PAKISTAN STATE OIL Analysis of Financial Statements Financial Year 2003-3Q’11

Pakistan State Oil came into existence in 1976 when the government merged PNO (Pakistan National Oil) and POCL (Premier Oil Company Limited) into SOCL (State Oil Company Limited) and named it as Pakistan State Oil Company Limited (PSO). It is the largest oil marketing company of Pakistan with a market share of approximately 68%.

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COMPANY SNAPSHOT
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Name of company Pakistan State Oil
Nature of Business Oil & Gas
Ticker PSO
Net Sales 3Q’11 Rs 558,376,509,000
Net Sales 3Q’10 Rs 531,157,262,000
Net Profit 3Q’11 Rs 9,258,100,000
Net Profit 3Q’10 Rs 7,534,154,000
Share price (avg. over Jul’09-Mar’11) Rs 285.48 per share
Market Capitalization as at Mar 31st 2011 Rs 48,965,244,120
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Continuous improvement, innovation as well as diversification has enabled PSO to enrich its market share. It has strategic investments in refining and distribution companies such as Asia Petroleum Limited, Pak Grease Manufacturing Company, Pakistan Refinery Limited and White Oil Pipeline Project, which give it a strong backing in terms of procuring inventory. With an extensive storage capacity of 860,000 metric tons, the company has 3,700 retail outlets across the country while more to come in future.

Apart from this, PSO also has 240 CNG stations operational in more than 30 cities and plenty more in the pipeline since its policy formulation in 1995. It is the first Oil Marketing Company (OMC) to commission a CNG facility at its retail outlet in January 1996. Along with CNG, PSO is also active in the LPG domain.

PSO generates over 18,000 metric tons of LPG in sales volume/annum, supplying the product in all corners of the country with the brand name ‘PakGas’. PSO enhanced the loading facilities at Shikarpur Terminal and Keamari Terminal ‘B’. In FY10, your Company increased the Fuel Oil throughput by 20% as compared to last year to meet emergent demand in Energy Sector. In FY10, Zulfiqarabad Oil Terminal acquired IMS certification. Furthermore, surveillance audits of ISO 9001:2000 were carried out at Keamari Terminal-A, B, ZOT, Shikarpur, Sihala, Mehmoodkot, Machike, Tarujabba, Chakpirana, Lalpir, Vehari, Faisalabad and Quetta.

The company successfully tested and launched E-10 gasoline at more than 70 outlets in Sindh and Punjab during FY10. E-10 is a blend of ethanol and gasoline, which consists of 10 percent ethanol dissolved in normal gasoline. This initiative is in line with the government’s strategy to promote alternate energy resources. This fuel will not only help the country in reducing its import bill in coming years but is also providing motorists with an economical fuel option. Ethanol, a byproduct of molasses through distillation, would not only be comparatively cheaper but will also enhance performance of the engine through lead removal. The Company signed MOU with NUST and Ghulam Ishaq Khan University for research work on biodiesel impact on diesel engines’ performance.

MoU with KPT was signed and Terms of Reference were finalised during the period under review for conducting feasibility study to connect Keamari Port with Port Qasim through a pipeline. In FY10, the company completed study for optimization of current infrastructure at Port Qasim. This would enable enhancement of imported petroleum products handling capacities of FOTCO Jetty and PSO pipeline infrastructure.

Highlights (FY10)

Mentioned below are the highlights of the FY10.

— Highest filling of LSFO through Tank Lorries and Tank Wagons ie 8529.91 MTs on 01st May 2010 from Keamari Terminal ‘B’.

— Highest HSFO dispatches from Zulfiqarabad Oil Terminal Complex through Pipeline, Tank Lorries and Tank Wagons ie 563,480 MTs in the month of April 2010.

— 13618 K.Ltrs of HSD were filled in a day ie on 20th April, 2010 at Mehmoodkot terminal.

— Highest filling of PMG ie 1028 K.Ltrs. was reported in a single day on 01st March, 2010 at Vehari

— Highest filling of PMG in a day at Faisalabad depot ie 1027 KL on 01st January 2010.

— Highest ever volume ie 354,069 M.Ts of LSFO/HSFO/HSD were handled in a month of July 2009 at Lalpir depot.

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Recent performance (3Q11)
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Rupees in 000s 3Q’10 3Q’11 % Change
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Gross Sales 627,318,717 662,605,317 5.62
Net Sales 531,157,262 558,376,509 5.12
Cost of products sold 511,354,350 536,678,342 4.95
Gross Profit 19,802,912 21,698,167 9.57
Operating costs
Transportation 439,180 557,063 26.84
Distribution and marketing expenses 2,888,529 3,455,869 19.64
Administrative expenses 914,607 1,048,129 14.60
Other income 4,629,680 2,536,489 -45.21
Profit from Operations(EBIT) 18,718,850 18,490,012 -1.22
Finance cost 7,617,951 9,099,093 19.44
Loss/Profit before taxation 11,505,739 9,801,822 -14.81
Taxation 3,971,585 543,722 -86.31
Profit after taxation 7,534,154 9,258,100 22.88
EPS 43.93 53.98 22.88
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Gross sales increased by 5.62% from Rs 627 billion in 3Q10 to Rs 663 billion in 3Q11. After accounting for the 10% increase in sales tax, net sales increased by 5.12% from Rs 531 billion in 3Q10 to Rs 558 billion in 3Q11.

