LIOC 23-3-07a

8/18/2019 LIOC 23-3-07a

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LANKA IOC LIMITED(LIOC)

1st MARCH 2007 Reuters Code: LIOC.CM

E Q U I T Y R E S E A R C

H

PRICE LKR 32.75 COUNTRY Sri Lanka

NO. OF SHARES 532,529,905 EXCHANGE Colombo Stock ExchangeRECOMMENDATION LONG TERM BUY SECTOR Power & Energy

SUMMARY

• Lanka IOC Ltd. (LIOC) is owned 75% by the Indian Oil Corporation Limited, a Fortune 500 company

which, in turn, is owned by the Indian Government.

• LIOC procured a twenty year Petroleum Products Licence on 22nd January 2004 which authorises the

company to “Import, Export, Store, Distribute, Sell and Supply Petrol, Auto Diesel, Heavy Diesel

(Industrial Diesel), Furnace Oil and Kerosene, Naphtha and other mineral petroleum including Premium

Petrol and Premium Diesel but excluding Aviation and Marine Fuels and Liquid Petroleum Gas”.

• Company has recently announced plans to invest in a Lube Blending Plant and to offer Marine Bunkering

services, with over Rs. 1.8 Billion in Capital Expenditure.• LIOC is strategically positioned to benefit from possible oil exploration activities in Sri Lanka in the Long

Term.

FINANCIAL HIGHLIGHTS

2005/6 2006/7 E 2007/8 E 2008/9 E

Turnover (Rs. Mn) 37,492 38,188 58,348 92,687Profit After Tax (Rs. Mn) (1,722) (906) 1,256 4,266

Earnings Per Share (Rs.) (3.23) (1.70) 2.35 8.00

P/E Ratio @ 32.75 (x) - - 13.88 4.09

Dividend Per Share (Rs) - - 2.00 2.00

Price to Book @ 32.75 (x) 2.09 2.35 2.29 1.61

Net Asset Per Share (Rs.) 15.66 13.96 14.32 20.33

PRICE CHARTS

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LIOC Price ASPI

of 8 Amana Securities Ltd.

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SECTOR OVERVIEW

• International Petroleum Market

Despite increasing oil prices, the global demand for oil has continued unabated. This trend is expected to

continue with The International Energy Agency estimating crude oil demand in the year 2030 to be 115

million barrels a day, from 86 million barrels per day forecasted for 2007.

Independent estimates suggest that by the end of 2007, the price of Brent crude oil may be around US $ 65.

A key assumption in this estimate is that the geopolitics of Iran’s nuclear programme does not become too

volatile.

Other developments that could arrest the inexorable rise in oil prices are the increasing presence of Gas and

Biomass in meeting energy needs and Oilfield development projects straddling the globe. This should

restrain energy prices from skyrocketing, although short-term fluctuations could still persist.

Figure 1: Average Crude Oil Prices ( Brent) in 2005 & 2006

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• Sri Lanka Market

The Petroleum industry in Sri Lanka comprises of three major segments: Importing of Crude Oil, Importing

of Refined Petroleum Products and Liquefied Petroleum Gas (LP Gas). The state-owned Ceylon Petroleum

Corporation (CPC) enjoys a monopoly in the import of crude oil. The import of Refined Petroleum products

is an oligopoly with CPC and LIOC sharing the market while the import of LP Gas enjoys a similar status with

Shell Gas Lanka Ltd. and Laugfs Lanka Gas (Pvt) Ltd. being the participants.

Table 1: Petroleum Products in Sri Lankan 2002 2003 2004 2005

Quantity Imported (MT’000)

Crude Oil 2,280 1,995 2,201 2,008

Refined Products 1,344 1,168 1,644 1,823

L.P.Gas 137 141 148 149

Value of Imports (Rs.Mn)

Crude Oil 40,404 41,708 61,434 77,795

Refined Products 27,781 39,179 61,298 88,767

Average crude oilprices are shownas closing pricesin New York.


