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The Hascol fiasco appears to be a basket case of corporate malpractices. All players must take blame for collective failure. It is a combination of governance failure – from banks to board of directors of Hascol and fiduciary malfeasance by the management. Loans worth Rs 58 billion given by 18 domestic banks have turned bad. Investors at Pakistan Stock Exchange (PSX) are said to have lost tens of billions of rupees. Given the existing dynamics, there is no way for banks to recover, albeit partially, money, without restructuring and restrengthening the franchise value of the business. With the Federal Investigation Agency (FIA) and others probing the company, there is a slim chance that lenders will be able to salvage their loans. It appears to be a mega scam, and it is likely to be dealt with as such.

The rise of Hascol began with a “smart and opportunist” management team taking the reigns of the company in 2009. Hascol received an oil marketing company (OMC) licence in 2005 and was a small-time operator. Its market share was less than one percent at that time in the OMCs’ business. In 2013-14, aggressive expansion began taking place, and its market share peaked to 12 percent in 2017-18 – surpassing the likes of Attock Petroleum and Shell Pakistan. It was second to Pakistan State Oil (PSO) in the market.

The company was said to be doing unusual transactions. The market share was growing too fast. It was reported to be offering a substantial retailing and sub-distribution discount in an industry that operates on razor thin margins. The meteoric rise was too good to be true. Yet, the board of directors was happy – as the company was making money. The banks were happy to lend as bank spreads were too lucrative. The company was listed at PSX in 2014. Its share price increased manifold within a couple of years – investors were ecstatic. In 2015, Vitol Dubai Limited (VTL) – a global energy trading giant – bought 15 percent shares of the company and later increased its holding to 25 percent by 2016.

The company’s financials flourished with Vitol on board. This integrated the backend supply chain. Everyone was happy and making money. But overall, the business model was not sustainable which was ignored by investors and lenders. The company was expanding too fast. It was acquiring new location/sites by bidding higher. New storage depots were established.

In its initial years, Hascol made money by importing and selling furnace oil (FO). FO sales jumped further after Vitol’s investment. It purchased FO on credit and was able to extend credit to its clients. That is how it increased its market share and used that money to expand its franchises and storage capacity. In 2018-19, FO sales fell industry-wise as new power plants based on RLNG, and other fuels started coming online. Hascol’s edge was in importing FO by having Vitol on board. The company landed in a tight spot with other costs beginning to hurt the company.

Vitol started taking more control of the company by acquiring shares of the then chairman and CEO and brought in new management that disclosed to banks that the company’s loans must be restructured if default is to be avoided. However, the story is not that simple. Vitol could probably try to recoup its money through charging higher amount in trading and other businesses. There are allegations of transfer pricing and misuse of power by the previous management team.

For example, Hascol Terminal Limited (HTL), a joint venture of Hascol and Vitol, was commissioned in 2019. Twenty four percent shareholding in HTL is held by another firm called Fossil Energy. As per a whistleblower (in April 2020), Hascol paid throughput charges to HTL at Rs1.3 per litre on annual volume of 1.2 million metric ton as against the industry average of Re 0.3 per litre. How can a company pay half of its total margins to its terminal handling company and survive?

Then there were other issues. Vitol’s interest is in trading. Higher the volumes traded more money it makes. Hascol is a marketing company, and it supposedly operates on thin margins. The business model was rigged. For example, Hascol extended unsecured credit to one sub-supplier in Punjab to the tune of Rs 10-12 billion of which Rs 8-10 billion landed in default. Usually, the industry gives 5-10 days credit supply of 1-2 tanker loads. But the decision-makers at Hascol were said to be more interested in trading volumes than anything else.

It is pertinent to mention here that allegations of financial irregularities are said to pre-date investment by Vitol. It is said that the purported modus operandi was to make sales on credit to attain market share in petrol and diesel sales. Insiders suggest several methodologies were used. They insist that credit sales were partly financed by higher FO margins; by selling fuel close to port while booking sales at far-flung areas to pocket inland freight equalization margin (IFEM). Moreover, it is said that the company sold fuel to other companies’ retail franchises. While there is no concrete evidence of these allegations, it, however, does not make sense that a company would sell fuel at Rs3 per litre discount when the gross margin on the products is regulated and is less than Rs 3 per litre.

