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Commissioning of new projects to drive EPS CAGR of 51% over FY11-14E
We initiate coverage on Essar Oil (ESOIL) with a Buy rating and a target price of
INR130, implying upside potential of 33%. Our positive investment case is
premised on: 1) refinery capacity expansion by 29% to 18mmtpa in 3QFY12E, and
almost a doubling of complexity to 11.8 leading to higher refining margins; 2)
commercial production start-up from Raniganj CBM by 3QFY12E; and 3) a current
valuation of 4.6x FY13E EV/EBITDA, which is a 20% discount to regional peers.
Major capex completed; time to monetize investments
ESOIL is aiming to expand its refining capacity by 40%, to 20mmtpa, by 2HFY13,
and simultaneously upgrade its refinery from a Nelson Complexity Index (NCI) of
6.1 to 11.8, with capex of US$2.2bn. Compared with FY11, we expect this to lead
to a 25% higher throughput and a 65% higher gross refining margin (including
sales tax benefit) of US$11.4/bbl in FY13. We also expect ESOIL to start
commercial production of coal bed methane (CBM) gas from its Raniganj block in
2HFY12, achieving peak production of 3.5mmscmd in FY14.
Refining margin improvement to drive EBITDA CAGR of 37% over FY11-14E
We estimate the expansion and upgradation of the refinery, and the start-up of
CBM production to drive an EBITDA CAGR of 37%, and an EPS CAGR of 51%
over FY11-14E. We expect strong cash flow generation (FY13E FCF yield of 10%)
to lead to a reduction in debt and leverage from FY13 onwards. We estimate net
debt/equity to fall below 1x in FY14, from 1.8x in FY11. However, if the global
economy worsens, leading to a fall in global refining margins, this may have a
significant adverse impact on ESOIL’s earnings and valuations - a US$1/bbl lower
GRM would reduce our FY13E EPS by 22% and our valuation by 20% (INR26/sh).
We have already seen the stock price correct by 24% in the last two months on
fears of the global economic slowdown impacting ESOIL’s GRMs.
SOTP-based target price of INR130; worsening global economy is key risk
We value ESOIL at INR130/share on an SOTP-basis. We value the refining
business on 6x FY13E EV/EBITDA, and the E&P business on DCF with a 14.2%
WACC. Risks are: 1) a worsening global economy that could hurt refining demand
and margins; 2) project execution risks; and 3) policy vagaries.
Investment thesis
Outlook
We are initiating coverage on Essar Oil with a Buy rating. Our investment thesis is premised
on robust growth in profitability, driven by capacity expansion and upgradation of the refinery
and commissioning of the company’s Raniganj coal bed methane (CBM) gas project. We
expect the commissioning of these projects and an improvement in ESOIL’s refining margins
to drive an EBITDA CAGR of 37% and an EPS CAGR of 51% over FY11-14E. Our Buy rating is
driven predominantly by capacity expansion and the upgradation of Essar Oil’s refinery, in
addition to Deutsche Bank’s forecast of strong regional refining (Singapore Complex) margins
of above US$7/bbl. We believe the refining margin is the key determinant of ESOIL’s
profitability and valuation. Every US$1/bbl change in the estimated gross refining margin
(GRM) of ESOIL changes our FY13E EPS by 20% and our base case valuation by INR26/sh
(20%). ESOIL plans to expand its refining capacity by 40%, to 20mmtpa, by 1HFY13, which
we believe will enable it to increase its throughput at an 11% CAGR over the next three
years. Simultaneously, ESOIL is also increasing the complexity of its refinery from the Nelson
Complexity Index (NCI) of 6.1 to 11.8. We expect this to enable ESOIL to earn a robust GRM
in FY13 of more than US$10/bbl (excluding sales tax benefit), which is more than double its
comparable FY11 GRM of US$4.5/bbl. Moreover, we expect ESOIL to begin commercial
production of CBM gas from its Raniganj block in 2HFY12, which is awaiting statutory
approvals, and to achieve peak production of 3.5mmscmd in FY14.
