Essar Oil - Sizeable impact of SC ruling against sales tax deferral; company update; Buy ::Edelweiss

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Essar Oil (ESOIL IN, INR 52, Buy)

The Supreme Court has set aside an earlier judgment of the Gujarat High Court which allowed Essar Oil to defer payment of sales tax to Gujarat government from its Vadinar refinery in the state. Gujarat govt. claimed that the refinery was set up after the incentive cut-off date. The deferment of sales tax payment bestowed NPV benefits to Essar, which it showed as a part of reported GRMs (~USD2.5/bbl). Post the SC decision, Essar might have to pay back the state INR63bn of sales tax deferred so far. This will lead to higher debt and we estimate a cut in SOTP by INR74bn (INR 52/share).

SC ruling against deferral of sales tax

The Gujarat govt. had come out with a Capital Investment Incentive Scheme, 1995-2000, encouraging investments in refineries, whereby it allowed companies to retain sales tax collected for the first 17 years of operations, and repay the same in six equal annual installments thereafter. Refineries benefited from the time value of money as no interest was paid due to the deferral. However, the state govt. contested that Essar’s Vadinar refinery was set up beyond the incentive date of August 2003 and hence, not eligible for a deferral. Essar countered, saying that the refinery commissioning was delayed due to reasons beyond its control.

As per Essar Oil’s claims, it was eligible for a total Sales Tax Deferral of INR91bn. NPV of savings as a result of this would have been ~ INR58bn. Till Dec 2011, Essar had availed Sales Tax Deferral of INR63bn (reported EBITDA on account of the same at INR42bn). While Essar may be filing a review petition, we are assuming that the recent SC judgment is final. Hence, we are factoring in the repayment of INR42bn plus our estimate of interest of INR 14 bn by ESOIL to Gujarat in FY13.

Outlook and Valuation: SOTP to fall by INR52/share to INR101

Absence of earnings from Sales Tax Deferral and higher interest expenses will lower FY13E EPS by INR8 to INR3.3. Assuming an upfront payment of INR56bn and lowering refining valuations to 5.5x EV/EBITDA on weaker outlook for refinery demand, our SOTP for Essar Oil would fall by INR52/sh to INR101/sh. At CMP INR52, Essar Oil is trading at a P/E of 15.8x FY13 EPS and EV/EBITDA of 7.8x FY13 EBITDA. Maintain ‘BUY’.