RESEARCH AND ANALYSIS PROJECT OXFORD BROOKES UNIVERSITY
Business and Financial Performance of Pakistan State Oil Company Ltd
Period: 2008-2010
INDEX
CONTENTS PAGE NO
RESEARCH REPORT
PART 1
Project objectives and overall research approach
Introduction
Aims and objectives
Framework of the project 4
4
4
Oil marketing sector in Pakistan 5
The company 6
PART 2 Information gathering and limitations
Sources of information gathering 7
Primary sources 7
Secondary sources 8
Limitations encountered 9
Ethical issues 9
Tools to analyze the business 9
Accounting concepts to analyze the financial position 10
PART 3 Result, analysis, conclusion and limitation
Financial position analysis of pso 11
Tests of liquidity 11
Tests of solvency 12
Tests of profitability 14
Tests of financial efficiency 16
Shareholder value analysis 17
Financial comparison of pso with shell 19
Analysis Factor affecting pso business model 20
SWOT analysis 20
Porter’s five forces analysis 21
Conclusion with recommendations 22
Appendices 24
The Research paper on Risk and Return Analysis
The concept of risk is intuitively understood by investors. In general, it refers to the possibility of incurring a loss in a financial transaction. But risk involves much more than that. The word ‘risk’ has a definite financial meaning. The possibility of variation of the actual return from the expected return is termed risk. Corporate securities and government securities constitute important ...
References 29
CONTENTS PAGE NO
SKILLS AND LEARNING STATEMENT
A Meetings with the project mentor
First meeting 32
Second meeting 33
Third meeting 34
B Summary of skills gained during the meetings
Communication skills 37
Interpersonal skills 38
C
Role of RAP in accounting knowledge
39
Glossary 40
Introduction
The world’s best economies have seen the worst financial crisis in last two years which have led economic managers to re-think about how are companies operating and what liberty they enjoy which led to such a huge disaster. Many central banks are in the process of providing stimulus to their economies and at the same time coping with difficulties to curb budget deficits and increase employment levels. All this has convinced me for once and for all that financial risk management is the key to mitigate overall risk which has far reaching implications. Therefore, I have chosen topic number 8 (The business and financial performance of an organisation over a three year period) for my project so that I gain in-depth knowledge of a specific company (both from an operational and financial perspective) and see how it operates during tough times.
Selection of an appropriate company for research was a difficult task as I had to consider several factors such as the availability of information, the size of the company and the company management’s openness to discuss internal matters required for the research project. After careful consideration I have chosen Pakistan State Oil Company (PSO) as my target research company.
Aims and objectives
Being a student of ACCA, My objective is to develop skills in analysing and interpreting the operational and financial position of a particular company. Studying the company’s business model and financial position will allow me to cover different angles of the business and its external environment. The financial position of the company will reveal its health and allow me to draw judgements on its future course of action.
My aim is to obtain the OBUBsc degree which will open my chances to enter the corporate world and start my career in finance with a reputable organisation. ACCA will provide me an insight of core finance and the OBU degree will present me as a person with management skills which will propel my career growth.
The Business plan on Pakistan State Oil Report
... the Premier Oil Company Limited and State Oil Company Limited, giving way to Pakistan state Oil (PSO). After ... * Legislative environmental pressures are increasing. * Financial losses resulting from accidents increased. HSE Policy ... of operations of the White Oil Pipeline Project (WOPP) from Karachi to Mehmood ... advantage over its competitors. 9. Technical skills in Fleet management are strength ...
Framework of the project
Good presentation and layout of the project is important so that the reader stays focussed and overall objectives of the project are met with reasonable conclusions and judgements. It was important for me to decide the layout of the project for which the OBU guide acted as a perfect coach.
The project will be divided into different sections to provide a perfect flow which according to me should start with the discussion about the company in general and how economic conditions have affected it in the past. The discussion will then move onto the second stage where the financial and operational performance over the last three years will be conversed using the factual data from the published accounts and other relevant sources.
The later stages will involve devising a strategy where I discuss the outcomes from the historical research and thereby using judgemental skills to forecast the future of the company and the sector.