The government carried out fixation of the OMC margins on sales prices of oil products, which had been earlier based on percentage of international prices. The margins have been revised for Motor Spirit (MS), High Octane Blended Component (HOBC), Kerosene (SKO) and Light Diesel Oil (LDO) to Rs 1.50/liter, Rs 1.72/liter, Rs 1.58/liter and Rs 1.61/liter respectively. As a result Margins on MS, HOBC, SKO and LDO have been reduced by 21.9%, 21.8%, 24.8% and 22.2% respectively, which implies that the margins are fixed at oil price cap of USD65/bbl.

It should be noted, however, that margins on High Speed Diesel (HSD) are to remain fixed at PKR1.35/liter while those on Furnace Oil (FO) and deregulated products will remain in line with previous regime. Thus fixation of margins on regulated products will not have a significant impact on either of three listed OMCs (PSO, APL and SHEL) as they derive a significant chunk of their revenues from deregulated products. PSO derives 59% of its gross profit from FO and HSD sales for which margins have not been changed. Thus PSO faced slight decline in revenue margins.

The cost of goods sold increased by a relatively low 4.95% from Rs 511 billion in 3Q10 to Rs 537 billion in 3Q11. Overall, gross profit increased by 9.57% from Rs 19.8 billion in 3Q10 to Rs 21.7 billion in 3Q11. An increase of 26.84%, 19.64% and 14.60% was witnessed in transportation, distribution and marketing, and administrative expenses respectively. This surge in expenses was further aggravated by 45.21% decline in other income, leading to 1.22% decline in operating profit from Rs 18.7 billion in 3Q10 to Rs 18.5 billion in 3Q11.

The circular debt issue in the energy chain continues to threaten the profitability of OMC companies, due to the rising finance cost. The balance sheet position of PSO registered a 25.28% increase in trade debts over July 2010-March 2011. As a result finance cost increased by 19.44% from Rs 7.62 billion in 3Q10 to Rs 9.10 billion in 3Q11, leading to a net 14.81% decline in profit before taxation from Rs 11.51 billion in 3Q10 to Rs 9.80 billion in 3Q11.

During 2Q11, Ministry of Finance agreed to reduce turnover tax applicable on OMCs to 0.5%. Previously, FBR in Jul’10 had announced increase in turnover tax to 1.0% in its FY11 Budget. As a result, PSO recorded tax expense of Rs 9 billion (49.6% effective tax rate) for FY10. However, taxation decreased by a vast 86.31% from Rs 3.97 billion in 3Q10 to Rs 0.54 billion in 3Q11. This led to a 22.88% increase in profit after taxation from Rs 7.53 billion in 3Q10 to Rs 9.26 billion in 3Q11. The EPS registered a similar increase from Rs 43.93 per share in 3Q10 to Rs 53.98 per share in 3Q11.

Sector performance in 3Q11

This market comparison has been based on APL, Shell Pakistan and PSO nine-month reports. Fiscal year of APL and PSO ends in June 2011, whereas Shell ended its fiscal year in December 2010. Hence the comparison is only indicative, made on the basis of APL and PSO Jul’10-Mar’11 results and Shell’s Jan’10-Sep’10 results. The companies may have been subject to varying environments over their respective periods under review.

PSO was the market leader with sales of Rs 558 billion in 3Q11, followed by Shell at Rs 139 billion and APL at Rs 27 billion. However, the sales growth of PSO over 3Q10-3Q11 registered a 5.12% increase, compared to 31.43% and 22.88% sales growth of APL and Shell respectively. This indicates poor advertising and distribution activities of the company as compared to the competitors.

In line with its leading market share, PSO achieved earnings of Rs 9.26 billion in 3Q11, compared to APL’s earnings of Rs 1.01 billion. PSO registered a 22.88% increase in earnings over 3Q10-3Q11, followed by APL at 21.02%. However, earnings of Shell fell by 100.68% to a net loss of Rs 11.51 million in the quarter ended September 2010, due to doubling of minimum turnover tax to 1% in July 2010. This weak performance of Shell is not comparable with APL and PSO’s performance, due to the discrepancy in fiscal periods.

