Too much Debt; Chennai Petroleum (CPCL) is a refinery based in Tamil Nadu (India) with a capacity of 11MMT. CPCL s networth eroded by ~5%% between FY11-15 led by 1) high energy costs & crude price impacting GRMs during FY11-14 & 2) sizeable inventory losses in FY15. From the lows in 15, the stock has delivered 2% returns led by hopes of better GRM and debt reduction. Based on CPCL s current capex projects worth >Rs. 35bn and operating cashflows of Rs. 3bn over the next 2 years, we do not see a case for debt reduction. On the GRM front, we believe current GRMs are in the top quartile range (1 yr history) and are unlikely to remain elevated and are fraught with downside risks. Even a marginal $.5/bbl reduction is GRM would lead to >3% decline in earnings and lead to further debt requirement to fund capex. Overall, sustained high debt and susceptibility of earnings to small changes in GRM are key risks in our view. Initiate coverage with a TP of High Capex intensity to keep Debt at elevated levels: CPCL is undertaking capex projects totaling to Rs. 4bn off which Rs. 14bn has been spent to date. With all the projects set completion in 2HFY17E, we see a sizeable capex outflow in the next 18months. Also Euro V/VI upgrade capex is likely to be in the range of Rs. 1-15bn (~Rs. 5bn pa). With yearly cash flows of Rs. 12-15bn (assuming $5/bbl GRM) and capex of Rs. 35bn over next 2 years we do not see debt levels reducing and expect debt to remain at elevated levels Earnings are highly sensitive to even $1/bbl delta in GRM PAT swing of 5-7%: Based on our estimate of $5/bbl of GRMs we see earnings of ~Rs. 7bn for FY17/18E. A $1/bbl reduction would lead to a PAT of Rs. 2bn which is a substantial 7% reduction in earnings. GRMs in general are highly volatile (based on parameters like crude price, discounts / premium on price, product cracks, inv. gain / loss etc.,) and $5/bbl is top quartile estimates and we see very little chance of GRMs remaining at elevated levels (> $5/bbl) for a sustained period and see more risks hence our negativity on the stock Resid upgrade project to add GRMs of $.7/bbl; t exciting enough; ~8% ROCE on Investments: CPCL undertaking a Resid upgrade project for Rs. 32bn which 1) upgrades low value FO stream to high value HSD/ATF/Naphtha and some Petcoke. The project helps CPCL improve its distillate yield by 8% to 77-78% post completion (COD in 2HF17E 76% completed as on date). CPCL believes the project would add $1.5/bbl of incremental GRMs, however based on current product cracks we believe it would add a max of $.7-$.8/bbl from FY18E onwards Initiating Coverage Date 29 th March Market Data SENSEX 24966 Nifty 7615 Bloomberg MRL IN Shares o/s 149mn Market Cap Rs. 3bn 52-wk High-Low Rs. 265-65 3m Avg. Daily Vol Rs. 126mn Index member BSE 5 Promoters 67.3 Institutions 19. Public 13.7 Stock performance (%) 1m 3m 12m CPCL 17% -3% 26% Sensex 8% -3% -11% BSE O&G 8% -4% -4% Financial summary Year Revenues (Rs. mn) EBITDA (Rs. mn) Adj. PAT (Rs. mn) EPS (Rs.) P/E(x) P/B (x) EV/EBITDA (x) FY15 4,18,475 (1,677) (39) -2.6 (76.) 1.8-49.6 FY16E 2,73,148 19,435 13,664 91.7 2.2.7 3.4 FY17E 2,82,54 15,95 8,484 56.9 3.5.6 4.5 FY18E 3,33,91 14,691 6,724 45.1 4.4.5 4.6 VISHNU KUMAR A S vishnu@sparkcapital.in +91 44 4344 69 PRANAY J SHAH pranayshah@sparkcapital.in +91 44 4344 82 Find Spark Research on Bloomberg (SPAK <go>), Thomson First Call, Reuters Knowledge and Factset Page 1
