Financial Times

LIOC to set up 170 more new fuel stations
The chances of the government defaulting on its payment (some Rs 7 billion) of the subsidy to Lanka IOC is very unlikely – given that last year it paid approximately Rs.700 million and showed that it’s duty bound to make these payments, a stockbroker said.

HNB Stockbrokers said in a report that LIOC was planning to go ahead with the construction of the lubricant blending plant with tenders expected to be called shortly.

The plant, to be sited in Trincomalee, would cost LIOC an estimated Rs.500 million to construct.

The report said it expects a domestic petroleum price increase within the next few months resulting in a reduction in the accumulation of subsidy dues.
Referring to the subsidy payments, it said the company is facing mounting financial strain due to the substantial value of the subsidy receivable from the government.

Thus irregular and small-scale payments in subsidy would not be sufficient to tide over the cash flow problems currently confronted.

The management has emphasized that they have spoken to many officials at different levels in the government, in recovering the subsidy dues but has failed to obtain a clear response from the government as to when or how the government intends to settle the dues owed to LIOC, the report said, although adding that it expected the government would pay up at some point.

The proposed lubricant blending plant would benefit the company in terms of cost reductions (shipment charges and duty tariffs etc).
The setting up of the blending plant is expected to take 6 months, thus the plant should be operational by the mid or latter part of 2006.

Expansions on hold
Apart from the lubricant blending plant, LIOC is looking towards setting up new pumping stations, in selected areas throughout the country. While the company is expected to start off the expansions from mid of next year, the commencement would depend on the receipt of a substantial amount of the subsidy.

According to the management they intend to set up approximately 170 stations, which could cost an estimated Rs.1.7 billion in total.

Bank borrowings
The financing for the above stated expansions are to come through from a combination of debt and internally generated funds.

As at 30th September 2005, the company had debt amounting to Rs.6.8 billion, which resulted in a debt to total capital ratio of 38.2%. “With gearing levels of the company still at acceptable levels we believe that bank borrowings would be used to fund the expansions. However this is provided there is no further accumulation in government subsidy payments, as any further build up of the subsidy may increase the borrowings to a larger magnitude,” HNB said.

Subsidy dues
“While accumulating subsidy dues seem to be the key stumbling block for growth, we believe that the company setting up the blending plant and making plans to expand through the opening of new stations is a positive development.

Further we believe the government would look towards increasing domestic petroleum prices at least partially in accordance with global oil prices, which should reduce the accumulation of subsidy dues,” the report said adding that diplomatic pressure from India would also push the government towards settling a substantial part of the subsidy amounts.

“While it is difficult to determine a time line we expect a somewhat reasonable development on the subsidy issue during the next couple of months.”
LIOC 1st half results for FY 2006 show a 62.1% dip in net profits compared to the corresponding period of the last financial year to stand at Rs.512.3 million.
The 2nd quarter alone saw a 69% dip in profits to stand at Rs.175.1 million. The deterioration in profits was mainly due to the disparity between the rise in turnover and rise in cost of sales for the period.

Turnover for the 6 months witnessed a 34.9% growth compared to a 43% increase in cost of sales. Turnover growth for the period has been limited due to a Rs.2 per month ceiling when increasing prices (subsidy).
With oil prices soaring during the first 6 months of FY2006, an Rs.2 monthly increase in the prices (subsidy) is insufficient.

Thus a lag effect has arisen; over raising the prices as LIOC has to wait till the next month to cover the balance of the subsidy (anything more than the Rs.2).

The above stated lag effect, has dampened the turnover growth which in turn has adversely affected on gross profit for the 6 months. The 1st half gross profits showed a drop of 38.8% compared to the 6 months of the last financial year to stand at Rs.784.2 million.

The gross margin for the 6 months was a mere 4% compared to 9.3% posted during the 1st half of the last financial year.

At operational level, profits fell by 61.2% compared to the 1st half of the last financial year, mainly due to increases in administration costs. Administration costs rose by a notable 31.6% to stand at Rs.359 million for the 6 months, due to the combined effect of a rise in staff costs (amid the payment of arrears in salaries) and deprecation costs.

Depreciation rose by 57.2% compared to the 6 month period of the last financial year, to stand at Rs.130.6 million.

Outlook challenging
Oil prices are unlikely to show a substantial increase in the coming months with relatively warmer weather expected in the US. Even though at present oil prices are ranging above $60 per barrel due to speculative reasons, oil prices should dampen in the short to medium term. Thus if oil prices were to remain below $60 levels, LIOC’s second half of FY2006, would show an improvement in performance from what was witnessed in the 1st half.

However despite an improvement in profitability the cash flows are likely to be under pressure due to the delays in receiving the subsidy.

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