Although PSO achieved a 3.89% gross profit margin in 3Q11, which was comparable with APL’s GP margin of 3.73%, net profit margin of PSO was only 1.665, compared to APL’s NP margin of 3.63%. This shows that PSO is experiencing major operating inefficiencies, in part explained by the high finance cost of PSO. Shell achieved a high GP margin of 5.93% in the quarter ended September 2010, partly due to the higher OMC margins prior to December 2010. However, the NP margin of Shell was 0% due to the high turnover tax prior to December 2010, as Shell suffered a net loss of Rs 11.51 billion in this period, as shown in the figures above.

The third quarter of FY11 witnessed a steep rise in oil prices on account of international supply constraints owing primarily to the ongoing crisis in the Middle East and North Africa coupled with the aftermath of the devastating earthquake and tsunami in Japan. Oil prices averaged $101/bbl with a high of $112/bbl during the quarter, the highest since FY2009. Although the sales price performed well, driven by international oil prices, circular debt remained a pressing concern that threatened the profitability of oil marketing companies. Further, in December 2010, the Ministry of Petroleum and Natural Resources directed that OMS margins on Motor Gasoline, HOBC, SKO and LDO be fixed. Previously these margins had been calculated on a percentage basis, linked to the international fuel prices.

The country’s overall fuel consumption during the nine months declined by 1.7% as compared to the corresponding period last year. In Black Oil, the industry declined by 1.6%, whereas the White Oil industry declined by 1.9%. PSO’s market share in the Black Oil and White Oil segments stood at 77.9% and 54.3%, respectively, thereby contributing to an overall market share of 65.4%.

Stock performance

Analysis of stock returns volatility of weekly continuously-compounded returns shows that the standard deviation of these stock returns is 3.3%. The future stock returns are expected to vary with a standard deviation of 3.3% and have been comparatively less volatile over Jul’09-Mar’11.

Beta analysis of the company over Jul’09-Mar’11 shows that the beta of PSO is average at 0.97, as given by the slope of the trend line. This indicates the stable stock returns in accordance with the secure demand of the company as the leading OMC. Further, PSO stock closely follows, and can be considered to be a good indicator of returns on the market, as PSO’ beta of 0.97 is almost equal to the market beta of 1.00. The beta declined slightly from a value of 1.03 over Jul’09-Jun’10, indicating that the company has maintained its performance over in 3Q11 as well.

Performance in FY10

Fluctuation in international oil prices has rendered the performance of Oil Marketing Companies (OMCs) unpredictable in terms of productivity. While the crude oil has again receded to below $75 per barrel in August/September 2010, internationally, world oil prices are expected to rise by about 8%, according to the current futures curve as shown.

Sales are directly linked with the international oil prices, therefore, any increase or decrease will affect the industry’s performance accordingly. In FY10, POL consumption in the country was recorded to be 20.8 million tons, as compared to 19.2 million tons last year. The primary reason for this 8% growth has been the increased consumption of Mogas and Fuel Oil. PSO lost 2.1% share in Mogas as compared to previous year bringing its market share in this product to around 45.9%. PSO’s Mogas volumes increased by 22% whereas the industry volumes grew by 27%. This increase in volumes was reported due to increase usage of generators and more vehicles on the road.

Consumption of Black Oil grew to 9.3 million tons – an increase of 14% over the preceding year. Black Oil demand picked up owing to supply constraints for natural gas. In Black Oil, PSO enhanced its market share appreciably from 85.8% in FY09 to 88.3%. The surge was mainly due to increase in demand in power generation sector. Reduced hydro-electric potential also contributed to rise in Fuel Oil consumption. This trend in Fuel Oil consumption is expected to continue in subsequent years.

During FY10 demand for motor gasoline increased by over 27% over the preceding year mainly due to 50% increase in cars sales and 44% increase in motorcycles’ sales, gas shortage in winters, one-day holiday of CNG per week and extraordinary increase in use of generators due to frequent power outages.

During FY10, local refineries produced 7.9 million tons while the deficit requirement of around 11.3 million tons was imported. PSO has over 90% share in import of deficit products in the country. The major chunk of demand was in FO and HSD for which 6.7 million and 3.75 million tons were imported respectively by PSO. A significant reduction in the refining capacity of different refineries was witnessed mainly due to the mounting circular debt and lower refining margins.

During the period under review, Lubricants market share has increased to 26.6% as compared to 23.3% in the last fiscal year. PSO’s lubricants maintained the market leader position in the sugar industry segment with 60% share.

PSO has a market share of 22% in CNG industry in FY10. It has shown growth of 13% in FY10 against industry growth of 11% as compared to FY09.

Financial performance (FY03-10)

An overview of the liquidity position of the company shows that the liquidity dropped from 13.7% from 1.24 in FY08 to 1.07 in FY09 but again stabilised to 1.14 in FY10. The power generation companies were PSO’s main debtors, as well as GoP since PSO was entitled to receive the amount of price differential as compared to world oil prices. The increasing trade debts worsened the liquidity position, but FY10 saw some relief as PSO received some of its payments due. In the short-term, the current liabilities were covered by short-term borrowings.