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L.P.Gas 3,773 4,502 6,095 7,573

The demand for petroleum products comes from the transportation sectors (50%) followed by power

generation (25%). The remaining demand (25%) arises from industries, households and other sectors.

In June 2006, the Government of Sri Lankan (GOSL) decided to remove price control mechanism, which was

introduced in 2002 and permitted CPC and LIOC to determine their own pricing strategies. This was a key

development, which saw sales of Super Petrol stagnate with 0% growth, while the sale of Diesel dropped 12%

year-on-year in real terms. However, part of the drop in Diesel volumes was attributed to the increasing use

of furnace oil for power generation.

Table 2: Domestic Sales (Metric Tonnes ’000)

2004 2005 % Change YOY

Petrol (90 Octane) 417 443 6.2%

Petrol (95 Octane) 20 20 0.0%

Auto Diesel 1890 1674 -11.4%

Super Diesel 36 16 -55.6%

Kerosene 204 209 2.5%

• Key Players

Ceylon Petroleum Corporation (CPC), since its inception in 1962, has thus far dominated the Petroleum

industry in Sri Lanka, with monopoly rights in petroleum imports, refining, export and distribution. The need

for reforming the industry was identified by successive governments, which eventually resulted in the

privatisation of some of CPC subsidiaries like Colombo Gas Ltd., Lanka Lubricants Ltd. and Lanka Marine

Services Ltd in the 1990’s. Further reforms included selling CPC’s 200 retail outlets. CPC retained ownership

of 262 filling stations of the country’s estimated 1100 outlets.

CPC also has a refining capacity of 2.2 million metric tonnes per annum. Caltex Lanka Lubricants, the Sri

Lankan arm of Chevron Texaco is the market leader in Sri Lanka in lubricants, with a market share in excess

of 80%.

COMPANY OVERVIEW

• Parent Company

Indian Oil Corporation Ltd.(IOC) owns 75% of LIOC, with the Government of India owning more than 80% of

IOC. It is currently India’s largest company in terms of sales with a turnover of Indian Rupees 1,832 billion

(US$ 41 billion) and profits of Indian Rs. 49 billion (US$ 1.10 billion) for fiscal year 2005. IOC is also the

highest ranked Indian company in the prestigious Fortune ‘Global 500’ listing, having moved up 17 places to

the 153rd position in 2006. It is also the 21st largest petroleum company in the world. LIOC has a overseas

subsidiary in Mauritius as well.


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Indian Oil has set its sights on achieving US$ 60 billion revenues by the year 2011-12 from its current level of

US$ 41 billion. The road map to attain this milestone has been laid through vertical integration – forward

into Petrochemicals and backwards into Exploration & Production of oil. It has also diversified into Natural

Gas. The globalisation of its marketing operations is expected to provide an additional impetus.

•

Core Business

LIOC procured a twenty year Petroleum Products Licence on 22nd January 2004 which authorises the

company to “Import, Export, Store, Distribute, Sell and Supply Petrol, Auto Diesel, Heavy Diesel (Industrial

Diesel), Furnace Oil and Kerosene, Naphtha and other mineral petroleum including Premium Petrol and

Premium Diesel but excluding Aviation and Marine Fuels and Liquid Petroleum Gas”. Subsequently, LIOC has

reportedly acquired licences to carry out offshore bunkering operation and to supply bulk fuel as well.

Almost 60% of the company’s revenue during the last two years came from the sale of Auto Diesel while

another 30% came from the sale of Petrol (90 Octane).

