EQUITY RESEARCH: Mangalore Refinery and Petrochemicals Ltd

Summary

Mangalore Refinery and Petrochemicals Ltd manufactures and sells refined petroleum products in India. The corporation produces and sells bitumen, furnace oil, high speed diesel, xylol, naphtha pet coke, sulphur, and motor gasoline, as well as polypropylene and other products. The company was established in 1988 and is primarily based in Mangalore, India. Mangalore Refinery and Petrochemicals Ltd is a subsidiary of Oil and Natural Gas Corporation Ltd.

ABOUT

Mangalore Refinery & Petrochemicals Limited (MRPL) was set up as a joint venture between the AV Birla Group and Hindustan Petroleum Corporation Limited (HPCL). MRPL operates a refinery at Mangalore, with a nameplate capacity of 15 million metric tonnes per annum (MMTPA). The refinery project was initially implemented in two phases during a period of administered pricing, where the regulatory framework provided assured returns on the capital employed. However, since the deregulation of the refining sector in 1998, the company has been exposed to low and volatile international refining margins, which affected its operating profitability quite significantly. This, together with the high debt service commitments, resulted in MRPL posting large losses in the past. Oil and Natural Gas Corporation Limited (ONGC) acquired a 51% stake in MRPL in March 2003 and later increased its stake to 72%. With a change in management, fund infusion by ONGC, and the upturn in the refining margin cycle, the company made a
financial turnaround in the subsequent period. The refining capacity was enhanced to 15 MMTPA from 11.82 MMTPA in March 2012 with the commissioning of Phase III. It also commissioned a 440-KTPA polypropylene unit. In July 2015, MRPL’s board approved the merger of its subsidiary, viz. ONGC Mangalore Petrochemicals Limited (OMPL). In January 2021, MRPL acquired ONGC’s stake in OMPL, increasing its stake in OMPL to 99.99% from 51%. The Ministry of Corporate Affairs, vide its final order dated April 14, 2022, approved the amalgamation of ONGC Mangalore Petrochemicals Limited with Mangalore Refinery and Petrochemicals Limited with April 01, 2021, as the appointed date and the effective date for the scheme of amalgamation as May 01, 2022.

SHAREHOLDING PATTERN

KEY INVESTMENT RATIONAL

Expectation of healthy throughput and rise in GRMs

Because of the dramatic decline in demand for petroleum products during the lockdowns brought on by the COVID-19 pandemic, MRPL's throughput suffered in FY21. It did, however, disclose that throughput increased to 15.04 million tonnes (MTs) in FY22 from 11.5 MTs in FY21. In FY23, it recorded its greatest throughput ever of 17.14 MTs. As a result, the capacity utilization climbed from 76.7% in FY21 to 103% in FY22 and then to 114.3% in FY23. Due to increased crude prices and enhanced capacity utilization, the company reported a total operating income of Rs 108,856 crore in FY23 as opposed to Rs 69,813 crore in FY22. Due to higher operating GRMs of US$ 11.30 per barrel and inventory loss of US$ 1.42 per barrel, MRPL's GRMs increased to US$ 9.88/bbl in FY23 from US$ 8.72/bbl in FY22. Additionally, the high Nelson Complexity Index of 10.6 of MRPL's refinery makes it possible for it to process heavy oil with excellent quality. It can handle different APIs of crude oil and produce a range of products, including High-Speed Diesel (HSD), Petrol/Motor Spirit (MS), Aviation Turbine Fuel (ATF), etc.

The past financial year and H1FY24 saw a rise in the gross refining margins (GRM) at refineries controlled by public sector oil marketing corporations (OMC), thanks to rising demand for petroleum products and more affordable oil imports from Russia. Strong demand for diesel, petrol, and aviation turbine fuel (ATF) last year, particularly in the fourth quarter of FY23, has contributed to GRM growth. The healthy crack spreads in the first and fourth quarters of FY23 helped the GRMs increase to US$9.88/bbl. However, the decrease in crack spreads and the imposition of special additional excise duty (SAED) and road & infrastructure cess (RIC) on the export of high-speed diesel, aviation turbine fuel, and petrol had an impact on GRMs in Q2 and Q3FY23.