After a depressing profitability scenario and the downward spike in FY09, PSO recovered to a net profit situation in FY10. However, this recovery was not complete, as can be seen from the return on assets, which decreased from 11% in FY08 to -4.7% in FY09 and then recovered to 4.7% in FY10. While the other profitability ratios, basic earning power, gross profit ratio and net profit ratio followed a similar trend, the return on equity showed the most marked variation. Return on equity decreased from 45.4% in FY08 to -32.1% and then increased to 30.

The inventory turnover ratio increased from 12.70 in FY08 through 13.96 in FY09 to 15.05 in FY10. This shows that PSO was able to sell more of its inventory throughout the years under review, indicating better inventory management and strong sales position in the market. Likewise, the inventory turnover in days declined.

Due to stability in sales, the total assets turnover remained stable over the recent period from 2008 to 2010, showing that a sufficient amount of sales was generated to justify the investment in assets. However, the day sales outstanding continued to increase from 20.93 in 2008 through 40.30 in 2009 to 48.89 in 2010. This shows the continual weakness of the firm in managing its receivables, and serious implication for the liquidity position.

The debt to equity ratio rose from 310.5% in FY08 to 635.1% in FY09 but declined to 589.4% in FY10. The spike in the debt to equity ratio in FY09, due to severe accumulation of circular debt on account of companies like HUBCO, KAPCO, PEPCO, and PIA who defaulted on their payments and created acute liquidity problems, was only marginally improved in FY10, since PSO was able to recover only a small portion of its debts. However, this cycle of circular debt led to excessive short-term borrowing and piling of financial charges – factors which has tarnished the profitability of the company. The Time Interest Earned (TIE) ratio crashed from 16.4 in FY08 to -0.89 in FY09 due to the hike in financial charges on account of short-term borrowings to meet due financial obligations. The ratio only slightly improved to 2.77 in FY10, due to the improved net income of the company in 2010.

The capitalisation ratio likewise showed a peak in FY09 due to dependence on external borrowings to meet payments due to foreign exporters, but capitalisation ratio decreased again in FY10 after some recovery in net income.

The market value ratios show a great decline in dividend per share from 24 in FY08 to 5 in FY09 due to the liquidity crisis. However dividends further declined to 3 in FY10, since there was no real significant improvement in liquidity position even during FY10. Earnings per share and price earnings ratio showed a similar trend, with the EPS falling from 81.94 in FY08 to -39.05 in FY09 and partially recovering to 52.76 in FY10.

Book value per Share and market value both followed the other market value ratios. Book value fell from 180.5 in FY08 to 120.6 in FY09 and rebounded to 171.0 in FY10, whereas market value decline by 47% from 430 in FY08 to 213.65 in FY09, but increased again by 37% to 292.26 in FY10.

Future outlook

It is expected that future energy demand in the country will continue to grow owing to expected natural gas constraints specifically for power generation sector. PSO plans to acquire a refinery as part of its backward integration strategy to develop a confirmed supply source and reduce reliance on imports.

In the current fiscal year, PSO shall focus on improving service at its retail outlets and promoting the environment-friendly ethanol based gasoline ie E-10. By the end of 2010, PSO plans to have E-10 available at 100 outlets across the country.

The Circular debt crisis held PSO back in FY10 and it had to shelve its plans for enhancement of the storage network. PSO plans to augment its storage infrastructure to meet the future oil demand. A development/upgradation plan for key storages in line with future Furnace Oil demand for IPPs has been chalked out.

PSO is also working on a scoping study to connect Keamari with Port Qasim through a white oil pipeline. It is expected that efficiency and flexibility shall be increased manifold if these two ports are connected to each other through an integrated pipeline system.

IFEM deregulation awaits implementation, and if implemented would certainly change market dynamics. PSO is expected to benefit from this deregulation with the largest distribution network in the country. This would result in setting competitive market prices and increase its market share in the southern region. However, Punjab would continue to remain a competitive region.

Rising international crude oil prices amid fixed absolute margins for the OMCs will increase working capital requirements and reduce return on working capital for them. Circular debt continues to haunt the industry and especially PSO among the OMCs. Any rise in working capital requirements for the oil giant will worsen the situation and increase overall inter-corporate debt in the energy chain. This risk is especially pertinent for PSO, which has a share of 89% in the Furnace Oil market, due the reluctance of other OMCs, APL and Shell, in supplying oil to the power producing companies, due to the rising circular debt in the power sector. However, in case that the circular debt issue gets resolved, this scenario is likely to turn the tables in favor of PSO, since it would receive its due payments resulting in improved financial position of the company.

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