Mkt Cap: Rs331bn; US$8.2bn Bloomberg code (ESOIL IN)
Essar Oil (EOL) is on its way to becoming a vertically integrated oil company with significant presence in E&P, large presence in refining and a commensurate marketing infrastructure. A timely investment in expanding its refining capacity by ~3x to 34m tonnes and upgrading its complexity to take advantage of the global tightness in refining would be the biggest value creator for the company. E&P portfolio, though small, is highly prospective and holds significant potential to throw up positive surprises. The currently loss-making fuel marketing business could add value in the long term. Initiating coverage with Outperformer and a 24-month target price of Rs413/share.
Timely investment in refining to leverage global tightness: Given the tight supply, EOL’s capacity expansion (3x by 2010E) and complexity upgradation from 6.1 to 12.8 (among the top 5% globally) come at an opportune time. The superior refinery configuration would enable EOL to leverage the emerging complex refining environment. Also, EOL has surmounted funding issues, which had earlier led to a long delay in commissioning of the existing 10.5m tpa refinery. With a significant portion of domestic (most of them internal) EPC resources committed to the project to overcome global EPC resource tightness, we see limited execution risk.
E&P likely to throw up positive surprises: EOL holds two development and 10 exploration blocks, five of them overseas. Reserves stand at a modest 80.5m boe of oil of Ratna R series. We believe Ratna R-series deserves premium valuations owing to a favourable production sharing contract (PSC). E&P also holds potential to throw up significant positive surprise from possible discoveries in the highly prospective Nigerian block carved out of a block with existing discoveries, Madagascar blocks located in a prolific basin with in place reserves of 20-30bn bbl and from CBM block development.
Ride the refining volume growth; Outperformer: We expect the timely refining investment to deliver large value, while E&P too offers significant potential upside. Initiating coverage with Outperformer and a 24-month, SOTP-based price target of Rs413/share – upside of 94% from CMP.
Key valuation metrics
| FY07 | FY08E | FY09E | FY10E | FY11E | FY12E | |
| Net sales (Rs m) | 4,740 | 6,899 | 230,515 | 214,615 | 298,037 | 640,358 |
| Adj. net profit (Rs m) | (675) | (548) | 5,661 | 8,897 | 20,229 | 63,361 |
| Shares in issue (m) | 1,156 | 1,156 | 1,556 | 1,556 | 1,556 | 1,556 |
| Adj. EPS (Rs) | (0.6) | (0.5) | 3.6 | 5.7 | 13.0 | 40.7 |
| % growth | (31.5) | (18.8) | n/a | 57.2 | 127.4 | 213.2 |
| PER (x) | n/a | n/a | 58.6 | 37.3 | 16.4 | 5.2 |
| Price/Book (x) | 8.1 | 8.3 | 2.9 | 2.7 | 2.3 | 1.6 |
| EV/EBITDA (x) | n/a | n/a | 17.9 | 17.5 | 12.4 | 4.3 |
| RoE (%) | (2.4) | (1.8) | 7.8 | 7.4 | 15.1 | 36.0 |
| RoCE (%) | (0.5) | (0.6) | 9.4 | 7.7 | 9.4 | 22.7 |
