Financial Performance of Mangalore Refinery and Petrochemicals Finance Essay

INTRODUCTION

Mangalore Refinery and Petrochemicals Limited (MRPL) and Reliance Petroleum Limited (RPL) were the first two refineries established by the private sector in India. In March 1992, MRPL brought out a public issue of shares, and in September 1993, RPL did the same. Both these refineries were established at a time when the administered pricing mechanism (APM) [1] was in force. APM involved full government control over the oil and natural gas sector, where only four major government owned oil companies (IOC, HPCL, BPCL and IBP) had the right to directly market petroleum products (Refer Exhibit I).

The government refineries were not able to meet the increasing demand for petroleum products. Hence, opening up of the oil and natural gas sector to private companies and dismantling APM were considered as methods for reducing the demand-supply gap of petroleum products.

When the Government of India (GOI) approved private sector participation in the oil refining and petroleum industry, a new investment opportunity was made available to Indian investors. Those who invested in MRPL and RPL were optimistic about the returns on shares of both these companies since reputed leading business houses such as the Aditya Birla Group (ABG) [2] and the Reliance Group [3] promoted these refinery projects. Due to the dearth of oil company stocks promoted by the private sector, the shares of both these companies were lapped up by public investors and financial institutions. Both the public issues were heavily oversubscribed.

However, few investment analysts expressed their reservations about investing in stand-alone refineries like MRPL and RPL since they felt that the financial performance of companies in the refining industry was completely dependant on the crude oil prices.

In March 2002 Reliance group approved the merger of RPL with Reliance Industries Ltd. (RIL) [4] . The appointed date of merger was April 2001. Once again in April 2006 Reliance Group came out with an initial public offer (IPO) for RPL. In this case an analysis of two oil refining companies viz. MRPL and RPL (2005)[Merged] for understanding risk and return involved in investment.

MANGALORE REFINERY AND PETROCHEMICALS LTD. (MRPL):

Mangalore Refinery and Petrochemicals Limited (MRPL) was incorporated on 7th March 1988. Company was started as joint venture of Hindustan Petroleum Corporation (HPCL) [5] and Indian Rayon & Industries Limited (IRIL) & Associates (AV Birla Group). MRPL has the distinction of being the only refinery in India with two CCRs which produces unleaded petrol of high octane.

In the year 1993 MRPL made a public issue consisting 4,31,60,000 shares of which 16 percent was Secured Redeemable Partly Convertible Debentures (PCDs) priced at Rs 135 which fetched 582.66 crores. It also issued 2,80,00,000 shares of which 17.5 percent was Secured Redeemable Non Convertible Debentures of Rs 200 each (with Detachable Equity Warrants) fetching Rs 560 crores. In the same year MRPL also tied up with internationally reputed technology suppliers for process technologies.

In March 2003 ONGC acquired the share holding of 37.39 percent which was held by AV Birla Group. Further ONGC added the capital of Rs 600 crores and made MRPL as a majority held subsidiary of ONGC. As on 31st March 2010 HPCL holds 16.96 percent (297153518 shares) and ONGC 71.63 percent (1255354097 shares) shares of MRPL.

In September 1995 MRPL started a 45 MW cogeneration plant and also three million tones refinery by the end of 1995- 96 financial year. In 1999 MRPL signed deal with Chevron- Texaco for crude sourcing. The cost effective process of debottlenecking of some units resulted in enhancing the refining capacity to 12 million tones. The refining capacity was increased to 9 MMTPA in 2001.

In 2006 MRPL mad an alliance with Abu Dhabi firm and also an agreement with Mauritius Company. The refinery up gradation and expansion project was undertaken at a cost of Rs 7943 crores in 2006-07. ONGC Mangalore Petrochemicals Ltd. (OMPL), a joint venture of ONGC and MRPL was incorporated for Aromatics Project worth of Rs. 4852 crore. In 2007 MRPL entered contract with State Trading Corporation (STC), Mauritius for supplying petroleum products and 4 year product supply agreement with Shell India Marketing. MRPL and Shell Aviation in 2008 entered an agreement for a joint venture to market and supply aviation fuel.

