Chennai Petroleum: Too Cheap to Resist

The steep valuation differential compared to its peers makes Chennai Petroleum a great value buy. Dividends can add a new flavour going forward

ALTHOUGH somewhat disadvantaged compared to its peers, the market is valuing Chennai Petroleum a bit cheaply. The company is investing in making its operations and profitability more robust and reliable while the restoration of its long dividend paying tradition this year bodes well for the long-term investors.

BUSINESS
Chennai Petroleum(CPCL) is a standalone refinery with 9.5 million tonne capacity operating in Tamil Nadu on the eastern coast of south India. The company is 51.9% owned by Indian Oil and Iran’s National Oil Company holds 15.4%. Being old units, the company’s product slate comprises around 20% light distillates, 50% middle distillates and 21% heavy distillates with the rest 9% representing fuel loss. The proportion of heavy distillates in the output and fuel loss is higher compared to other domestic refineries.
Besides LPG, petrol, diesel, kerosene, aviation fuel and fuel oil, the company also produces propylene, lube oil feedstock, wax and bitumen. It exports around 10% of its output and sells the rest in the domestic market.

GROWTH DRIVERS
The company has been on an investment spree that will extend into the next couple of years. The completed projects include 17.5 MW of wind power, 20 MW gasbased power plant, seawater desalination project and revamp of catalytic reforming unit for converting naphtha into petrol.
The company is currently implementing a debottlenecking project to increase its refining capacity by 10% to 10.5 MTPA by the end of FY10. Similarly, the upgradation project is nearing completion to meet the April 1, 2010 deadline to introduce Euro III/IV grade auto fuels.
The company has also gone ahead with setting up a single point mooring (SPM) facility integrated with crude oil terminal for its Manali Refinery to enable crude imports through very large crude carriers (VLCCs). Similarly, it is considering an upgradation project to improve product yield by 7-8%. All these projects will not only optimise its costs and improve operations, but also make its profitability more sustainable.

FINANCIALS
The company’s net worth has increased at a cumulative annualised growth rate (CAGR) of 13.7% over the past five years, while the gross block grew at 6.6%. Even despite a net loss reported in FY09, the debtto-equity ratio has gradually improved to 0.5 from 0.7 in FY08 and 1.5 in FY04.In FY09, CPCL posted a net loss for the first time in the past 15 years due to the unprecedented volatility in oil prices and missed the annual dividend. However, the earlier track record represents a healthy 30% portion of profits distributed as dividends in the previous decade. CPCL’s refinery is currently undergoing a partial shutdown for hooking up new units. This is likely to impact its March 2010 quarter numbers.

VALUATIONS
At the current market price, CPCL is trading at a price-to-earnings multiple of 3.8, which is at a substantial discount compared to its domestic peers. At this valuation every tonne of CPCL’s refining capacity is being valued around Rs 3,800, considerably cheaper to its peers. CPCL’s share price is just 1.2 times its FY09 book value, but lower than expected book value for FY10. The company is expected to end the FY10 with a net profit of around Rs 800 crore and distribute around 30% of it as dividend. This works out to nearly 6.6% dividend yield, which adds to the margin of safety for the investors.

CONCERNS
In case of very high volatility in crude oil prices, as witnessed in the second half of 2008, CPCL will likely face the largest impact on profits compared to its domestic peers.