Essar's trading update was encouraging, but the stock remains too risky to buy at 144.3p.
India-focused oil refiner and power generator Essar Energy’s third-quarter trading update on Monday showed encouraging signs across its portfolio.
The FTSE 250 energy group owns the giant Vadinar refinery in Gujarat and a string of power plants across India in which it intends to burn coal from its own mines, capitalising on India’s burgeoning energy demand.
Outside India, Essar also owns Stanlow refinery at Ellesmere Port. This enjoys advantages of location and technology that should make it one of the better-placed UK refineries to ride out the sector’s troubles, which include overcapacity.
Monday’s update showed that performance at both refineries significantly improved on the same period last year. Margins at Vadinar more than tripled, boosted by a major expansion completed last year. This increased the refinery’s capacity from 300,000 barrels per day (bpd) to 405,000 and also enabled it to process lower cost oils and produce higher value diesel and jet fuels.
Stanlow is starting to see the benefits of an upgrade programme. It also benefited from industry-wide recovery, to enjoy margins that were 128pc higher.
Essar’s Indian power projects have also made progress. On Christmas Eve the first of two units at its Mahan coal-fired power station began operating.
However, there remains a long way to go before the project is operating as Essar intends. The plant is currently running on a mixture of domestic and imported coal — Essar wants to use its own coal, which it hopes to mine nearby and should cost five times less.
Approvals for the Mahan coal block have taken far longer than expected. Essar got first stage approval, for forest clearance, in October, but must pass a series of bureaucratic hurdles before it can start mining. Full production is likely to be several years off.
Other coal mines intended to fuel power stations that Essar is constructing elsewhere in India are also still in approval stage. The company hopes these will come on stream more quickly, given the Indian government’s desire to expand power capacity, but timetables remain subject to significant uncertainty.
Having invested in major upgrades and construction projects, Essar also has a hefty debt pile; its financing cost for the half-year to last September rose to $400m (£255m).
Its subsidiary, Essar Oil (BSE: ESSAROIL.BO - news) , is in talks with banks to refinance $2.27bn of debt about one-third of the group’s total net debt from rupees into dollars. The company believes this would reduce the interest rate it faces to about 7pc, down from about 13pc now, potentially saving it as much as $120m a year. But until the deal is done the actual savings remain to be seen.
Anyone who bought into Essar when it floated in the UK at 420p in 2010 will need no reminder of the risks of operating in India; setbacks at Mahan and a tax ruling against it helped wipe 75pc off its value within the first two years.
Questor last advised steering clear at 113.8p in March 2012 . Yesterday the trading update helped the shares rise 3.3p to 144.3p. There is further upside if the debt refinancing and power projects proceed as well as hoped; the average target price on the stock for nine analysts monitored by Bloomberg is 201p.
But after the recent sharp rally, Questor remains concerned about valuations in general; it is therefore especially reticent about a company with as much short-term risk to execution as Essar. Avoid.