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Ready for a leap of faith?

Ongoing concerns over the supply of refined products and switch from costly gas to oil, led to a rise in SG complex GRM to ~USD12/bbl in the past few days.

International Energy Agency (IEA) expects the ongoing Russia-Ukraine war to reduce refining throughput by ~1.1mnbopd. This will result in continued high refining margin till supply concerns abate.

Standalone refiners like MRPL and MRL (not under our coverage) stand to benefit the most from rising GRMs. However, high debt and operational inefficiencies call for a leap of faith in both companies.

Rising GRMs

Peak maintenance season in the US, declining inventories, supply concerns, and switch to diesel from gas in Industrial as well as the Transportation sector has resulted in a sharp rise in petrol/diesel cracks to as high as USD20/USD48 per bbl. However, average crack spreads remain at USD15/18 per bbl for petrol/diesel in 4QFY22 till date as against USD13/11 in 3Q and USD10/7 in 9MFY22.

IEA, in its latest monthly report, has indicated that global refining throughput may be cut by ~1.1mnbopd due to ongoing Russia-Ukraine concerns. This is likely to keep the demand-supply balance tight till supply eases.

In the past few days, although SG GRM has touched a high of ~USD12/bbl, it still averages USD7.8/bbl in 4QFY22 till date v/s USD6.1/bbl in 3QFY22. The current rise in GRMs is expected to benefit all Indian refiners. Amid various other moving parts, standalone refiners like MRPL and MRL are likely to benefit the most.

MRPL: at an inflection point?

MRPL completed expansion/modernization capex of ~INR150b (Phase III) over FY12-15. This included a polypropylene plant as well as Single Point Mooring (SPM) for facilitating anchoring of Very Large Crude Carriers (VLCCs).

Despite these expansions and modernization, the company failed to sustainably improve its performance. As a result, its standalone Balance Sheet worsened with a net debt/equity ratio of 2x in FY21 from net cash/equity ratio of 1.1x in FY16. Acquiring ONGC’s stake in ONGC Mangalore Petrochem (OMPL) raised its consolidated net debt to a staggering INR244b, or a net debt/equity ratio of ~7x.

We have mapped reasons for its poor performance since 1QFY12. Since 1QFY13, the refinery has suffered at times due to inadequate availability of water during the summer season. With operationalization of the desalination plant in late CY21, the problem seems to be largely taken care of. (refer exhibit 3).

Valuation and view

While we don’t expect any performance disruptions due to inadequate water supply, it remains to be seen if MRPL can take advantage of the current strength in GRMs. Our FY22 financials do not factor in possible inventory gains in 4Q as most of it may be countered by a similar, but slower inventory loss in FY23.

At our base GRM assumption of USD6.5/bbl in FY23, we estimate an EBITDA of INR43b. Every USD1/bbl change in GRM, results in a 25% change in EBITDA. We estimate standalone net debt to fall to INR92b in FY23 from INR153b in FY21. An USD3/bbl improvement in GRM in FY23 will pare down its standalone debt to INR80b. Assuming no change in OMPL’s net debt, this deleveraging may result in a sharp upside in the stock.

The historical inconsistency in performance calls for a big leap of faith. In our Base case, we value the standalone entity at 6x FY24E EV/EBITDA and subtract INR34/share for OMPL. If the company outperforms our assumption by, say, USD3/bbl in FY23, then our TP may rise to INR55/share.

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