players to start CBM production in India, thus providing early mover
advantage to EOL. We assign an NPV value of INR39bn (INR29/share) for
its Raniganj block implying a resource multiple of USD5.2/boe. We assign a
significantly lower resource multiple of USD1.2/boe for the Rajmahal CBM
block due to early stages of exploration. EOL has another 4.4tcf of unrisked
resource in place, where exploration activity is yet to commence, and thus, not
accounted in our valuations.
Option values - to act as future catalysts
Signing of PSC agreement for Ratna R-series field will help unlock an option
value of INR23/share. We employ DCF methodology to value the field implying
a valuation of INR46/share but currently assign a 50% valuation weight to
our valuations. Progress on diesel price de-control would also enable EOL to
capitalise on its strong retail network.
Valuation and outlook
We recommend a BUY on EOL with SOTP-based target price of INR171/
share implying a potential return of 53% from current levels.
Refining and marketing divisions has been valued at INR213bn (INR156/share)
using DCF methodology. We have assumed expansion of Vadinar refinery to
18mmtpa by 1HFY12e and to 20mmtpa by 2HFY13e. Our valuations also include
sales tax deferral benefit of INR91bn implying an NPV benefit of INR10/share.
We value EOL's Raniganj CBM block at INR39bn (INR29/share) using DCF
methodology, implying a resource valuation of USD5.2/boe. Our valuation
comprises both Phase-1 and Phase-2 development.
We value Ratna and R-series field at INR62bn (INR46/share) using DCF
methodology implying a resource valuation of USD20/bbl. We however assign a
50% valuation weight to our DCF valuations as we await signing of PSC agreement
for the block. We are currently assuming INR2,625/ton of cess and 10% of royalty
in our valuations for the block.
Rajmahal CBM block is valued using a resource multiple of USD1.2/boe, significantly
lower than that derived for Raniganj CBM block due to early stages of exploration.
For the Nigerian block, we currently account for only oil reserves in our valuations.
Resource valuation includes 2C net oil reserves of 11MMbbl and 50% of prospective
oil resources of 49MMbbl. We assign a resource multiple of USD4/boe implying
a valuation of INR5/share.
Key macro risks to our earnings forecasts and ratings
Domestic or global economic slowdown may dampen refining demand and thus
impact our refinery margin assumptions.
Volatile crude and oil product prices may affect refining margins and earnings.
Delays in commissioning of Vadinar expansion project could affect our throughput
assumption and valuation.
Regulatory delays in signing of PSC agreement for Ratna R series field beyond
1QFY12e could impact our DCF assumptions for the field.
Volatility in foreign exchange may increase costs of key feedstock (crude oil), which
is denominated in US dollars.
Any adverse regulatory change with respect to direct or indirect taxation may
affect our earnings and DCF estimates.
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