Resid Upgrade project helps but not so much!; To add $.7/bbl of GRM CPCL Product Slate Pre & Post Resid Upgrade Particulars Pre Post HSD 38% 42% MS 1% 1% Naphtha 5% 7% ATF 1% 12% LPG 3% 3% SKO 4% 4% Distillate yield 7% 78% FO 13% % Lube 2% 2% Bitumen 6% 6% Coke % 5% Total 21% 13% Fuel & Loss 9% 9% Crude Throughput 1% 1% +8% Resid upgrade project increases the distillate yield of CPCL by 8% to 78% Fuel oil 13% of Fuel Oil gets replaced by 8% distillates & 5% Petcoke 13% Current Naphtha ATF HSD Petcoke 2% 2% 4% 5% Post Upgrade Project Based on our computation the Resid upgradation project could add an incremental GRM of ~$.5-.7/bbl Particulars 2Q'16 3Q'16 4Q'16 HSD $/tn 451 421 291 Naphtha $/tn 48 43 293 ATF $/tn 479 447 325 Petcoke $/tn 6 5 4 Blended realisation- (A) 38.8 36.3 26. Fuel oil- (B) $/tn 35.1 3. 2.4 Delta (C)=(A)-(B) $/tn 3.7 6.4 5.5 GRM Benefit $/bbl.51.87.76 CPCL is currently undertaking residual upgrade project, which will increase the distillate yield by 8% and help improve the GRMs of the company. As per our interaction with the company about ~75-8% of the project is complete and it is likely to start in 2HFY17E. CPCL believes the project will add $1-$1.5/bbl of incremental GRMs to its earnings, however we believe at current crack spreads the incremental GRMs are likely to range around $.5-$.8/bbl. From a returns perspective, we believe it would give < 1% ROCE Source: Company, Spark Capital Research Page 2
Rs. bn Sizeable capex spend in FY17E to keep Debt @ elevated levels! Capex projects underway Capex (Rs. Bn) Spent to Date (Rs. Bn) Balance to spent (Rs. Bn) % completed Resid Upgrade 32. 13. 19. 76% COD 2HFY17 E Crude Pipeline 2.6.8 1.8 25% v-16 BS IV Revamp 3.7.6 3.1 16% Feb-17 Total 38.3 14.3 24. BS V/VI upgrade (min) 1. 1. FY19/2 BS V/VI upgrade (max) 15. 15. FY19/2 CPCL is currently undertaking Capex project worth Rs, 4bn, off which only Rs. 14bn is spent to date. With most projects, likely to get commissioned in FY17E, we see a very high capex spend both for FY16/17E. With a likely capex of ~Rs. 13-15bn pa for the next few years we do not see a case of debt reducing from the current elevated levels. We are factoring in best case GRMs of $5/bbl for FY17E/18E. Even a $1bb drop in GRM would lead to a reduction in OCF by Rs. 5bn and this could lead to further worsening in debt. Also Euro V/VI upgrade capex could start from FY17E /18E onwards (est. Rs. 1-15bn) with a yrly run rate of ~Rs. 5bn. Considering the ongoing capex program CPCL s debt is likely to remain at elevated levels for the next 3 years 6 55 5 45 4 35 3 25 54 16 7 15 46 12 14 34 34 34 48 1 2 38 38 8 4 48 2 Net Debt (Mar'15) OCF (adj for interest) WC Changes Capex Net Debt (Mar'16) OCF (adj for interest) WC Changes Capex Net Debt (Mar'17) OCF (adj for interest) WC Changes Capex Net Debt (Mar'18) Source: Company, Spark Capital Research Page 3