•

Strategies

Currently LIOC’s distribution network consists of 100 company-owned outlets, known as Company Owned

Dealer Operated outlets(CODO) and 53 outlets owned and operated by dealers known as Dealer Owned and

Dealer Operated outlets (DODO). Most of these outlets, reportedly generating 70% of the sales, are

concentrated in the Western Province. Ceylon Petroleum Corporation (CPC), LIOC’s major competitor, has a

significant advantage over LIOC in its channel presence, which consists of around 262 CODO’s and around

640 DODO’s spread island-wide.

LIOC is focussed in increasing its channel presence and is seeking approval from the Sri Lankan authorities to

develop more than 300 sites island-wide, mainly on a CODO basis. This would obviously have a significant

impact on the company’s revenue stream, if approved.

LIOC has an advantage over CPC due to its reportedly 10% lower operating cost. This is attributed largely to

inefficiencies at CPC, which is an inherent feature of many government enterprises. LIOC is poised to

exploit this in terms of a more competitive pricing structure.

LIOC’s emerging market in lubricants carries a tariff advantage. LIOC is only liable for a 14.5% tariff based

on level of refining of the import, whereas its competitors pay a 28% tariff. LIOC has already exploited this

opportunity, gaining rapid market share (estimated at about 10%) by selling its “Servo” brand at discounts to

its competitors.

The parent company, IOC, is a key supplier of petroleum products to LIOC. The sales are made on a pre-

agreed transfer pricing mechanism based on Singapore PLATTS. Both IOC and LIOC could use this

strategically to the greater benefit of the Group.


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It is somewhat ironic that, following the liberalisation of pricing by the GOSL, LIOC embarked on a premium

pricing strategy targeting what it perceived to be “discerning customers”. This resulted in the company

losing volumes during the second quarter of 2006/7. LIOC has since aligned its prices to CPC, regaining lost

ground.

LIOC is also expecting to increase its product offering to the market and to diversify its sources of income

(See “Future Prospects”)

• Grant/ Subsidy

Until June 2006, both CPC and LIOC sold petrol at what was perceived to be a subsidised price, based on an

agreement with the GOSL. From January 2004 to March 2006, LIOC had accrued Rs. 7.7 billion in subsidy

receivable from the GOSL. However, this was based on the initial agreement where the Government agreed

to pay a mark-up of 5% on the cost, which was subsequently revised to 1.5% in June 2006. The resulting

losses, amounting to Rs. 2.1 billion, were written off during the financial year 2005/6. On 5 th of January

2007, LIOC accepted Rs. 5.16 Bn. as the settlement of the balance, with Rs. 700 million in cash and Rs. 4.46

billion in 2-year government bonds carrying a coupon rate of 11% p.a. Therefore, a further write-off of Rs.

440 million may be incorporated for the financial year 2006/7. There could also be a further write-off in

terms of disallowed input VAT on this amount.

• Key Risks

LIOC, controls the strategic China Bay tank farm, located in Trincomalee and which has 99 tanks, each with

a capacity of storing 12,000 kilolitres. In 2006, only 15 of these were operational. LIOC spent Rs. 22.7

million to refurbish this tank farm during the Financial year 2005/2006 with further Investments envisaged.

However, Trincomalee is a strategic location for the country’s security forces and the LTTE rebels. Severe

escalation of violence could cause damage to the property and hamper LIOC’s aims of making Trincomalee

an “important industrial site”.

Approvals that are pending from regulatory authorities is another possible risk that could impact on LIOC’s

future plans. Currently, LIOC needs to get approvals for its expansion of retail outlets and to expand into

related services like selling aviation fuel and refining petroleum.

Entry of a third player, which has been expected for sometime, seems to have been stalled, at least for the

time being. However, the risk of increased competition from the potential entry of new players cannot be

ignored.

PERFORMANCE ANALYSIS

LIOC reported the biggest ever loss of Rs. 1.721 billion on the Colombo Stock Exchange (CSE) for the

financial year 2005/6. Rs. 2.1 billion written off on the subsidy receivable contributed more than 120%

towards it. A further write off during the financial year 2006/7 is expected to be in the range of Rs. 440-

500 million. LIOC is exempted from Income Tax up to 2013.