Valuation
We value Essar Oil at INR130/share based on a sum-of-the-parts valuation. We value the
refining business on 6x FY13E EV/EBITDA, implying a 10% premium to its regional peers. We
value the company’s E&P interests on a DCF basis, using a 14.2% WACC, based on
Deutsche Bank's cost of equity assumptions for India (risk-free rate of 6.7% and market risk
premium of 8.1%) and a three-year beta of 1.5. Our valuation of ESOIL's E&P segment
includes the value of the Raniganj CBM block and the Mehsana oil reserves.
Risks
The key downside risks are: i) a worsening global economy, which could hurt refining
demand and margins – a US$1/bbl lower GRM will reduce our FY13E EPS by 22% and our
valuation by 20% (INR26/sh), ii) any delay in completion of its refinery expansion project or
delay in the start-up of CBM production from Raniganj, and iii) disappointing results in its
exploratory drilling in Rajmahal or any other CBM block.
Valuation and risks
We value Essar Oil (ESOIL) at INR130/share based on a sum-of-the-parts valuation. We value
the refining business on 6x FY13E EV/EBITDA, implying a 10% premium to its regional peers,
to account for the higher complexity of ESOIL’s expanded refinery. We value the company’s
E&P interests on a DCF basis, using a 14.2% WACC, based on Deutsche Bank's cost of
equity assumptions for India (risk-free rate of 6.7% and market risk premium of 8.1%) and a
three-year beta of 1.5. Our valuation of ESOIL's E&P segment includes the value of the
Raniganj CBM block and the Mehsana oil reserves. We choose not to include the value of the
other exploratory/prospective resources of the company (such as Rajmahal, Ratna and the RSeries), due to the early stage of development in these blocks
Alternative valuation methodologies also imply significant upside potential
A DCF-based valuation of the company, using a WACC of 14.2% and terminal growth of 3%,
yields a valuation of INR125/share. ESOIL’s estimated FY13 RoE is 23%. If we value the
company on the Gordon Growth Model, with a terminal growth rate of 3%, this yields a
target FY13E P/BV of 1.8x and a valuation of INR120/share. Even if we value the company on
a PE multiple, using a target FY13E P/E of 9.5x (10% premium to regional peers, to account
for the higher complexity), this yields a valuation of INR133/share. We therefore believe that
the stock is undervalued at the current market price, and rate it a Buy.
Above consensus by 15%/1% on FY13E EBITDA/EPS
We are above consensus on FY13 earnings estimates at both the EBITDA and net profit
levels. We believe that the consensus is factoring in a lower refining margin estimate for the
highly complex refinery of Essar Oil in FY13. However, we are below consensus on FY12
estimates, which we believe is because the consensus has not yet accounted for the delay in
capacity expansion, to 18mmtpa, which was earlier scheduled to be completed in Q1FY12,
but is now expected to be completed in Q3FY12.
Peer group valuation
We compare ESOIL with the regional refining peers. On FY13E, ESOIL is trading at 7.0x PE
and 4.6x EV/EBITDA, which implies a 20% discount to its regional peers. ESOIL is trading at a
1.4 FY13E P/BV, in line with its regional peers, despite its higher estimated FY13 RoE at
23.0%, vs 17.3% for peers. The peer group comparison suggests that the full impact of the
expected earnings increase from higher throughput/higher complexity is yet to be factored in
the current market price.