GRM / $/bbl GRM / $/bbl Earnings highly sensitive to even $1/bbl GRM swing (>5% + in PAT) Sensitivity of FY17E PAT to GRM & FX INR / USD 7.8 63. 64. 65. 67. 68. 7. 3.5 -.4 -.1.1.7 1. 1.5 4. 2.1 2.4 2.7 3.3 3.7 4.3 4.5 4.6 4.9 5.3 6. 6.3 7. 5. 7. 7.4 7.8 8.6 9. 9.8 5.5 9.5 1. 1.4 11.3 11.7 12.6 For every $1/bbl change in GRM the delta in PAT is Rs. 5bn or about 5-7% change depending on the direction CPCL has clocked an avg. GRM of $4.2/bbl in the last 1 years, we model $5/bbl for FY17/18E FY18E FY17E FY16E FY15 FY14 2. GRM $/bbl 4.1 5. 5. 6. 6. 12. 12.5 13. 13.9 14.4 15.3 $1bbl GRM Sensitivity of FY18E PAT to GRM & FX in PAT is 5-7% INR / USD 6.3 63. 64. 65. 67. 68. 7. 3.5-1.9-1.6-1.4 -.8 -.5. 4..6.9 1.2 1.8 2.1 2.8 We factor in $5/bbl (1 yr avg of $4.2/bbl) which are top quartile of GRMs for CPCL. Any slip up in GRMs could lead to substantial reduction in PAT and similar increase in debt to fund the ongoing capex plans FY13 FY12 FY11 FY1 FY9 FY8 1. 1.2 4.2 5.4 4.8 8.5 4.5 3.1 3.4 3.8 4.5 4.8 5.5 FY7 5. 5. 5.5 5.9 6.3 7.1 7.5 8.3 FY6 4.4 5.5 8. 8.5 8.9 9.8 1.2 11.1 FY5 5.3 6. 1.5 11. 11.5 12.4 12.9 13.8. 3. 6. 9. Earnings are highly susceptible to even $1/bbl GRM change, leading to a 5%-7% swing in PAT on either sides. We have factored in GRMs of $5/bbl for FY17/18E which is higher than the last 1 year avg of $4.2/bbl and in the top quartile of GRMs. Any minor slip up could lead to substantial reduction in PAT, which we see as a big risk and could lead to further increase in debt for funding the ongoing capex a key negative in our view Source: Spark Capital Research Page 4
MMT $/bbl Focus Charts # 1 Expect GRMs to range at $5/bbl over FY17/18E GRM is in line with peers 12 11 5. 8.5 1.2 Crude Throughput 5.4 4.8 4.2 4.1 1. GRM (RHS) 6. 2. 5. 5. 9 6 3 6 4 2 5. 4.3 3.6 2.1 3.4 213 214 215 4.2 4.1 3.2 2.8 1..3 2..5 1.5 1 1.4 1.3 1.1 1.1 1.7 1.6 9.7 1.6 1.8 1.8 1.8 1.8 FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18-2 BPCL HPCL IOCL CPCL MRPL -.6 CPCL being an east coast refiner has a higher working capital days Fuel loss is in line with other OMC s 5 4 3 2 1 13 1 34 29 FY13 FY14 FY15 4 34 31 23 11 25 19 7 12% 1% 8% 6% 4% 6% 6% 5% 8% 7% 213 214 215 9% 7% 9% 9% 9% 9% 9% 9% 8% 1% 2% -1-4 -3-6 BPCL HPCL IOC CPCL MRPL % BPCL HPCL IOCL CPCL MRPL Source: Company, Spark Capital Research Page 5
FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Rs. Bn Rs. Bn FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Rs. Bn Focus Charts # 2 EBITDA vs EBITDA adjusted for exchange fluctuations PAT to range between Rs. 7-8bn in FY17/18 3 2 1-1 2 12 12 2-2 4 EBITDA 12 12 9 9 Adjusted EBITDA 1 8 6 4-6 -9-2 21 19 15 15 15 15 12 7 2-3 -8-13 -18 6 11 6-4 5 PAT (Rs. Bn) 1-18 -3 14 8 7 Substantial losses in FY12/15 led to debt spiral & Equity erosion..d/e peaked in FY15 due to consistent losses Total Debt 57 56 54 Equity D/E Net D/E 41 42 34 25 18 15 39 39 39 26 38 38 35 35 31 2 17 17 4 55 49 8. 4..69.7.5 1.17 1.12.89 2.8 2.82 3.22 3.24 3.25 3.26.88.79.69..7.71.5 1.18 1.12.9 1.62 1.27 1.8 Source: Company, Spark Capital Research Page 6
Mar-9 Jul-9 v-9 Mar-1 Jul-1 v-1 Mar-11 Jul-11 v-11 Mar-12 Jul-12 v-12 Mar-13 Jul-13 v-13 Mar-14 Jul-14 v-14 Mar-15 Jul-15 v-15 GRM / $/bbl Valuation Valuation Particulars FY18E EBITDA Rs. Bn 14.7 Multiple x 5. EV @ 5x FY17E EBITDA Rs. Bn 73.5 Debt 39. Preference shares 1. Cash + Cur. Invst.7 Net Debt Rs. Bn 48.3 Equity Value Rs. Bn 25.2. of Shares mn 149 Equity Value Rs. / sh 169 CPCL has traded at a median range of 4-6x in the last 1 yrs 8. 7. 12M fwd EV/EBITDA 6. 5. 4. 3. 2. 1.. Key model estimates FY14 FY15 FY16E FY17E FY18E Exchange Rate Rs. / $ 6.5 61.2 65.5 65. 65. Brent oil $/bbl 17.6 85. 46.8 5. 6. Crude throughput mmt 1.6 1.8 1.8 1.8 1.8 Refining margin $/bbl 4.1 2. 6. 5. 5. Financials Gross margin Rs. Bn 19.7 9.7 31. 25.7 25.7 Employee Costs 2.9 3.4 3.6 4.1 4.3 Other Expenses 1.9 8. 