MRPL's GRM was $9.8/bbl as opposed to $15.1 in Q4 FY23 and $24.5 in FY22. The core GRM was trading at $11.5/bbl, a premium of US$7.4 above the benchmark Singapore GRM, which was trading at US$4.1 in Q4 FY23 and US$20.2 a year earlier. Higher cracks for key products including petrol ($14/bbl), ATF ($14.3), and petrol ($12.2), as well as crude discounts from Russia and possibly Iraqi crude, bolstered GRM. The loss on inventory was US$1.7/bbl (Rs4.7bn). Special Additional Excise Duty (SAED) had a minor effect. Benchmark Singapore's gross refining margin (GRM) was US$ 4.1/bbl in Q1FY24 compared to US$ 21.5 in Q1FY23 and 8.3% in Q4FY23. The complicated GRM for Singapore is currently trading at US$ 14.3/bbl in Q2FY24TD compared to US$ 4.7/bbl and US$ 6.9/bbl in Q1FY24 and Q2FY23, respectively. The quick recovery of Singapore's GRMs may enable MRPL to record good GRMs in the upcoming quarters. On the strength of rising Singapore GRMs and the benefit of discounted Russian crude, refining margin is anticipated to increase; however, windfall taxes may limit the gains. We anticipate that the MRPL could continue to profit from the discount on Russian crude oil in Q2FY24, albeit on a smaller scale, and that a better demand environment for other spreads may contribute to future reports of improved GRM. In July 2023, MRPL processed 1.439 MMT of crude. It might continue to process the crude at a high capacity utilization, barring the effects of the shutdown, whose timing is undetermined.

Focus on expansion of petrochemical business to de-risk its business

Petrochemicals are being backed by big companies like Exxon Mobil Corp., Indian and Chinese refiners, and others to support future oil demand as the switch to electric vehicles reduces the need for transportation fuels. India is currently faced with a make-or-buy choice because it is a net importer of petrochemicals. Local production can be captured for a higher value. To increase its petrochemical production capability, MRPL has planned a refinery expansion that might cost up to Rs. 47,000 crores ($5.7 billion). The MRPL has decided to concentrate its efforts on expanding the output of chemicals that can be used for plastics and paints due to a changing energy landscape that is mostly caused by the uptake of electric vehicles. A new production facility in Karnataka will get the majority of the company's investment. In the upcoming three to five years, the new MRPL plant is projected to be in operation. Approximately Rs 30,000–40,000 crore has been budgeted by MRPL for the new plant, and an additional Rs 6000–7000 crore for smaller petrochemical units. While the plant is currently operating above operational levels, MRPL canceled plans to increase the capacity of its refinery on the west coast to 18 million tonnes per year from 15 million tonnes. In FY23, the refinery ran at a record-high average of 17.1 mt. The investment will help to de-risk MRPL’s future during the energy transition.       

Phase four expansion and commissioning of the Ethanol plant could help generate revenue

MRPL intends to proceed with its fourth phase of expansion. When phase-four development is completed, the MRPL is considering concentrating more on petrochemicals than petroleum given the government's drive for electric and natural gas-powered automobiles. The process of acquiring land has begun for this, and MRPL will later decide whether to use the site for refining or petrochemical production. The Permude and Kuthethur areas will see the acquisition of about 850 acres. For its second-generation ethanol plant at Harihara in the Davangere district, MRPL is awaiting environmental clearance. Execution of the project is anticipated to cost around Rs 1,000 crore. The project has already purchased land, and in 2025, the plant is anticipated to be operational. The project may contribute to the daily production of 60,000 liters of ethanol. The plant's feedstocks will be based on agricultural waste, such as corn cobs, cotton stalks, and other materials. In addition to reducing greenhouse gas emissions, this will lessen import dependency and speed up the marketing of biofuels.

Healthy operational profile and supported by ONGC, India’s one of the largest Oil & Gas PSU company

