Refinery: ATTOCK REFINERY LIMITED - Analysis of Financial Statements Financial Year 2004 - 3Q 2010

Attock Refinery Limited (ARL) is a pioneer crude oil refining company and a major supplier of refined petroleum products in Pakistan. The company is a subsidiary of the Attock Oil Company Limited, UK and its ultimate parent is Bay View International Group S.A. It began its operations in 1922 and was the first refinery in the region.
ARL became a private limited company in 1978 and in 1979 the company was converted into a public limited company. It is listed on all the three stock exchanges of the country.

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COMPANY SNAPSHOT

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Name                ATTOCK REFINERY LIMITED

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Business        Oil Refiners & Distributors

Ticker Symbol                          ATRL

Market Capitalization      Rs 9,569,874,600

Earnings per Share                  Rs 3.63

Average Share Price                Rs 143.8

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The company's primary activity is refining crude oil. It also produces certain petroleum products such as liquefied petroleum gas (LPG), unleaded petroleum solvent grade (PMG), naphtha, premium motor gasoline, mineral turpentine (MTT), JP-1 & JP-8, kerosene oil, high speed diesel (HSD), light diesel oil (LDO), furnace fuel oil (FFO), low sulfur fuel oil (LSFO), and polymer modified bitumen (PMB). ARL has an edge over other refineries because of its configuration which enables it to process the lightest to the heaviest indigenous crude and produce a complete range of both energy and non-energy products. The non-energy products include lubes and greases, asphalt, solvent oil, mineral turpentine (MTT), benzene toluene xylene (BTX), jute batching oil (JBO), processing oil, carbon oil, and wax.
RECENT RESULTS 3Q10
The Gross Refiner's Margin (GRM) during the third quarter January - March 2010 remained unfavorable as a result of which the company's financial results from its core refining operations still showed further loss of Rs 157 million during the quarter. The GRM during the nine months was much lower than corresponding period of last year. Though the adverse impact of changes made by the government in the refineries pricing formula for HSD and motor gasoline had been more severe, the negative impact of exchanges loss during the period July 2008 and March 2009 substantially reduced from Rs 1,401 million to Rs 220 million between July 2009 and March 2010. The financial results after inclusion of other income of Rs 642 million show a net loss of Rs 556.784 million as against profit of Rs 474.54 million during corresponding of nine months of last year.
After accounting for dividend income (being non-refinery income) of Rs 626.269 million the net profit for the nine months ended March 31, 2010 was Rs 69.485 million (March 31, 2009: Rs 1,085.283 million).
CAPACITY
Attock Refinery is located in Morgah, near Rawalpindi. The company had commenced its operations with a capacity of 119ktpa. Now the company's capacity has reached to 1.82mtpa. The overall total capacity of the refinery sector is 12.87mtpa. ARL, with a 14.14% of total refining capacity of the sector is the fourth largest refinery of Pakistan in terms of refining capacity.
The company is constructing a 100,000 barrels crude oil storage tanks, costing Rs 73 million and a furnace fuel; storage tank with a capacity of 500 M tons to supply fuel oil to AGL's Power Plant. The company is further constructing other products storage tanks such as a 4000 M tons capacity naphtha storage and a Jute Batching Oil (JBO) of 500 M tons. This will help ARL achieve more operational flexibility in the future.
Attock Refinery Limited has is the fourth largest refinery in term of market share too. PARCO is the market leader with 35% market share followed by PRL (17%), NRL (22%) and ARL (14%). ARL's market share declined by 2% over the last year, and so has PARCO's, whereby NRL's share has increased. Total Capacity is of 12.8 MTOE per annum.
ARL operates under the Import Parity Pricing Formula whereby net profit after tax greater than 50% of paid-up capital is required to be diverted to a special reserve to offset any future loss of make investment for expansion or up-gradation of the Refinery.
Current crude production of Pakistan is 65,000 to 67,000 barrels per day and total capacity of the refineries is 285,000 barrels per day or 12 million tons hence 22,0000 barrels per day are imported.
Due to the continuous circular debt difficulties and unfavorable refiner's margin arising from international market price fluctuation and pricing formula changes the refinery throughput during the nine months under report could not be achieved at its full capacity. The refining throughput during the nine months July, 2009 to March, 2010 was 9.921 million barrels (March 2009: 9.738 million barrels) which was 88.53% of its capacity while the sales volume for nine months was 9.559 million barrels as compared to 9.439 million barrels in the corresponding period of last year. Except for the under capacity operations, all the processing units of refinery operated smoothly.