8.1 6.5 6.7 - Recurring - 6.5 6.5 6.5 6.5 6.7 - n Recurring - 4.4 1.5 1.6 Reported EBITDA Rs. Bn 5.9-1.7 19.4 15.1 14.7 Clean EBITDA 1.2 -.2 21. 15.1 14.7 PAT (before pref div.) Rs. Bn -3. -.4 13.7 8.5 6.7 TP is highly sensitive to even a $.5/bbl change in GRM. At the current FX rate, TP could jump to ~2x & vice versa if GRM increases/ decreases by $1/bbl. INR / USD #### 63 64 65 67 68 7 3.5 (18) (99) (9) (71) (62) (43) 4. (25) (14) (4) 18 28 49 4.5 59 71 83 16 118 142 5. 142 156 169 195 29 235 12M fwd EV/EBITDA Source: Bloomberg, Spark Capital Research 5.5 226 24 255 284 299 328 6. 39 325 341 373 389 421 Page 7
Financial Summary Abridged Financial Summary Key metrics Rs. mn FY14 FY15 FY16E FY17E FY18E FY14 FY15 FY16E FY17E FY18E Profit & Loss Growth ratios (%) Revenues 493,426 418,475 273,148 282,54 333,91 Sales 15% -15% -35% 3% 18% EBITDA 5,858 (1,677) 19,435 15,95 14,691 EBITDA -166% -129% -1259% -22% -3% Depreciation 3,896 2,261 2,616 3,192 3,768 Adj. Net Profit -83% -87% -364% -38% -21% EBIT 1,962 (3,938) 16,818 11,93 1,923 Margin ratios (%) Other (Income)/Exp (48) (552) (5) (5) (5) EBITDA 1% -2% 1% % 7% Interest 5,68 4,37 3,254 3,119 3,899 EBIT % -1% 6% 4% 3% PBT (3,31) (7,424) 14,64 9,284 7,524 Adj. Net Profit -1% % 5% 3% 2% Net Profit (3,38) (39) 13,664 8,484 6,724 Performance ratios Adjusted Net Profit (3,38) (39) 13,664 8,484 6,724 RoIC (%) 2% -4% 22% 14% 12% Balance Sheet RoE (%) -16% -2% 58% 25% 16% Shareholders Equity 17,225 16,551 4,215 48,699 55,422 RoCE (%) 4% -6% 46% 3% 25% Total debt 55,996 53,991 38,991 38,991 38,991 Sales / Total Assets (x) 6. 5.6 3.6 3.4 3.7 Total Networth & Liabilities 8,255 7,541 79,26 87,689 94,413 Fixed Assets Turnover (x) 6. 5.1 3.3 2.4 2.8 Net fixed assets 42,919 4,768 38,152 7,959 67,191 Financial stability ratios CWIP 3,441 7,824 22,824 824 8,824 Total Debt to Equity (x) 3.3 3.3 1.6 1.3 1.1 Investments 248 254 254 254 254 Inventory & Debtor days 66 49 49 49 49 Current assets 92,89 59,416 42,775 41,31 48,437 Creditor days 43 33 33 33 33 Current liabilities 59,162 38,993 26,72 26,922 31,566 Valuation metrics Net current assets 33,646 2,422 16,73 14,379 16,871 Current Share Price (Rs.) 198 Total Assets 8,255 7,541 79,26 87,69 94,413 Market Cap (Rs.mn) 29,8 29,8 29,8 29,8 29,8 Cash Flows Fully Diluted Shares (mn) 149 149 149 149 149 Cash flows from Operations 11,46 1,768 26,677 15,184 12,939 Adjusted EPS (Rs.) (2.4) (2.6) 91.7 56.9 45.1 Cash flows from Investing (2,793) (4,766) (15,) (14,) (8,) P/E (x) (9.8) (76.4) 2.2 3.5 4.4 Cash flows from Financing (8,562) (6,63) (8,654) (3,919) (4,699) P/B (x) 1.7 1.8.7.6.5 Cash Generated 51 (61) 3,22 (2,735) 24 EV (Rs.mn) 85,218 83,273 65,369 68,15 67,864 Opening Cash(incl OD) 49 46 399 3,422 686 EV/ EBITDA (x) 14.5 (49.6) 3.4 4.5 4.6 Closing Cash(incl. OD) 46 399 3,422 686 926 Dividend Yield (%) - - - - - Page 8
Disclaimer Absolute Interpretation BUY Stock expected to provide positive returns of >15% over a 1-year horizon REDUCE ADD Stock expected to provide positive returns of >5% <15% over a 1-year horizon Stock expected to provide returns of <5% -1% over a 1-year horizon Stock expected to fall >1% over a 1-year horizon Spark Disclaimer Spark Capital Advisors (India) Private Limited (Spark Capital) and its affiliates are engaged in investment banking, investment advisory and institutional equities and infrastructure advisory services. Spark Capital is registered with SEBI as a Stock Broker and Category 1 Merchant Banker. We hereby declare that our activities were neither suspended nor we have defaulted with any stock exchange authority with whom we are registered in the last five years. We have not been debarred from doing business by any Stock Exchange/SEBI or any other authorities, nor has our certificate of registration been cancelled by SEBI at any point of time. 