FINANCIAL PERFORMANCE

Table 1 shows the financial performance of MRPL for last five years (i.e. from 2005- 06 to 2009- 10). Total income has increased consistently in first four years from Rs 2,50,443.20 million in 2005- 06 to Rs 3,84,303.90 million in 2008- 09. But it declined by 15.25 percent to Rs 3,25,670.80 million in 2009- 10. Profit before depreciation and tax (PBDT) also has followed the same trend as in the case of total income, which increased in first four years before it declined by 5.14 percent in 2009- 10. Net profit increased in first three years and declined in last two years. Net profit declined by 6.26 percent in 2008- 09 in comparison with 2007- 08 and by 6.72 percent in 2009- 10 in comparison with 2008- 09. Operating profit margin (OPM) and net profit margin (NPM) have increased over the years and company has sustained it in the last three years at a higher level compared to first two years. MRPL has also sustained the level of earnings per share (EPS) and cash earnings per share (CEPS) albeit declining marginally since 2007- 08. Depreciation has increased consistently in all five years. Even reserves also has followed the same trend. It has increased by 29.2 percent in 2009- 10 in comparison with 2008- 09.

RECENT QUARTERLY PERFORMANCE

Recent quarterly performance is shown in EXHIBIT V. In case of MRPL, for 4th quarter of 2009-10 financial year reported net profit of 2,530.7 million, 58.3 percent decline from corresponding quarter of the previous year (6,076.2 million). Total income increased by 35 percent as against 50 percent increase in expenditure. Operating profit margin (OPM) was 5.75 percent as against 15.42 percent whereas net profit margin (NPM) was 2.85 percent as against 9.26 percent in the corresponding quarter of the previous year.

Profit for 3rd quarter of 2009-10 financial year was at Rs. 2595.4 million compared to loss of Rs. 2854.1 million in the corresponding quarter of the previous year. Operating margin was 4.8 percent and operating profits of Rs 4486.2 million as against negative 4.7 percent operating margin and loss of 3511.7 million in the corresponding quarter of the previous year. Other income increased by 43 percent (Rs. 696.6 million) and interest cost fell by 20 percent. Company also registered a marginal rise in depreciation (3 percent). These factors led to profit before tax (PBT) of Rs 2838.3 million as against loss of 4348.6 million in the corresponding quarter of the previous year. The final outcome for the company was profit of Rs. 2595.4 million as against the loss of Rs. 2854.1 million in the corresponding quarter of the previous year.

RELIANCE PETROLEUM LTD. (RPL) [2005] (MERGED):

Reliance Petroleum Ltd. (RPL) was incorporated in October 2005 as a subsidiary of Reliance Industries Ltd. (RIL) in the special economic zone (SEZ) at Jamnagar. The main objective behind setting up of RPL was to take advantage of the emerging opportunities in the energy sector i.e. the rising demand in the west for high quality fuels that meet stern emission rules and expanding price gap between heavy and light crude oil.

In 2006, RPL made initial public offering (IPO) of 1350 million equity shares with a face value of Rs. 10. Out of it 450 million shares were offered for retail investors with a price band of Rs 57 to Rs 62. Retail investors had the option of paying Rs 16 per share on application. Shares were oversubscribed close to 50 times and finally shares were offered at Rs. 60, Rs 2 below the upper price band. RIL subscribed to an additional 900 million equity shares at Rs. 62. RIL was holding around 80 percent of stake in RPL in the post IPO period which also included the 2700 million shares subscribed at Rs. 10 before the public issue.

Analysts saw positives about investing in RPL IPO mainly from the point of view of Reliance group's experience in running large capacity businesses. But they also cautioned about possible delay in commissioning of the refinery by the set deadline of December 2008. Concern was also raised about the fact that opportunity spotted by RPL was known to other MNCs as well and it may be just a matter of time before others get in to the same business. They also cautioned about the possibility of merger of new entity with RIL as they were in similar business and given the history of Reliance group of merging the subsidiaries with itself.

RPL was set up in the special economic zone in Jamnagar, Gujarat, adjacent to the existing RIL refinery. The refinery had the capacity to process 580,000 barrels per day, or 27 million tonnes per annum of crude oil. The expected capital cost of the refinery was Rs. 270000 million. Company made considerable progress in 2007-08 in implementing the refinery project. Director's report on March 2008 claimed that it completed around 90 percent of the implementation of the project. It was one of the largest and most efficient refineries in the world with good synergies. In December 2008 it started the refining activity and announced that it will attain the full capacity shortly. With the completion RPL refinery, Jamnagar became the largest refining complex with an aggregate refining capacity of 1.24 million barrels of oil per day in any single location in the world.

RECENT QUARTERLY PERFORMANCE

RPL reported the income of Rs 76390 million from operations for the quarter ended in June 2009 and net profit was at Rs. 1050 million. Gross refining margin was $5.4 per barrel. 4.04 million tonnes of crude oil was processed in the quarter which included 20 types of crude oils. Total export was at 2.5 million tonnes of refined products to 26 countries. Company was successful in commissioning all key processing units in that quarter.

RPL reported income of 36780 million for the year ended March 2009 and profit stood at 2270 million. Operating profit margin was 6.2 percent.