OVERVIEW OF PRICING FORMULA
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 2001-2002 is under 10 percent guaranteed rate. The IPP formula was modified in 2002 and minimum 10 percent guaranteed with upper limit of 40 percent done away with.
Tariff protection was allowed to NRL, PRL and ARL giving incentive of custom/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.
CONSUMPTION AND PRODUCTION OF POL PRODUCTS
Share of the petroleum products is about 40 percent of the current energy consumption in Pakistan. This consumption has grown sharply during 1980s at rate of almost 7 percent per annum but it has shown a decreasing trend during 1990s and later it gained the pace during 2004-05 at about 10 percent per annum.
Oil consumption of different energy products is dominated by gasoline and fuel oil. Gasoline in Pakistan consists of high-speed diesel (HSD) and light speed diesel oil (LSDO), while fuel oil is normally used in terms of furnace oil, which is used in thermal power generation projects.
Transport and agricultural sectors are the two major users of gasoline. Transport sector includes both private and commercial types. In the recent years, a high amount of subsidy was provided by the government on gasoline due to which its consumption has increased. But in 2007, increase in oil prices in the international market affected the Pakistan's economy due to which government gradually reduced the subsidy levels; as a result, gasoline prices are on the increase in local market and effecting the consumption. Secondly, the government is promoting the compressed natural gas (CNG) sector in Pakistan and both encouraging and forcing the transport sector to convert on CNG. This indicates that in the coming years Pakistan will see reduced consumption of Gasoline products. But there is no alternative of Gasoline in Agriculture sector and as a result, this sector is facing extreme difficulties due to rise of gasoline process.
Furnace oil or fuel oil is normally used for the production of electricity. At the moment, the country is facing extreme energy crisis and government is planning for short-term power generation plants that are oil-based and also encouraging independent power producers to invest in the country. As all the new thermal power plants are oil-based and the country has now very limited natural gas resources, the consumption of furnace oil will also increase in the years to come.
PROFITABILITY
The sales performance of ARL displayed a consistent upward trend from FY04 to FY08, recording a phenomenal increase of 55% increase in sales in FY08 but this was followed by a 16.72% decline in sales in FY09. Cost of Sales has varied correspondingly to almost near levels as of the sales.
The refinery product prices in Pakistan are linked to the prices in the Gulf region. The Arab Light crude oil prices increased by 44.3% to an average US $83.34 per barrel in FY08 as compared to US $57.77 per barrel during FY07. This increase in oil prices has helped improving the sales revenue and profits of the refinery sector. The companies in the refinery sector registered a substantial rise in the gross refining margins (GRMs) during FY08 as compared to in FY07 also because the increase in product prices was higher than the increase in the crude prices.
While the inflated crude oil resulted in huge profits in FY08, the same reason deteriorated revenue in FY09. The economic recession of 2008 also affected the oil prices, with the Arabian light hitting a record all-time low of US $40 per bbl in November 2008. Asymmetric prices of company's product went drastically down as a result and eroded the profitability. The cost of this main input averaged at US $67.83 per BBL inFY09.
Profits earned at the back of naphtha export also registered a decline of 27% contributing to the already low sales of ARL. The declined sales figures correspond to the declining PAT of ARL in FY09.
The company is operating under the import parity pricing formula, as modified from time to time, whereby it is charged the cost of crude on 'import parity' basis and is allowed product prices equivalent to the 'import parity' price, calculated under prescribed parameters.
Effective July 1, 2007, the government made certain modifications in the prescribed parameters effectively reducing the price of Kerosene oil, light diesel oil (LDO) and JP-8 in 2007 and 2008. The government has further modified the refineries pricing formula in August, 2008 whereby the 10% duty included in pricing of HSD has been cut to 7.5% and the motor gasoline pricing has been unilaterally revised by linking its price to Arab Gulf 95 RON prices and calculating the price of 87 RON motor gasoline on a unitary method basis. This revision adversely affected the pricing of HSD and motor gasoline, which are company's two major products.
