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Essar Oil – Focus on Integrated Play

December 9, 2009

Like its enviable neighbor in Gujarat, Essar Oil Ltd too is emerging as an integrated player across the energy chain with value-creation options in refining and upstream.

Essar is upgrading its 10.5mmtpa refinery to 16mmtpa, adding significant secondary processing capacities. The expansion would give ESOIL significant advantages in: complexity allowing ESOIL to process a tougher crude diet (API 24.8), enabling better GRMs; and (2) competitive cost structure.

Essar will start monetizing the Raniganj CBM reserves from FY11. Raniganj block has significant value (US$662 million in our estimate) based on the proposed 17 year plateau of 3.5mmscmd, and the current unavailability of competitive gas in Eastern India. We estimate Rs5.8 billion of EBITDA contribution from CBM over FY11-12.

Essar Oil has the option to go for a significant low-cost refinery expansion (to 34mmtpa) which will be value accretive. The company also has concession for Ratna fields (161 million bbls of reserves), awarded to the company pre-NELP. A dispute on the royalty/cess payable for the field has delayed the commencement of development of the block.

Other Positive Drivers – Brownfield project, low capital costs and option on further expansion, Complexity and scale advantage, Fiscal and Tax benefits.

Essar Oil is expected to report an EPS of Rs 2.63 and Rs 4.61 for FY10 and FY11 respectively.

JP Morgan has initiated coverage with a Price Target of Rs 160 based on 7x EV/ EBTIDA for 16mmtpa refinery, NPV for Raniganj, and the value of tax incentives. Do not BUY at current levels, HOLD or ADD on significant Decline.

Update on 22/12/2009:
HDFC Institutional Research has initiated coverage on Essar Oil with the following comment,

Essar Oil is set to emerge as India’s third largest oil refining company and one of the most complex refineries worldwide. While refinery expansions will result in ~US$3/bbl premium over Singapore complex GRM (Dubai crude), strategic focus on
product evacuation will help maintain high capacity utilization. The company is strengthening its presence in the E&P segment. The company is expected to report an EPS of Rs 1.8 for Fy10 and Rs 8.0 for FY11 respectively.

Expect EBITDA margins to improve from 3.1% in FY09 to above 10% by FY13E. Our target of Rs191/share provides an upside of 41%.

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