The question is how these elements were not observed by the then board of directors of the company, banks, and Vitol (which purchased its stake in the company beginning 2015). The company was opening usance (deferred payment) LC (letter of credit). OMC business needs higher working capital (WC) financing, and which is extended on LCs. It is a high margin business and banks were happy to lend and make easy money.

In usance LC, the company is exposed to foreign exchange movement risk. The price is locked in dollars and payment is made later. Usual OMC cash cycle is 15-30 days (it’s higher on FO and lower on petrol/diesel). Hascol issued LCs for 90 days which increased its currency exposure excessively.

In 2018, when the PKR stared depreciating, the situation started unravelling. At the same time, FO sales started dropping too, exacerbating the financial stress. In the quarter ending Dec-18, the company showed loss for the first time. And the loss started increasing in 2019 and 2020. The Covid pandemic did not help either. In June 2020, all OMCs were under stress when the international oil prices fell, and government passed on the benefit to consumers while companies were holding inventories (as sales were low in April and May due to lockdown) and they incurred inventory losses.

The fall was too steep for Hascol. Their high-cost overheads were becoming visible. The higher throughput charges and substantial unsecured credit were aggravating the situation for them. There was no cushion from FO sales. The hour of reckoning was upon it, the company defaulted on its loans and has not published its latest accounts – and is thus on the defaulters list on PSX.

Meanwhile, the company issued right shares. Vitol increased its shareholding. Right now, 40 percent shares are held by VTL, and rest are in various hands. The control is with Vitol and banks have formed a consortium to negotiate with the company. Now, it is in the best interest of the banks to revive the company or else, they will not be able to recover anything – especially, since more losses will accrue as the company recently stated that Rs7.5 billion worth of fake purchases were booked against its fixed assets.

OMC business is based on franchise value. It operates on high volumes and low margins. Fixed assets have a lower share. As per OCAC in 2020, there were 531 retail outlets of Hascol in Pakistan out of 9,113 in total. The current number is 675. Around 95 percent of these are franchise owners while the remainder are company operated. Some storage facilities are leased as well. The company has a good retail network with pumps at key locations.

For the company to revive, these outlets need to survive and thrive. However, with investigation agencies poking in, the brand equity of Hascol will diminish. Consumers may stop buying petrol/diesel from it. Franchises may go to other OMCs, as all they need to do, is enter in a new agreement and change sign boards and branding. But if that happens, the company will die. Banks will not be able to recoup even Rs10 billion out of their outstanding Rs58 billion.

The consortium of banks is negotiating with the new management. Banks need to understand that they have to take a haircut. They will be living in a fool’s paradise if they expect full recovery. The other problem with banks is that each bank is trying to undercut the other by insisting that it has a first charge. Each bank wants to recover its full amount, but in the process everyone would lose. It has happened in the past, and it can happen now. In game theory, it is referred to as the prisoner’s dilemma.

The other problem banks have is trusting Vitol. The company must restructure. Banks will convert part of their debt into equity and part of it into long-term financing. Then the company would need working capital to revive. For this to happen, banks would need to put more money into the company. They are contemplating the option of putting good money into bad in anticipation of turning bad into good.

Banks want Vitol to make full disclosure on long-term contracts. Banks expect Vitol to put further equity into the company. Additionally, Vitol, in principle, should not be the sole supplier of fuel to the company. There are too many ifs and buts. Seeing the past, it is in the best interests of the financial system to find a new buyer for Hascol and let Vitol make an exit.

If Pakistan had strong bankruptcy laws, this management shift could be easier. Still, this can happen. But with FIA (and possibly NAB) in the picture, no new player would like to burn their hands. That is why it is important to deal the case as corporate default and fraud. Here the SBP-SECP role is critical. But SECP is toothless and does not have history or capacity to unearth and handle corporate frauds. It is high time for SECP to pull its socks up and do its job.

Copyright Business Recorder, 2021

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Ali Khizar

Ali Khizar is the Head of Research at Business Recorder. His Twitter handle is @AliKhizar

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