Refinery: NATIONAL REFINERY LIMITED - Analysis of Financial Statements Financial Year 2005 - Financial Year 2010

National Refinery Limited (NRL) was incorporated on August 19, 1963 as a public limited company. The Government of Pakistan, under the Ministry of Production took over the management of NRL as per the Economic Reforms Order, 1972; which was previously exercising control through its shareholding in State Petroleum Refining and Petrochemical Corporation (PERAC).
The Government of Pakistan decided to place NRL under the administrative control of Ministry of Petroleum and Natural Resources in November 1998.

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COMPANY SNAPSHOT
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Name of company              National Refinery Limited
Nature of Business         Oil Refinery & Distributors
Ticker                                             NRL
Share price (at year end)                       Rs 182
Market Capitalization                Rs 14,621,965,950
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In June 2003, the government decided to include NRL in its privatisation programme. The selling of 51% equity and transfer of management control to a strategic investor had been proposed and the due diligence process for the privatisation was initiated accordingly. After competitive bidding, NRL was acquired by Attock Oil Group in July 2005.
The company's principal activity is to manufacture and supply fuel products, lubes, BTX asphalts and specialty products. It operates in two segments: Fuel and lube: The fuel segment is a diverse supplier of fuel products and offers gasoline, diesel oil, kerosene, and furnace oil. The lube segment provides different types of lube-based oils, asphalt and wax-free oil for different sectors of the economy.
INDUSTRY OVERVIEW
There are 5 refineries currently operating in Pakistan.
1. PARCO: production 100,000 barrels per day equivalent to 4.5 million tons.
2. NRL: production 65,000 barrels per day equivalent to 2.8 million tons.
3. PRL: production 50,000 barrels per day equivalent to 2.2 million tons.
4. ARL: production 42,000 barrels per day equivalent to 1.8 million tons.
5. Byco: production 30,000 barrels per day equivalent to 1.5 million tons.
Current crude production of Pakistan is 65,000 to 67,000 barrels per day and total capacity of the refineries is 287,000 barrels per day or 12 million tons hence 220,000 barrels per day are imported.
In terms of market share, National Refinery Limited currently possesses the fourth position, with PARCO being the market leader. The market share of NRL stands at 13%, a sharp drop from a share of 23% during FY09.
FY10 has been a very challenging year for the entire oil sector, especially the refineries. FY09 saw severe fluctuations in international petroleum prices, with prices of Arab Light crude reaching all time high of USD 143.09/bbl and slumping to a low USD 35.35/bbl respectively. In comparison, prices varied between USD 70/bbl to USD 87/bbl during FY10, which is a considerable improvement. However, the stabilization in prices was not sufficient to maintain profitability, as the guaranteed return for the refineries was withdrawn, causing an erosion of the gross refiners margin (GRM). The average GRM for the year was insufficient to cover production costs, and the refineries could not as a result, post a profit in the fuel segment of their operations. The issue of circular debt, which has been hampering the industry for the past two years, has added to the difficulties, posing severe risks to liquidity and disrupting daily operations of the refineries.
Petroleum products off-take for the year grew by 8.52%, with volumetric sales standing at 20,314,743 MT (FY09: 18,719,300 MT). Demand for Gasoline (HSD and LDO) dropped, while furnace oil sales expanded by 15%.
Currently, PARCO, the market leader, works under oil refinery formula with 25 percent guaranteed rate of return up to December 2008. The profit of NRL, PRL and ARL up to 2001-02 is under 10 percent guaranteed rate. The IPP formula was modified in 2002 and minimum 10 percent guaranteed with upper limit of 40 percent was done away with.
Tariff protection was allowed to NRL, PRL and ARL giving incentive of customs/deemed duty of 10 percent on high speed diesel (HSD) and 6 percent on kerosene oil, light diesel oil (LDO) and jet propulsion (JP-4) in their ex-refinery prices to operate on self financing basis. The formula was further revised in 2007-08 by reducing deemed duty to 7.5 percent on HSD and removing 6 percent deemed duty on kerosene, LDO and JP-4/8 through budgets. This reduction in deemed duty, twined with fall in global oil prices and caused a considerable decline in the profitability of the oil refineries.
The companies have been actively involved in deliberations with the government over changes in the pricing policy; however no progress has been over the past year.
Share of the petroleum products is about 40% of the current energy consumption in Pakistan. This consumption has grown sharply during 1980s at a rate of almost 7% per annum. However, it showed a decreasing trend during 1990's and during 2004-2005, it gained pace at about 10% per annum.