MRPL is one of India's biggest oil refining firms, situated in South India, with a current operating capacity of 15mtpa. ONGC is the company's promoter. MRPL features a modular design with complicated secondary processing units and high flexibility to process crudes of varying API gravity, resulting in a wide range of high-quality products. It manufactures a wide variety of petroleum products, including naphtha, LPG, motor spirits, high-speed diesel, kerosene, aviation turbine fuel, sulphur, Xylene, bitumen, petcoke and polypropylene. The 440 KTA Novolen gas-phase Polypropylene Plant at MRPL, which uses Zeigler Natta catalyst, can produce the entire range of homo polymer grades. MRPL operates an Aromatic Complex, a petrochemical operation that produces 0.905 MMTPA of Para Xylene and 0.273 MMTPA of Benzene in the Mangalore Special Economic Zone (MSEZ). This complex is fully integrated with MRPL. In NMPT, MRPL operates two captive jetties, a single point mooring facility, a white oil loading facility, a rail wagon loading silo for Petcoke, and truck loading silos. Marketing Infrastructure Depots are located in Kasargod (Kerala), Hindupur (AP), and Hosur (TN) for MRPL. Shell MRPL Aviation Fuels and Services Ltd (SMA) is a 50:50 joint venture between MRPL and Shell Gas B.V. (Shell), a step-down company of Royal Dutch Shell Plc in the Netherlands that markets aviation turbine fuel (ATF) to domestic and international airlines. SMA currently obtains ATF from the MRPL Refinery Complex and distributes it to airports in Bengaluru, Goa, Mangalore, Hyderabad, Chennai, Calicut, Madurai, Trichy, Coimbatore, Kannur, and other cities. SMA enables Indian carriers to meet their fueling needs at international airports. MRPL's refinery has been operating at 100%+ capacity utilisation in the past, delivering a solid ramp up in operations since the Phase-III expansion and its polypropylene plant were commissioned. Capacity usage was affected in FY20 and FY21 due to challenges with locals, water shortages, landslides, and Covid-19, while demand and utilisation levels have recovered since Q3FY21. The utilisation rate for FY23 was 114%, up from 99% in FY22, thanks to strong demand for petroleum products in both the local and export markets. Furthermore, the merger of OMPL is projected to create some synergy because the combined business will manage its activities in an integrated manner.

ONGC holds a 71.63% equity investment in MRPL, and another subsidiary of ONGC, HPCL, owns a 16.96% stake. Given that it plays a crucial role in the downstream area of ONGC's integrated oil and gas value chain, the firm is crucial from a strategic perspective. The two organizations have significant management relationships in addition to strategic ones. The chairman of ONGC and the board chairman of MRPL are both Mr. Arun Kumar Singh. The senior management of ONGC provides the organization with managerial help as well. In addition to managerial and board support, ONGC has provided financial assistance to the business, and MRPL has previously received loans for carrying out its expenditure plans at competitive interest rates. The corporation buys from ONGC between 10 and 15% of the crude oil it needs. Additionally, ONGC has provided a guarantee for the payment of MRPL's crude purchases to one of the company's overseas crude oil suppliers.

Advantageous location

The New Mangalore Port Trust manages the product exports as well as the procurement of crude for MRPL, which is situated on the western coast of India. The refinery's location gives it strategic advantages in terms of obtaining crude oil, improving its eligibility for export markets, and expanding its reach into the local market's southern region. Around 80% of MRPL's crude oil needs in FY23 were met by imports. Additionally, during the year, exports contributed to almost 39% of its total revenue. By combining with OMPL, MRPL now has a foothold in the petrochemical industry, which is expected to gain from forward integration.

Expectations of the merger of MRPL with HPCL could add investors value going forward

HPCL was purchased by ONGC five years ago. There were proposals for HPCL and MRPL to unite following ONGC's purchase of HPCL. However, it took the ministry five years to begin putting the strategy into action. Currently, the ministry is working on the merger of HPCL and MRPL, which will primarily involve a share exchange. Government consolidation of MRPL and HPCL is anticipated, and work on the process may shortly begin at ONGC. This action might facilitate ONGC's downstream vertical streamlining. Prior to the merging of MRPL and HPCL, the former had finished the purchase of OMPL. The oil ministry's efforts to unify most of its energy businesses under a single roof may be seen in the numerous mergers and acquisitions that have taken place. ONGC and MRPL collaborated to promote OMPL. Their respective shareholdings were 49% and 51%. OMPL was acquired by MRPL in December of last year using 100% of compulsorily convertible debentures. OMPL primarily exports benzene and paraxylene, which are its primary products. The combination of MRPL with HPCL is anticipated to increase HPCL's refining capacity, allowing it to sell more product in the market despite its current refining capacity limitations. Given the extensive documentation and clearances required for the merger and the fact that MRPL, HPCL, and ONGC are all public businesses, it might take longer for ONGC to execute the merger.