The last stage will involve assessing self skills in skills and learning section where I will discuss the role of my mentor in guiding me and how I overcame problems that arose during the making of this research project.
OIL MARKETINGSECTOR IN PAKISTAN
The oil sector of Pakistan is the backbone of the Pakistani economy as Petroleum products and natural gas account for about 70 percent of commercial energy use, hydroelectricity for about 15 percent, and coal and liquefied petroleum gas (LPG) for the balance. Due to dependence on oil imports, the country’s oil sector has attracted large investments from both local and foreign players.
The Oil Marketing Sector (OMS) of Pakistan constitutes of five OMCs having its operations all over Pakistan. The companies are PSO, Shell Pakistan Limited, Caltex Oil Pakistan Limited, Attock Petroleum Limited and Total-PARCO Pakistan Limited.
Below is the projected demand and production of oil products:
(In million tonnes)
2007-2008 2008-09 2012-13 2017-18
Demand of Petroleum Products 14.3 15.0 17.0 19.0
Production from Local Refineries 10.3 12.0 11.3 11.8
Surplus Naphtha / Motor gasoline available for exports 1.3 1.3 0.8 0.8
The Essay on Standard Oil Policy Company Power
Policy as defined by Webster is a principle, plan or course of action, as pursued by a government, organization or individual. In the case of this paper, we will be dealing with policies with regard to government, initiated by various people of the state, particularly the American government and the United States of America. Policy-making is an integral part of governmental duties that is critical ...
Deficit of HSD and FO 5.0 5.0 6.5 8.2
Source: Ministry of Petroleum & Natural Resources
The consumption of petroleum products in the country during 2007-2008 was 14.3 million tonnes. The drop in consumption compared to previous year is mainly due to lower demand of Furnace Oil because of conversion of thermal power plants on gas and availability of additional Hydel power. The demand is expected to increase around 17 million tonnes per annum by the year 2012-13. Thereafter, it is expected to further increase to around 19 million tonnes by the year 2017-18. The production of refined products by the local refineries during the year 2007-08 was 10.27 million tons. The deficit products import were 5 million tons in 2007-08 while it will remain around 5-6 million tons per annum up to year 2008-09. Thereafter, it is expected to increase to a level of around 8.0 million tons per annum by the year 2017-18.
The Company
PSO is the largest OMC of Pakistan and is listed on the Karachi Stock Exchange (KSE).
The company is primarily involved in oil storage and marketing business and operates under the governing body OGRA.
The company has the highest market share of furnace oil or black oil as it is the major supplier to power generation companies. This year the market share of PSO stood at 92% for black oil as compared to 78% and 70% during FY09 and FY08 respectively. Similarly, the market share for white oil stood at 57% as compared to 52% and 50% during FY09-FY08.
During FY10, PSO sold 14.2 million tons of POL products as compared to 13.2 million tons during the preceding year.
Market share Pie chart
Source: OCAC
SOURCES OF INFORMATION GATHERING
If you want to get information, get it from the best ~ Hilary Hinton ZigZiglar. Reliable and credibleinformation is of utmost importance for efficient and accurate decision making. Choosing the right sources of information is the key to any research as it clears many hurdles and draws a clear line what one needs to achieve. This section is important for the RAP as it will act as one of the pillars and define the overall path for strategic and financial analysis. The information is derived from two sources, primary and the secondary.
The following primary sources were initiated:
The Business plan on Marketing Management Company Analysis Work
"Marketing ideas have made singularly little penetration into the centres of influence of the construction industry. To some extent this follows from the character of the industry as an agglomeration of service organisations, not without structural relationship to one another, but serving a clientele from which individuals seek service very infrequently." (Jepson & Nicholson, 1972: p. 1) ...
Management meetings
The meetings were initiated by contacting the investor relations team and were productive as I had a chance to set meetings with some of the most senior members of the finance team who are as follows:
1) Mr. Iftikhar Ahmed. Mr. Iftikhar looks after the financial reporting section and was very helpful and cooperative in explaining the accounting concepts and IFRS application in financial statements.
