The 35 per cent decline in the price of the Essar Oil stock over the past six months presents a good buying opportunity for investors with a long-term perspective. While September quarter results of the refining major have been marred by forex losses due to the steep depreciation in the rupee, its core performance has been healthy. The company reported current price gross refining margin (GRM), excluding sales tax benefit, of $5.07 a barrel, compared with $4.20 in the June quarter.

GRM is the difference between the price of a refiner's product basket and its cost of crude oil. Essar Oil's ongoing refinery expansion programme is in an advanced stage of progress. Phase-I of the expansion, expected to be completed in December 2011, should significantly enhance the company's refining capacity and complexity, giving a fillip to its GRM.

Besides, the company is poised to step up commercial production in its coal bed methane (CBM) block in Raniganj, West Bengal. At its current price of Rs 85, the Essar Oil stock trades at around 13 times its trailing 12 month earnings, lower than its historical levels.

Expansion to benefit

Majority of the works for Phase I expansion at the company's Vadinar refinery have been completed, and the balance is expected to be wrapped up by the end of the calendar. With this, output of the refinery is expected to go up from around 14 mmtpa currently to 18 mmtpa in the March quarter. The expansion would also increase the refinery's complexity from 6.1 currently to 11.8, next only to that enjoyed by Reliance Industries. This is expected to give a boost to Essar Oil's ability to process heavy and ultra-heavy crude oil, which is cheaper than light crude. Post- expansion, almost 89 per cent of the company's crude basket would comprise of heavy and ultra-heavy crude, up from 72 per cent currently.

At the same time, the expansion would improve the company's distillate yield in favour of light and middle distillate products such as petrol and diesel. It would also improve the company's flexibility to produce petrochemical feedstock.

The combination of cheaper inputs, high-margin output and higher volumes should translate into a jump in the refinery's GRM, and aid sales and profit growth. In addition to the expansion programme, the refinery optimisation project is also under way. With almost 64 per cent progress achieved, this project is expected to be competed by September 2012 and would raise output to 20 mmtpa.

Essar Oil has indicated plans to increase capacity to 38 mmtpa in Phase II, depending on market conditions.

CBM commercial production

Essar Oil's plans to commercialise gas production from its coal bed methane (CBM) block in Raniganj are also progressing well.

Current production in the block is around 22,000 scmd, and the company has started pipeline supply of the gas to end customers on test basis at an approved rate of $6.25 per mmbtu.

With environmental clearance received for Phase I of the project, drilling plan of 500 wells approved, and some sales contracts tied-up, the company is in the process of deploying resources to increase production in the block. Ramp-up of output and sales in the coming fiscal could provide a fresh trigger for the stock.

Financials

Thanks to a positive refining environment and high refinery utilisation levels (more than 140 per cent), Essar Oil's sales in fiscal 2011 grew by around 28 per cent to Rs 47,905 crore, while its profits rose 23 times to Rs 654 crore.

The good performance continued in the June 2011 quarter, with sales growing at 42 per cent, and the company posting a profit of Rs 469 crore (against a loss of Rs 70 crore in the year-ago period).

However, the company hit a roadblock in the recent September quarter with forex loss of Rs 407 crore and a planned 13-day shutdown in connection with the refinery expansion plan, contributing to the loss of Rs 166 crore.

Nevertheless, with core operations registering a good show, as reflected in the improvement in GRM, the recent travails may be temporary.

This, combined with impending expansion in capacity, should aid the company's prospects. Essar Oil's debt to equity is high at 2.16.

However, expected improvement in profitability and cash flows, post-expansion, should aid debt servicing. The company's improved financial position is reflected in its intent to expedite closure of the ongoing corporate debt restructuring programme (implemented in 2005) before March 2012.

The Essar Oil stock has had a chequered history on the bourses, with plans by the company to delist in 2007 later shelved.

Delisting rumours had again surfaced in 2009 (denied by the company) and resulted in a sharp run-up in prices.

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