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Table 3: Key Ratios

Financial year ended 2003/4 2004/5 2005/6

Profitability

Gross Margin 7.26% 9.07% 6.09%

Operating Profit Margin 2.94% 7.10% -3.44%

Net profit Margin 3.98% 6.83% -4.59%

Liquidity / Solvency

Current Ratio 49.25% 138.30% 105.55%

Quick Ratio 10.52% 84.36% 78.10%

Long Term Debt/ Equity (Book) 0.39% 15.94% 5.17%

Total Debt/ Equity(Book) 136.56% 101.58% 110.38%

Management Effectiveness

Return on Equity (Book) 12.4% 18.7% -20.6%

Return on Assets 5.2% 9.3% -9.8%

Return on Investments(Book) 12.4% 16.1% -19.6%

• Revenue

The revenue during the last three financial years grew at an average rate (CAGR) of 61%. Key contributors to

the revenue were sale of Petrol-90 Octane (60%) and Auto Diesel (30%). LIOC’s sales volumes grew on

average (CAGR) 19% during the last three financial years, with the quantity of Petrol-90 Octane growing at

31% and Auto Diesel growing at 21%.

Figure 2: Average Revenue Increase (CAGR)

-40.00% -20.00% 0.00% 20.00% 40.00% 60.00% 80.00%

% Growth

Lubricants

Kerosene

Super Diesel

Auto Diesel

Lanka Petrol

Super Petrol

Table 4: LIOC’s average price per litre

2003 2004 2005 CAGR

Super Petrol 50.20 62.04 71.21 19.10%Lanka Petrol 46.88 59.41 68.40 20.80%

Auto Diesel 28.19 40.83 54.72 39.33%

Super Diesel 26.21 39.34 60.47 51.89%

Kerosene 24.89 38.80 53.35 46.39%

Lubricants 90.18 95.99 111.42 11.16%

During the first nine months of 2006/7, revenue has dropped 13.3% compared to the same period last year.

This decline is attributed largely to the drop in sales volume, in the aftermath of its previously adopted

premium pricing strategy and the decision of the management to discontinue sales, albeit temporarily.

•

Margins

The gross profit margin has dropped from 9% in 2004/5 to 6.09% in 2005/6. The gross margin for the nine

months up to 31st December 2006 is less than 1%. This is attributed to increasing oil prices that has

escalated the cost of sales.

Operating profit margin, which was a healthy 7.1% in 2004/5, turned a negative 3.4% in 2005/6 due to part

of the subsidy receivable write-off as losses and the VAT disallowed on the subsidy. The operating margin


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• Margins

We expect the company to report a loss during 2006/7, of around Rs. 906 Million. This is due to a drop in

gross margins, and a further subsidy write-off anticipated at Rs. 480 million.

• Capital Expenditure

Company plans to invest Rs. 1.8 billion in two major projects, i.e. in Lube Plant and for Marine Bunkering asdetailed above. However, some portion of this amount may be only for working capital requirements.

Company also plans to develop over 300 retail outlets.

VALUATION

• Free Cash Flow

We have used Capital Asset Pricing Model (CAPM) in calculating the share value on the discounted cash flow

basis, adjusted appropriately to capture the cost of both Debt and Equity. Based on the forecasts, the Free

Cash Flow value is in the range of Rs. 40 to 43 per share.

•

Price Earnings

The stock is trading at 13x on its 2007/8 earnings and 4x its 2008/9 earnings.

• Price to Book Value

LIOC is trading at 2.2x on its 2007/8 net book value and 1.61x on its 2008/9 net book value.

Based on t he above valuat ion we r ecommend a “Long Term Buy” .

CONTACT US

Amãna Securities Limited

550, R.A. De Mel Mawatha

Colombo 03

Sri Lanka

Telephone: 94 11 5552556/7

Fax: 94 11 5552553

Email [email protected]


LIOC 23-3-07a

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