KEY CONCERNS

• Economic downturn, volatility in oil and gas prices, and regulatory changes in the oil and gas business might all have an impact on the industry's future growth story. The shifting macroeconomic climate may have an impact on the company's growth strategy.
• Given the volatility of crude oil and petroleum product prices, inventory gains/losses can be significant in each quarter, influencing predictions. Any fall in the price of crude oil may have an impact on the company's profitability. The Russia-Ukraine conflict caused crude oil prices to surge to more than $120/bbl, but prices decreased to $82 in August 2023. The price of crude oil is determined by demand and supply, as well as OPEC policies.
• IMPORT: Because MRPL imports over 80% of its crude oil, any volatility in oil prices has an influence on operating performance while also exposing it to variations in foreign exchange rates.
• The decline in GRM can be ascribed to a slowdown in fuel use and an increase in the worldwide supply of refined goods. A lower GRM means that refiners earn less per barrel of crude processed. Based on demand-supply dynamics, refining margins may remain volatile from quarter to quarter.
• Any negative government policy affecting refineries, such as subsidy sharing, could have an influence on their profitability. However, we believe that in the future, the oil sector will have far greater independence than in the past.
• MRPL has been inconsistent in paying dividends in the past, and its profitability has been unpredictable. Furthermore, no dividend has been paid during FY23E.

FINANCIALS

• In Q1FY24, MRPL's revenue was in line with expectations, but profitability was missed due to a lower-than-anticipated reported gross refining margin of $9.8/barrel (bbl) of oil.
• The combined net income for MRPL fell by 34.4% year over year to Rs 21,173 crore. EBITDA for the company fell to Rs 2068 crore from Rs 4714 crore in Q1FY23, while the EBITDA margin was 9.8% in Q1FY24 from 14.6%. In Q1FY24, MRPL's net profit was Rs 1013 crore, down from Rs 2708 crore in Q1FY23.
• The throughput of refining crude was consistent at 4.36 Million Metric Tonnes (MMT), compared to 4.41 MMT in Q4 FY23 and 4.29 MMT in Q1 FY23. In comparison to US$15.12/bbl in Q4FY23 and US$24.45 in Q1FY23, MRPL's gross refining profit in Q1FY24 was US$9.8/bbl.
• The Singapore GRM - refining margins were abnormally high between Q4FY22 and Q4FY23 because to high crude prices. These margins eventually declined to an abnormally low of $2.5–$4 in April–May 2023. Since then, it has healed.
• Due to the government's imposition of SAED and RIC (Road and Infrastructure Cess) on July 22, the Domestic Refinery Transfer Price (RTP) for MRPL fell. Currently, there are 71 total retail shops, up from 63 at the end of FY23.

VALUATION

One of India's top refineries, MRPL was founded in 1988. A nearly complete variety of petroleum products, including Naphtha, LPG, Motor Spirit, High-Speed Diesel, Kerosene, Aviation Turbine Fuel, Sulphur, Xylene, Bitumen, Pet Coke and Polypropylene, may be produced at MRPL's refinery. The company's refinery, which has a 15.0 MMTPA capacity and can process crude oil with different API (American Petroleum Institute) gravities, is situated in the Dakshina Kannada District of Karnataka State (India). The company has a polypropylene facility in addition to its refinery capacity and produces value-added petrochemical products. Additionally, the high Nelson Complexity Index of 10.6 of MRPL's refinery makes it possible for it to process heavy oil with excellent quality. High-Speed Diesel (HSD), Petrol/Motor Spirit (MS), Aviation Turbine Fuel (ATF), and other products can be produced from crude oil with a range of API gravities.

In FY23, MRPL had a capex of Rs 640 crore as opposed to the original projection for FY23 of Rs 750 crore.  The business anticipates spending Rs. 1600 crore on capital expenditures in FY24, up Rs. 800 crore from the previously anticipated Aug.-Sep. 23 45-day outage of Phase 3 units (20% capacity). Every four years, these turnaround shutdowns occur. In addition, MRPL has been introducing retail pumps in order to increase marketing margins for both local and international sales, as well as the B2B sector. The company wants to gradually stop exporting fuel in the next two to three years. It also wants to increase the number of retail locations in southern India from the current 71 to 1800 by 2027. This will offer it a natural hedge earning marketing margins and allow it to diversify its revenue streams.

We anticipate that the financial performance and valuation will improve in the medium term given the refinery's strategic relevance in southern India, development plan, and solid promoter background. Future high-earning visibility and RoE improvement may result from MRPL's ongoing upgrade projects and the anticipated sustained rebound in GRM. The exceptional processing capabilities of its refinery, as evidenced by the high Nelson Complexity index, its experienced management team, and its advantageous position near the high-earning port all contribute to MRPL's solid asset profile. The stock is trading at a lower valuation than other refiners due to its smaller size and unstable refining margin profile (virtually no marketing margins). The case for a larger multiple is made by projections of significant revenue growth and margin expansion. In the next two to three quarters, the fair valuation of the stock in the base scenario is Rs. 120.