Band charts and FII holding
ESOIL is currently trading at 7.0x FY13E P/E and at 4.6x FY13E EV/EBITDA. At our target
price, the stock would trade at a FY13E P/E, EV/EBITDA and P/BV of 9.3x, 5.4x and 1.9x,
respectively. Over the past two years, the stock has traded between 4.2x and 24.9x
EV/EBITDA, and 1.3x and 4.2x on P/BV.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Commissioning of new projects to drive EPS CAGR of 51% over FY11-14E
We initiate coverage on Essar Oil (ESOIL) with a Buy rating and a target price of
INR130, implying upside potential of 33%. Our positive investment case is
premised on: 1) refinery capacity expansion by 29% to 18mmtpa in 3QFY12E, and
almost a doubling of complexity to 11.8 leading to higher refining margins; 2)
commercial production start-up from Raniganj CBM by 3QFY12E; and 3) a current
valuation of 4.6x FY13E EV/EBITDA, which is a 20% discount to regional peers.
Major capex completed; time to monetize investments
ESOIL is aiming to expand its refining capacity by 40%, to 20mmtpa, by 2HFY13,
and simultaneously upgrade its refinery from a Nelson Complexity Index (NCI) of
6.1 to 11.8, with capex of US$2.2bn. Compared with FY11, we expect this to lead
to a 25% higher throughput and a 65% higher gross refining margin (including
sales tax benefit) of US$11.4/bbl in FY13. We also expect ESOIL to start
commercial production of coal bed methane (CBM) gas from its Raniganj block in
2HFY12, achieving peak production of 3.5mmscmd in FY14.
Refining margin improvement to drive EBITDA CAGR of 37% over FY11-14E
We estimate the expansion and upgradation of the refinery, and the start-up of
CBM production to drive an EBITDA CAGR of 37%, and an EPS CAGR of 51%
over FY11-14E. We expect strong cash flow generation (FY13E FCF yield of 10%)
to lead to a reduction in debt and leverage from FY13 onwards. We estimate net
debt/equity to fall below 1x in FY14, from 1.8x in FY11. However, if the global
economy worsens, leading to a fall in global refining margins, this may have a
significant adverse impact on ESOIL’s earnings and valuations - a US$1/bbl lower
GRM would reduce our FY13E EPS by 22% and our valuation by 20% (INR26/sh).
We have already seen the stock price correct by 24% in the last two months on
fears of the global economic slowdown impacting ESOIL’s GRMs.
SOTP-based target price of INR130; worsening global economy is key risk
We value ESOIL at INR130/share on an SOTP-basis. We value the refining
business on 6x FY13E EV/EBITDA, and the E&P business on DCF with a 14.2%
WACC. Risks are: 1) a worsening global economy that could hurt refining demand
and margins; 2) project execution risks; and 3) policy vagaries.
Investment thesis
Outlook
We are initiating coverage on Essar Oil with a Buy rating. Our investment thesis is premised
on robust growth in profitability, driven by capacity expansion and upgradation of the refinery
and commissioning of the company’s Raniganj coal bed methane (CBM) gas project. We
expect the commissioning of these projects and an improvement in ESOIL’s refining margins
to drive an EBITDA CAGR of 37% and an EPS CAGR of 51% over FY11-14E. Our Buy rating is
driven predominantly by capacity expansion and the upgradation of Essar Oil’s refinery, in
addition to Deutsche Bank’s forecast of strong regional refining (Singapore Complex) margins
of above US$7/bbl. We believe the refining margin is the key determinant of ESOIL’s
profitability and valuation. Every US$1/bbl change in the estimated gross refining margin
(GRM) of ESOIL changes our FY13E EPS by 20% and our base case valuation by INR26/sh
(20%). ESOIL plans to expand its refining capacity by 40%, to 20mmtpa, by 1HFY13, which
we believe will enable it to increase its throughput at an 11% CAGR over the next three
years. Simultaneously, ESOIL is also increasing the complexity of its refinery from the Nelson
Complexity Index (NCI) of 6.1 to 11.8. We expect this to enable ESOIL to earn a robust GRM
in FY13 of more than US$10/bbl (excluding sales tax benefit), which is more than double its
comparable FY11 GRM of US$4.5/bbl. Moreover, we expect ESOIL to begin commercial
production of CBM gas from its Raniganj block in 2HFY12, which is awaiting statutory
approvals, and to achieve peak production of 3.5mmscmd in FY14.