MERGER

On February 27, 2009 it was announced that RIL and RPL will be merged. Board meeting of RPL and RIL on March 2nd 2009 finalized the modalities of merging RPL with RIL. Swap ratio was fixed at one RIL share for 16 RPL shares (1:16). Decision of merger did not come as a surprise for market participants given the track record of Reliance group in the last three decades. Reliance group is a combination of several companies which were floated for executing specific projects and subsequently merged with it. (For e.g. Reliance Petrochemicals Ltd., Reliance Polyethylene Ltd. and Reliance Polypropylene Ltd.). Market observers argued that the strategy of Reliance group was to start large capital intensive projects in the balance sheet of a new company and once project is operational, merging them with the RIL. Benefit for RIL is that it is protected from risk of project execution as well as its balance sheet will not be affected by equity or debt burden.

Different views have been expressed by analysts. It was argued that there was no business synergy in the merger of RPL with RIL. At least in the first merger of RPL and RIL in 2002, RPL was supplying refinery by- products to RIL. But in second merger in 2009, there was no difference between the refineries' of RIL and RPL except for the technological superiority of RPL's refinery. The main reason for setting up of separate company (i.e. RPL) was to reap the benefits of special economic zone since such benefits were not available for expansion plans of the existing companies (Srinivasan, R. 2009). PTI reported that, "it is an action replay after seven years". Announcement time as well as negative market reaction following merger announcement were common factors in both the mergers.

Merger announcement timing was criticized on the ground that it did not provide any arbitrage opportunity for traders. Merger decision was first announced on Friday (27th February, 2009) after the market close and swap ratio (1RIL: 16RPL) was fixed before the market open next Monday (2nd March, 2009). Swap ratio was same as the ratio of the closing price of the stocks on the announcement day. Traders were not able to adopt strategies according to their analysis of the companies and speculation on swap ratio.

On March 3rd, 2009, Economic Times reported that swap ratio of 1 RIL: 16 RPL was positive for RPL share holders and disappointing to RIL share holders. It was expressed by 3.1 percent fall in the RIL price and 1.4 percent fall in RPL price following the merger announcement. On same day The Hindu reported that merger was attractive for both RPL and RIL share holders. Merger helps RIL to consolidate its position since it acquired a world class refinery with minimum project risk; on the other hand, it helps RPL by reducing volatility in earnings.

FUTURE PROSPECTS IN REFINING SECTOR:

India has achieved impressive growth in refining sector since independence. It started with 0.25 million tonnes per annum at Digboi oil refinery, only refinery of independent India. As on December 2009, there are 20 refineries (17 in public sector and 3 in the private sector) with capacity of 179.956 MMTPA. India is not only self sufficient in refining oil for domestic consumption but also exports the petroleum products. Demand for petroleum products are directly linked to the energy requirements of the country and India being second fastest growing country in the world, shows positive signs for the refining sector.

Report of the Working Group on Petroleum and Natural Gas for the XI Plan (2007 - 2012) states that refinery sector in Asia is turning attractive due to no substantial capacity addition in Europe. With only marginal capacity addition in US and in Central Asia refineries being old require large investment. Only Middle East, China and India have seen significant growth in refining sector. As Asia in general being projected as the growth centre for coming decades provides an excellent opportunity for Asian countries in general and India in particular. The feasible way would be establishing refineries which meet the world fuel standards and accessing world markets by exporting the surplus products.

Report also stated that the target of 10th Five Years Plan (2002-2007) has been adequately met. 11th plan (2007- 2012) has fixed the target of 91.99 MMTPA capacity addition, however it states that actual capacity addition depends on various factors like domestic demand, tariff, refining margin and export potential. Plan expects the refining capacity to be around 190 to 200 MMTPA with the scope of export of 45 to 55 MMTPA by 2012.

11th plan has also given projection for the 12th plan period as well. An approximate assessment puts the capacity addition of 67.24 MMTPA (43.30 MMTPA in public sector and 23.94 MMTPA in private sector) is expected. But it depends on the commercial viability of the projects as well as demand for petroleum products during the 11th plan period.

THE STOCK MARKET PERSPECTIVE

According to stock market analysts, the share price of a company usually provided a true reflection of the company's present and expected financial performance. The stock price usually reflected various risks associated with the company, which could be broadly categorized as systematic and unsystematic risks (Refer Exhibit V).

An analysis of the stock price performance of MRPL and RPL would help investors analyze the quantum of returns offered to them and identify the extent of risks associated with these companies over a specified period of time. The quarterly share prices of MRPL and RPL from January 2005 to May 2010 are provided in Table III to help measure the risks and returns of these two companies.

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