Earlier, in July 2002, the government had modified the pricing formula. It was applicable to the company restricting the distribution of net profits after tax (if any) from the refinery operations to 50% of paid-up capital as at July 1, 2002 and diverting the surplus profits, if any, to a special reserve to offset any future loss, or make investment for expansion or upgradation of the refinery. Further, the government had abolished the minimum rate of return of 10% which continues to be contested by the company as it represented to the government that the already existing agreement for guaranteed return could be modified only with the mutual consent of both the parties. While this deregulation promoted competition in the sector, it caused a huge setback in the conditions where the international oil prices are subject to drastic price shocks.
PROFITABILITY
Attock Refinery Limited registered a drastic fall in profit after tax after a phenomenal increase in FY08. The company earned a profit after tax of Rs 1.016 billion in FY09 against Rs 6.147 billion posted in FY08. The gross sales earned by the company amounted to almost the same level as FY08. However, the petroleum development levy charge increased by 565% over the FY09, causing a setback in the already declining sales figures which amounted to Rs 76.546 billion against Rs 91.910 billion in FY08.
The cost of sales for the period FY09 decreased from Rs 89.65 billion in FY08 to Rs 75.342 billion in FY09 mainly on account of decline in the crude oil consumed. Research and Development cost reduced considerably by 78% indicating the company's reduced interest in initiating new projects in face of risky crude oil market and the slowdown of the economy.
Despite a 16% decrease in the cost of sales, the company netted 52% decline in gross profit in FY09. This is depicted in the sharp decrease in the gross profit margin of the company in FY09.
The administration and distribution costs for the period FY09 increased by 10.50% and 8.02% respectively. The financial charges of the company increased by 15% in FY09. Financial costs increased mainly due to the huge exchange loss amounting to Rs 1.464 billion in FY'09. The exchange difference arises due to translation of foreign currency liabilities of crude oil and increased to such a great extent due to the depreciation of the rupee against the dollar.
The profitability ratios have improved considerably after falling considerably in FY06. ARL observed cascading profit margins for the FY06 in tandem with the declining profitability in the sector to the extent that gross margins and profit from refinery operations turned negative during the first half of FY07. The fluctuating crude oil and petroleum products' prices were the major factors behind these results. However things started improving in the third quarter of FY07 as product prices increased more than crude oil prices, allowing the company to earn a net profit of Rs 504.33 million for the year and giving a much needed boost to the gross refiner's margin and net profit margin.
Sluggish demand for motor gasoline (PMG) due to high prices and unfavorable government policies also contributed to declining profits in FY06. PMG is a premium product for the company's profitability and the declining sales of the product forced the company to resort to the exports of naphtha. This transaction resulted in losses for the company because of the high transportation and handling costs and due to the lower margins available on sales of the product. Hence profitability crashed further during the year.
FY07 brought about a positive change in this regard as well as demand for motor gasoline increased, accompanied by a decline in naphtha exports. This was a result of curbing the smuggling of this product due to domestic rationing in one of the neighboring countries and a change in the geo-political situation in the border areas. This development also contributed to the profitability of the company during the FY07.
The upward trend of crude and oil prices continued in FY08, where the crude oil hit the record high price of US $147 per barrel in the international market. These fluctuations in the international prices of petroleum products and crude oil provided abnormally high returns to the refiners margins and the profitability increased to unprecedented level to Rs 6.147 billion in FY08 against Rs 0.748 billion in FY07.
However the refineries did face a challenging and testing time when the government this year didn't allow the full impact of these rising prices to be passed on to the consumers. Resultantly huge subsidies were given in the prices of motor gasoline, kerosene oil, diesel and other petroleum products. These subsidies were financed heavily by the oil industry including the oil refineries and the oil marketing companies creating a huge inter corporate debt. These inter corporate debt and price differential claims receivables are still outstanding by the government, seriously hampering the operations of the oil industry. A modification of the Pricing Formula in FY08, which reduced the deemed duty on HSD, Kerosene Oil, LDO and JP-8 resulted in corresponding decline in the prices of these products. Even though the GoP initiated this measure for public interest, it initiated resistance by the refineries as it would erode the profitability of the company and hamper continued operations at full capacity.