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Disclaimer (Cont d) Spark Capital and/or its affiliates and/or employees may have interests/positions, financial or otherwise in the securities mentioned in this report. To enhance transparency, Spark Capital has incorporated a disclosure of interest statement in this document. This should however not be treated as endorsement of views expressed in this report: Disclosure of interest statement Analyst financial interest in the company Group/directors ownership of the subject company covered Investment banking relationship with the company covered Spark Capital s ownership/any other financial interest in the company covered Associates of Spark Capital s ownership more than 1% in the company covered Any other material conflict of interest at the time of publishing the research report Receipt of compensation by Spark Capital or its Associate Companies from the subject company covered for in the last twelve months: Managing/co-managing public offering of securities Investment banking/merchant banking/brokerage services products or services other than those above in connection with research report Whether Research Analyst has served as an officer, director or employee of the subject company covered Whether the Research Analyst or Research Entity has been engaged in market making activity of the Subject Company; Yes/ Analyst Certification of Independence The views expressed in this research report accurately reflect the analyst s personal views about any and all of the subject securities or issuers; and no part of the research analyst s compensations was, is or will be, directly or indirectly, related to the specific recommendation or views expressed in the report. Additional Disclaimer for US Institutional Investors This research report prepared by Spark Capital Advisors (India) Private Limited is distributed in the United States to US Institutional Investors (as defined in Rule 15a-6 under the Securities Exchange Act of 1934, as amended) only by Decker and Co, LLC, a broker-dealer registered in the US (registered under Section 15 of Securities Exchange Act of 1934, as amended). Decker and Co accepts responsibility on the research reports and US Institutional Investors wishing to effect transaction in the securities discussed in the research material may do so through Decker and Co. All responsibility for the distribution of this report by Decker and Co, LLC in the US shall be borne by Decker and Co, LLC. All resulting transactions by a US person or entity should be effected through a registered broker-dealer in the US. This report is not directed at you if Spark Capital Advisors (India) Private Limited or Decker and Co, LLC is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that Decker and Co, LLC and Spark Capital Advisors (India) Private Limited are permitted to provide research material concerning investment to you under relevant legislation and regulations; Page 1