>ESSAR OIL (IDFC SSKI)

A giant in the making!

Essar Oil (EOL) is inching closer to becoming an integrated player in the Indian energy space. Expansion plans at its Vadinar refinery are gathering pace, and phase I (10.5m to 16m tpa) is well on track for commissioning in Q4FY11E. The uncertainties around global economic outlook and funding issues have affected timelines in the past, but we believe the relative stability in global economy and easing liquidity will aid execution of phase II (16m to 34m tpa) as well. This huge capacity addition by Q4FY12E is expected to help EOL leverage the product demand revival over FY10- 12E, while increase in complexity will improve GRMs. The nascent, but exciting, E&P portfolio has high value accretion potential as well. The slowdown in global refinery expansion plans implies a good opportunity for EOL to deliver in a tight supply environment over FY11-13E. However, a deeper economic slump may push timelines on the expansion backwards, and is a risk to our estimates. Reinitiating coverage with Outperformer and an SOTP-based price target of Rs242 per share.

EOL – moving towards scale and efficiency: The capacity expansion to 16m tpa in phase I and 34m tpa in phase II over FY10-13E would impart scale to EOL. Post expansion, EOL will have one of the largest single-location refineries in the world, which would lend sourcing flexibility and improve operational efficiencies. The complexity of the refinery would also expand considerably from 6.1 to 12.8 post phase II expansion.

Increased complexity to drive margin expansion: Higher Nelson Complexity would drive optimization of sourcing with ability to process a wider and tougher range of crude to produce superior quality products (38 varieties of crude processed in FY09). The additional secondary processing units will allow for greater middle distillate production, improving realizations and profitability of the refinery.

Valuation – firm GRMs and E&P provide upsides: Our optimism on the stock stems from the potential size and scale of the business, along with an attractive E&P portfolio. We see E&P proving to be a significant growth driver for EOL in the long term, and have attributed a value of Rs58 per share to the reserves. Based on higher volumes, improving GRMs and the value-accretion potential in E&P portfolio, we reinitiate coverage on the stock with Outperformer and a price target of Rs242.

To see full report: ESSAR OIL