With the global recession setting in the beginning of FY09, the international prices of petroleum products and crude oil started falling since August 2008 and hit the record low of US $38 per barrel in the international market. Without stabilization, these prices remained within the range of US $38 per barrel to US $per barrel.
With the change in the pricing formula and declining international crude oil prices, the also resulted in inventory losses, the refiners margins was affected by around 30% decline in dollar/rupee parity. With all these factors combined, ATRL suffered a huge loss in FY09 particularly in July-December 2008. ATRL was able to reverse the negative impact in the ensuing period through product management based on price economies and increase in production of high value products that was supported by an increase in demand for motor gasoline. The persistent issue of circular debt continued to hamper the optimal utilization of the refinery's capacity.
With the declining GRM, the profits from the refinery operations for the FY09 amounted to Rs 406,016 million against Rs 2,007.015 million in FY08. After accounting for non-refinery income of Rs 610.672 million the net profit after tax stood at Rs 1,016.758 million in FY09, demonstrating a decline of 83.46% from last year.
The declined profitability has simultaneously caused a drastic fall on return to assets and return to common equity, each falling by a colossal 81% and 84% over FY09. These declines are in line with industry trends, as similar factors plagued the profitability of the refineries in this year.
LIQUIDITY
In terms of the liquidity measure generated by the current ratio, ARL lags behind its counterparts.
The liquidity position of ARL had been declining over the period since FY04. The current ratio of the company reached dangerously low levels so that the current assets were no longer sufficient to cover the current liabilities. This decline was observed despite an increase in cash assets during FY06 from long-term loans taken by the company as a portion of the loan matured and became due. The trade payables increased rapidly over the last few years, thus making a significant contribution to the observed trend. This increase in trade payables may be traced back to rising crude oil prices over the years. The deteriorating liquidity situation was a source of concern for the company and a threat to its financial strength.
In FY08, ARL managed to slightly improve its liquidity position. This was because the current assets of ARL increased more in proportion (71%) than the current liabilities (45%). There was a significant of 113% in the cash and bank balance.
In FY09, liquidity of ATRL declined by just 0.01 but is subject to vulnerability as we can see a contraction in the cash balance from 56% of total current assets in FY08 to 24% of total current assets in FY09. Trade Debts have increased considerably between the two periods, from Rs 9.207 billion in FY08 to Rs 15.508 billion in FY09. This indicates illiquid assets of the company mainly tied up in PDC receivable from the GoP. Current Liabilities for the company have declined by almost 16% which was a little less than the 17% decline of current assets.
ASSET MANAGEMENT
ARL appears more efficient than the industry in management of its inventory but lags behind in the collection of receivables. In FY08 the asset management of the company further improved as the operating cycle of the company reduced by 8 days. In FY09 there is a reversal in this trend as the operating cycle increased drastically by almost 41 days. This signals a danger for the refinery, as slack credit policy and extension in collecting receivables endangers the cash flow of the company. This operating cycle is higher than that in the industry and hence ATRL should be cautious in future and be more prudent in carrying out its business.
The receivable collection period for ARL improved in FY06 but rose in FY07 whereas the opposite is true for the inventory turnover (days). The inventory turnover jumped up during the FY06 but declined slightly during FY07. As a result of these fluctuations in DSO and inventory turnover, the operating cycle also declined during FY06 and increased during HY07. The total assets turnover has been on a declining trend since FY05 and the trend continued till FY07. Both DSO and inventory turnover register increases in FY09 against last year. This is line with the industry trend in FY09. As lower sales and income constraints plagued the economy, effects of this are evident on the Refinery's ability to generate sales and subsequent cash flows.
The total asset turnover remained the same during FY08 because the company was able to generate business in proportion to the increase in the assets of the company. The same trend continued in FY09. The ratio of this turnover is line with that of the industry. The sales to equity had increased in FY06 as a result of a 34% increase in sales against a relatively small increase in equity. However in FY07, despite higher sales, the sales/equity declined. The sales to equity ratio maintained its declining trend in FY08 as well because the sales of the company increased less in proportion to its equity base. The company's equity base has been strengthened due to higher paid up capital and increased reserves. Downward trend continued in FY09, due to declining sales and increased equity on the back of issue of bonus shares of value Rs 142,155,000.
