We assume coverage of Essar Oil with a Neutral rating and a Sep-14 PT of Rs55
from a Not Rated designation (OW rating and Rs160 PT prior to NR designation)
– a highly leveraged refining company with unconventional gas assets. The shares
have underperformed by 28% and 34% in absolute terms and relative to its local
market this year, reflecting concerns around debt management. However, Essar
Oil’s recently upgraded refinery provides better refining margins than most
domestic peers, with continued domestic diesel reform providing some
profitability upside. The company’s upstream asset, Raniganj, is now poised to
begin production with possible natural gas price reform also providing good cash
generation to manage its debt burden. While ESOIL gearing levels remain high
(c.424% in FY16E) despite converting costly INR debt to cheaper US$ loans, we
see risk-reward as fairly well balanced as we approach FY15.
Sustainable refining margins from upgrading: With Essar Oil’s upgraded
refinery, with its higher complexity and optimization (using natural gas for
refinery power supply) providing more sustainable refining margins relative to
domestic peers despite our expectation of a broadly flat refining margin
environment in the medium term.
Some upstream bias, worth c52% of value: Small volumes have commenced
from Raniganj, a coal bed methane project, with output expected to rise toward
a peak plateau of 3mmscmd from FY15. Overall we value all of Essar Oil’s
unconventional assets at Rs29/share, 52% of our total value.
De-leveraging from debt conversion and operational delivery: Debt levels
remain elevated, with interest costs almost as high as EBITDA. While the
company is bringing interest costs down by converting INR debt to USD
(estimated saving of $60mn for every $1bn converted), gearing levels are likely
to remain high in the medium term.
Valuation and Risks: Our PT is based on SOTP – we use an 11x P/E multiple
(at a discount to regional peers to account for continuing high leverage and
lower profitability, and value the Raniganj asset on DCF; Rajmahal on resource
base). Downside risks are lower refining margins, upstream execution and
persistently higher interest costs. Upside risks improving debt management,
higher natural gas prices and faster-than-expected diesel price reform.
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from a Not Rated designation (OW rating and Rs160 PT prior to NR designation)
– a highly leveraged refining company with unconventional gas assets. The shares
have underperformed by 28% and 34% in absolute terms and relative to its local
market this year, reflecting concerns around debt management. However, Essar
Oil’s recently upgraded refinery provides better refining margins than most
domestic peers, with continued domestic diesel reform providing some
profitability upside. The company’s upstream asset, Raniganj, is now poised to
begin production with possible natural gas price reform also providing good cash
generation to manage its debt burden. While ESOIL gearing levels remain high
(c.424% in FY16E) despite converting costly INR debt to cheaper US$ loans, we
see risk-reward as fairly well balanced as we approach FY15.
Sustainable refining margins from upgrading: With Essar Oil’s upgraded
refinery, with its higher complexity and optimization (using natural gas for
refinery power supply) providing more sustainable refining margins relative to
domestic peers despite our expectation of a broadly flat refining margin
environment in the medium term.
Some upstream bias, worth c52% of value: Small volumes have commenced
from Raniganj, a coal bed methane project, with output expected to rise toward
a peak plateau of 3mmscmd from FY15. Overall we value all of Essar Oil’s
unconventional assets at Rs29/share, 52% of our total value.
De-leveraging from debt conversion and operational delivery: Debt levels
remain elevated, with interest costs almost as high as EBITDA. While the
company is bringing interest costs down by converting INR debt to USD
(estimated saving of $60mn for every $1bn converted), gearing levels are likely
to remain high in the medium term.
Valuation and Risks: Our PT is based on SOTP – we use an 11x P/E multiple
(at a discount to regional peers to account for continuing high leverage and
lower profitability, and value the Raniganj asset on DCF; Rajmahal on resource
base). Downside risks are lower refining margins, upstream execution and
persistently higher interest costs. Upside risks improving debt management,
higher natural gas prices and faster-than-expected diesel price reform.
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