Valuation
We value Essar Oil at INR130/share based on a sum-of-the-parts valuation. We value the
refining business on 6x FY13E EV/EBITDA, implying a 10% premium to its regional peers. We
value the company’s E&P interests on a DCF basis, using a 14.2% WACC, based on
Deutsche Bank's cost of equity assumptions for India (risk-free rate of 6.7% and market risk
premium of 8.1%) and a three-year beta of 1.5. Our valuation of ESOIL's E&P segment
includes the value of the Raniganj CBM block and the Mehsana oil reserves.
Risks
The key downside risks are: i) a worsening global economy, which could hurt refining
demand and margins – a US$1/bbl lower GRM will reduce our FY13E EPS by 22% and our
valuation by 20% (INR26/sh), ii) any delay in completion of its refinery expansion project or
delay in the start-up of CBM production from Raniganj, and iii) disappointing results in its
exploratory drilling in Rajmahal or any other CBM block.
Valuation and risks
We value Essar Oil (ESOIL) at INR130/share based on a sum-of-the-parts valuation. We value
the refining business on 6x FY13E EV/EBITDA, implying a 10% premium to its regional peers,
to account for the higher complexity of ESOIL’s expanded refinery. We value the company’s
E&P interests on a DCF basis, using a 14.2% WACC, based on Deutsche Bank's cost of
equity assumptions for India (risk-free rate of 6.7% and market risk premium of 8.1%) and a
three-year beta of 1.5. Our valuation of ESOIL's E&P segment includes the value of the
Raniganj CBM block and the Mehsana oil reserves. We choose not to include the value of the
other exploratory/prospective resources of the company (such as Rajmahal, Ratna and the RSeries), due to the early stage of development in these blocks
Alternative valuation methodologies also imply significant upside potential
A DCF-based valuation of the company, using a WACC of 14.2% and terminal growth of 3%,
yields a valuation of INR125/share. ESOIL’s estimated FY13 RoE is 23%. If we value the
company on the Gordon Growth Model, with a terminal growth rate of 3%, this yields a
target FY13E P/BV of 1.8x and a valuation of INR120/share. Even if we value the company on
a PE multiple, using a target FY13E P/E of 9.5x (10% premium to regional peers, to account
for the higher complexity), this yields a valuation of INR133/share. We therefore believe that
the stock is undervalued at the current market price, and rate it a Buy.
Above consensus by 15%/1% on FY13E EBITDA/EPS
We are above consensus on FY13 earnings estimates at both the EBITDA and net profit
levels. We believe that the consensus is factoring in a lower refining margin estimate for the
highly complex refinery of Essar Oil in FY13. However, we are below consensus on FY12
estimates, which we believe is because the consensus has not yet accounted for the delay in
capacity expansion, to 18mmtpa, which was earlier scheduled to be completed in Q1FY12,
but is now expected to be completed in Q3FY12.
Peer group valuation
We compare ESOIL with the regional refining peers. On FY13E, ESOIL is trading at 7.0x PE
and 4.6x EV/EBITDA, which implies a 20% discount to its regional peers. ESOIL is trading at a
1.4 FY13E P/BV, in line with its regional peers, despite its higher estimated FY13 RoE at
23.0%, vs 17.3% for peers. The peer group comparison suggests that the full impact of the
expected earnings increase from higher throughput/higher complexity is yet to be factored in
the current market price.
Band charts and FII holding
ESOIL is currently trading at 7.0x FY13E P/E and at 4.6x FY13E EV/EBITDA. At our target
price, the stock would trade at a FY13E P/E, EV/EBITDA and P/BV of 9.3x, 5.4x and 1.9x,
respectively. Over the past two years, the stock has traded between 4.2x and 24.9x
EV/EBITDA, and 1.3x and 4.2x on P/BV.
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