Oil consumption of energy products is dominated by gasoline and fuel oil. Gasoline in Pakistan consists of High Speed Diesel (HSD) and Light Speed Diesel Oil (LDO), while fuel oil consists of furnace oil.
The transport sector and agricultural sector are the two major users of gasoline in Pakistan. In recent years, a high level of subsidy was provided by the government of Pakistan over gasoline due to which its consumption increased. In 2007, however, the increase of oil prices in the international market affected Pakistan's economy, and as a result, the government is no longer in a position to provide the same amount of relaxation as before. The government has been gradually reducing the subsidy level, causing the local prices of gasoline to rise, and the consumption to drop. Secondly, the government is promoting the Compressed Natural Gas (CNG) sector in Pakistan and is encouraging as well as forcing certain sectors within transport to convert to CNG. This indicates that in the coming years Pakistan will see reduced consumption of gasoline products in the transport sector. There is however, no alternative for gasoline in the agriculture sector, which is facing extreme difficulties as a result of rising prices.
Furnace oil or fuel oil is normally used for production of electricity via thermal power plants. At the moment Pakistan is facing an extreme energy crisis due to which the government is planning construction of short-term power generation plants that are oil based, and is also encouraging independent power producers to invest in the country. As all the new thermal power plants are oil based and as the country has very limited natural gas resources, the consumption of furnace oil will also increase in the coming years.
FINANCIAL PERFORMANCE
For NRL, sales for the year stood at Rs 110 billion, a marginal rise of 0.6% YoY (FY09: Rs 109 billion). The fuel segment of the company registered a loss of Rs 707 million, which was characteristic of the industry as a whole (FY09: Rs 2.69 billion). As mentioned earlier, the erosion of the Gross Refiners' Margin (GRM) from USD 1.92 per barrel to USD 0.80 per barrel, a drop of over 58%, played a large role in reduction of profitability this year. NRL, also operating in the Lube business, was able to earn a profit of Rs 3.99 billion in this segment, which resulted in an overall profit of Rs 3.28 billion for the company (FY09: Rs 1.53 billion). During FY09, the lube segment of NRL earned a profit of Rs 4.23 billion, which shows deterioration in performance this year due to higher operating costs.
PROFITABILITY
While sales remained relatively stable over the year, with a rise of only 0.6% YoY, cost of sales decreased by a similar proportion, leaving the company with a gross profit of Rs 6.33 billion. Cost of sales for FY10 stood at Rs 103.8 billion, as compared to Rs 104.3 billion the previous year. The largest component of cost of sales is crude oil consumed, which stood at Rs 102 billion. Administrative, selling and general expenses for the year grew by 13%, an expected rise considering the factor of inflation and growing costs of carrying out business. The increase in expenses cannot be attributed to a single factor and is the combined effect of small increases in all expenses. Finance costs fell considerably over the period, standing at Rs 696 million, as compared to Rs 2.4 billion during FY09.
Gross profit margin for NRL stood at 4.64%, entirely due to the company's ability to cover costs through the lube business (FY09: 3.76%). Net profit margin stood at 2.4%, more than double of what it was during FY09 (FY09: 1.1%). As a result of the sharp drop in finance charges, the company's profit after tax showed a considerable rise, which was translated to an improvement in the net profit margin. ROA for the year stood at 6.4%, while ROE stood at 16.7%. Improvement of the ratios is a direct result of the growth in the company's profit in the lube segment of operations.
LIQUIDITY
In terms of liquidity, the company's position remained relatively stable, with only a slight deterioration. The current ratio fell from 1.58 in FY09 to 1.50 in FY10, which can be attributed to a greater proportionate rise in current liabilities as compared to current assets. NRL is however, performing better as compared to the sector in terms of liquidity, and its current ratio is well above the industry average of 1.10.
Current assets for the year stood at Rs 47.9 billion, a 22% rise YoY (FY09: Rs 39.2 billion). The largest proportionate change was seen in cash and bank balances, which grew from Rs 7.8 billion in FY09 to Rs 16.2 billion in FY10; a rise of 108% YoY. Trade debts, another large component of current assets grew by only 10%, which is an achievement for the company given the current situation of circular debt which is affecting the sector.
Current liabilities for the year stood at Rs 31.9 billion, with a 28% rise YoY (FY09: Rs 24.9 billion). Trade and other payables stand at Rs 29.9 billion, and is the only major component of current liabilities (FY09: Rs 23 billion). This amount includes Rs 7.9 billion payable to the government of Pakistan.
