Essar Oil scrip has surged over 30% in the past five trading sessions, outperforming the S&P BSE Sensex which has rallied by about 3%. News reports surrounding possible stake sale by promoters to Russian oil and gas major, Rosneft is a key reason behind this rally. The company’s plan to scale up their retail fuel outlets is another. Even as management remains non-committal on the former, analysts are not ruling out the possibility of talks being held.
Promoters are reportedly looking to sell 49% stake in Essar Oil to Rosneft for Rs 10,500 crore. The stock rallied on this news, hoping that on completion of this deal, Essar Oil’s debt burden (Rs 25,000 crore) will reduce which in turn will improve profits. However, analysts believe Essar Oil’s promoters will retain large part of the deal proceeds and hence Essar Oil’s balance sheet will continue to be stressed.
It is not yet clear whether promoters will end up selling their existing holding or Essar Oil will issue fresh shares or a mix of both. In case of the latter two routes, there could a reduction in debt of Essar Oil, which will be positive.
Notably, Essar Oil management has been looking at various options for their stake in the company for sometime now. It had tried to de-list Essar Oil in June 2014 but was unsuccessful due to muted response by minority shareholders and revision in delisting norms. The promoters’ latest plans to sell its stake is viewed as an attempt to monetise their holdings in the company.
Post the rally, the company/promoters are likely to receive a better price for its stake now, believe analysts. Interestingly, Essar Oil is the only viable refining and marketing company for foreign companies looking to enter India. This is because most other players have government ownership and other private players such as Reliance Industries are well funded. Thus, the chances of a deal going through is rather high.
The other news trigger for Essar Oil is its plan to ramp up its fuel retail outlets to 5,000 from 1,500 currently. The expansion will make Essar Oil the largest private fuel retailer in the country, and could push its market share from 1-2% (versus 0.5% for RIL) currently to around 10%. The public sector oil marketing companies together have about 50,000 fuel retail outlets nationwide at present, and dominate the market. While Essar Oil’s gross refining margins (GRMs) are likely to remain strong going forward, higher interest costs will eat away large part of these gains, unless the company is able to lower debt through a stake sale or some other route.
“Our analysis suggests that even levels of $9.5 a barrel will be barely enough to report $3/barrel of net profit (average PAT over last ten quarters at negative $0.1/barrel). In the last six quarters, we have seen EBITDA/barrel consistently fall short of the depreciation and interest burden when GRM has been less than $7.5; while the negotiations to reduce the interest burden are encouraging, we remain concerned about near term ability of Essar to report material earnings upsides”, writes Probal Sen of IDFC Securities in a recent report on the company.
The stock currently trades at 4.1 times FY16 estimated book value and seems to adequately capture the positives. Even on EV/Ebidta basis, the stock is richly valued. Due to lack of earnings triggers, high debt and corporate governance issues, most analysts remain bearish on the scrip.