DEBT MANAGEMENT
ARL is largely an equity-based company as evident from the low long-term debt to equity ratio. The ratio had jumped up in FY06 as the company acquired long-term loans but the repayment of the loans during the first half of FY07 has brought down the ratio to the previous lower levels. The ratio has further declined in FY08. The ratio registered a small climb in FY09 mainly at the back of 24% increase in provision for staff gratuity.
As a consequence of the loan undertaken during FY06, the TIE plunged drastically for the year. However with the repayment of the loan, it is expected that the company will be able to gradually redeem its position. An initiation of the trend has been observed during FY07, as TIE rose slightly and finance cost declined 53%. However this trend wasn't sustained as finance cost increase drastically in FY08 by 404% and in FY09 by 18.25%. The main reason for this cost has been the increasing exchange loss suffered by the Refinery.
Considerable discrepancy is seen in terms of the debt ratios of the company. ATRL has a history of higher than average debt to asset ratio whereas its long-term debt to equity ratio has stood well below average for all years except FY06 when it had taken on additional loans. However the TIE ratio for the company is very low compared to the average industry.
When assessed in terms of the total debt to equity, the company does not fare so well. This is due to the high current liability figures, comprised mainly of trade and other payables and provision for taxation. This ratio had also jumped up in FY06 as a consequence of the long-term loans but has not been able to regain its former level in FY07. Declining trend was witnessed in FY08 and FY09. In FY08 even though a 55% increase in current liabilities, equity expanded considerably by the increase in retained earnings on the back of high profits earned in the year. In FY09, the current liabilities decreased by 11%, equity experienced a rise due to the issue of bonus shares.
The strong debt ratios reflect the financial strength of ARL and with an improvement in the profit situation; the TIE may also improve.
MARKET VALUE
After consistently paying dividends in the form of cash or bonus shares, ATRL decided not to give out dividends in FY09 in view of the declining refiners' margins and uncertain future profitability. This also shows shareholders' commitment to undertake the projects relating to Naphtha Isomerization, Preflash unit, and Diesel Hydroesulfurization and to produce environment friendly products. Government is expected to take positive measures in providing requisite measures essential for the materialization of the projects for continued economic sustainability of the refinery.
FUTURE OUTLOOK
The revision of the pricing formula as notified in August 2008 has had an adverse effect on the revenues of the Refinery with prices of its two 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 fluctuating international prices of crude oil and petroleum products, which could not stabilize due to world recession in the past year. Unless these prices stabilize the refineries shall continue to carry the risk of unpredictable refiners' margins with the additional risk of exchange rate fluctuations that too had considerable effect on the profitability of the refineries.
Due to changes in product specifications warranted by environmental considerations and as part of its commitment to meet these requirements, ATRL has undertaken the task of implementing certain projects that shall cater to the market requirements of cleaner fuels, as well as to maintain and enhance its oil refining facilitated to meet any future growth in crude oil availability in the northern region, continued with its efforts to complete the engineering design of these projects to ensure expeditious implementations. These plans include construction of Pre-Flash Unit to enhance the overall refining capacity, an Isomerisation Unit that shall upgrade the motor gasoline by reducing benzene and aromatics and a Hydro-desulphurisation unit (DHDS) to reduce sulphur contents in HSD to meet Euro Standards. With the implementation of these projects ATRL shall not only be able to retain its market share in production and supply of petroleum products but also provide operational flexibility in its future operations.
COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for Business Recorder.
DISCLAIMER: No reliance should be placed on the [above information] by any one for making any financial, investment and business decision. The [above information] is general in nature and has not been prepared for any specific decision making process. [The newspaper] has not independently verified all of the [above information] and has relied on sources that have been deemed reliable in the past. Accordingly, the newspaper or any its staff or sources of information do not bear any liability or responsibility of any consequences for decisions or actions based on the [above information].
Copyright Business Recorder, 2010