ASSET MANAGEMENT
In terms of Asset Management, NRL has remained relatively stable, with only a small decline. Inventory turnover has remained steady, at 34 days during both FY09 and FY10. This is due to the stability in both sales and inventory over the period. Days sales outstanding increased from 38 days in FY09 to 43 days in FY10. This again is due to sales remaining stable, and receivables increasing by a relatively larger proportion. The operating cycle thus stands at 77 days, compared to 72 days in FY09. The company's operating cycle is considerably shorter than the industry average, which stands at 96 days.
Total asset turnover again declined, dropping from 3.3 in FY09 to 2.6 in FY10. With sales remaining stable, and assets increasing by 22%, the total asset turnover was forced to drop. The Sales/Equity ratio dropped from 8.1 in FY09 to 6.95 in FY10. This decline is due to the stability in sales and the increase in equity. Equity increased by 13% YoY, standing at Rs 19.6 billion (FY09: Rs 17.4 billion).
DEBT MANAGEMENT
Like asset management, debt management of NRL also declined over the year. The debt to asset ratio increased from 59% in FY09 to 62% in FY10, showing an increase of the company's debt. The company is however still in a better position than the industry, which has an average debt to asset ratio of 78%. Total liabilities for NRL stood at Rs 32 billion, a 28% rise YoY. Total assets on the other hand stood at Rs 51.6 billion, a smaller rise of 22% YoY. The increases in both the total assets and total liabilities were largely due to increases in the current portions of the two accounts. This is visible in the long-term debt to equity ratio which is only 0.7%; showing that the company has almost no long-term debt. Non-current liabilities stood at Rs 139 million (FY09: Rs 135 million), while equity stood at Rs 19.6 billion (FY09: 17.3 billion). This lack of long term debt is characteristic of the industry, and all the refineries show similar figures. The total debt to equity ratio on the other hand is very high, showing considerable risk of the company. The debt to equity ratio stood at 163% in FY10, from 144% in FY09. This is due to the large increase in current liabilities, as mentioned earlier.
As a result of the considerable drop in the company's finance costs this year, from Rs 2.4 billion in FY09 to Rs 696 million in FY10, the TIE ratio has shown improvement. The TIE ratio stood at 7.13, as compared to 1.69 in FY09.
MARKET VALUE
The market price of the stock has been on a decline, with the price dropping from Rs 220 per share at the end of FY09 to Rs 182 per share at the end of FY10. This is an expected decline, and is the direct result of the collapse and then stabilisation of the stock market. It does not indicate poor performance of the company itself. The beta for the stock is 0.025, which means it does not move with direct relation to the KSE-index. It provides less return than the average stock in the market, but is also less risky.
Earnings per share for NRL stood at Rs 41.08 per share, a rise of 114% YoY (FY09: Rs 19.17). The price earnings ratio stands at 4.45, as compared to 11.48 at the end of FY09. This shows that while the company's earnings have improved over the period, the market has not responded and investors remain doubtful. The share price has thus not risen as earnings would indicate. Book value increased over the year by 13%, which is exactly the proportion by which equity increased. Book value stands at 246, as compared to 217 in FY09. As a result of the improvement in earnings over the year, a dividend of Rs 20 per share was announced; as compared to a dividend of Rs 12.5 per share announced the previous year. While other refineries have failed to earn a profit over the year, NRL has succeeded in providing investors with not only improvement on performance, but also a dividend yield of 11%, which is a considerable return.
FUTURE OUTLOOK
The revision of the pricing formula as notified in August 2008 has had an adverse effect on the revenues of the refineries with prices of the main products HSD and PMG having being adversely impacted. These measures were taken by the GoP under extreme public pressure in addition to the earlier modifications it made to the pricing formula from time to time in the form of withdrawal of deemed duties on Jet Fuel, kerosene oil, and LDO. The year under review witnessed relative stabilisation of international prices of crude oil and petroleum products, but a heavy erosion of the GRM. Unless this margin improves, refineries run the risk of running heavy losses. Furthermore, with the impending issue of circular debt, the liquidity of the refineries has been severely affected, and urgent steps are required by the government to resolve the problem.
NRL, in order to sustain economical operations, made strong representations to the Government jointly with other refineries for a review of the pricing formula and held several meetings and negotiations during the year. The government though acknowledging the refineries' difficulties remains under public and other pressure, and has not taken a concrete decision as yet. The refineries have emphasised on the government that a revision in the pricing formula is extremely essential in order that the refineries are able to maintain their normal operations to continue supplying petroleum products to the domestic market.
COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for Business Recorder.
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