2) Mr. Ather Ali. Mr. Ali is heading the internal audit function and was very helpful in identifying the business processes and the risks PSO faces on the external front (regulatory and legal).
3) Mr. JavedAnis. Mr. Javed is an executive within the corporate planning department and his insight of the business played a pivotal role in understanding the environment in which PSO operates. He also helped me in identifying business techniques I should use for my RAP.
Questionnaire
Before I had meetings with the management of PSO, I made a specific questionnaire so that it forms an important part of the RAP. The questionnaire had both open and close end questions regarding the accounting concepts, business environment, future challenges, opportunities, risks etc. While structuring the analysis section, the questionnaire was a very good reference tool and made my job easier. A sample of questionnaire is provided in appendix 5.
Secondary sources referred
Secondary sources form the basis for fact finding purpose. A number of secondary sources were available for conducting sector and company analysis out of which these are the following which I have selected for the RAP:
ACCA study material
ACCA study material was my first choice when selecting the secondary sources as they are comprehensive and contain all the relevant material which has formed part of my analysis. Study text for paper P3 (Business Analysis) was indeed of great help in drafting the business analysis section. Other than that text books for paper F5 (Performance management), F7 (Financial reporting) and F9 (Financial management) were referred.
Online search
When formulating the RAP I have referred to various websites for collecting sector and company information and this was possible because of easy availability of internet without which things would have been very tough. The list of websites I have used during the research are:
The Business plan on Business Analysis Assessment Assignment 2
Business Analysis & Assessment Assignment 2. Company names (and registered addresses) and industrial classification (product tree). International business Machines (NYSE: IBM) The company has global presence and is Headquartered: I should start by saying that according to the corporate website http://www.ibm.com, International Business Machines Corporation (IBM), was incorporated in June 1911, ...
1) PSO’s official website. The first hand information about the company was available from the official website of PSO. Information such as financial statements, dividend information, corporate governance disclosures, pricing of products and historical numbers were fetched from the website.
2) OGRA’s website. OGRA is a regulatory authority governing rules for the downstream sector. The main purpose of OGRA is to determine the prices of regulated petroleum products every month. The trend of petroleum product prices was obtained from this website.
3) The website of Privatization Commission. PSO is on the list of preferred companies to be privatized by the Government of Pakistan (GoP).
To avail the latest information regarding the privatization process, the website was used.
Student Accountant Magazine
Student accountant magazines were another good resource to grab the understanding of business and accounting analysis. The following issue was considered:
1) Student Accountant Magazine published on October 06, 2010- Article named Position Basedand Resource-Based Strategiesproduced by Ken Garrett.
LIMITATIONS ENCOUNTERED
As PSO is a public limited company, the information was abundantly available from various sources. The major limitation I came across was insufficient information about the pricing mechanism of oil products as OGRA calculates the oil prices using the landed cost of oil in the country. Therefore, it was not possible for me to determine how the final price is calculated.
Other than the above mentioned limitation, I did have sufficient information at my disposal desired to prepare the project.
ETHICAL ISSUES
The major Ethical issue I came across was gathering monthly oil inventory data. During the management meetings I asked Mr. Iftikhar to provide me some information in this regard, but due to confidentiality of the matter, he could not entertain my wish. Other than that, since I obtained most of the information from the published secondary sources and self initiated primary sources, there were no ethical factors which I came across.
The Business plan on Wal Mart Capital Company Ratio
Introduction Every business decision is associated in one way or another with the financial condition of the organization. The results of a working capital analysis will assist in the determination of organization! |s ability to remain in a particular line of business. The primary focus of Team C! |s analysis of Wal-Mart, Inc is its current and future financial condition. The most imperative areas ...
TOOLS TO ANALYSE THE BUSNIESS
Any management is concerned about the continuity of improvement in performance and as there are numerous concepts, models, techniques and tools available, managers can take a broad view of the business making it easier to focus areas of improvement. To analyze the business environment of PSO, the business analysis tools which have been identified are:
1) SWOT Analysis. SWOT is the most common type of analysis but at the same time is the most effective method to check the strengths and weaknesses a business model possesses.
2) Porter’s five forces analysis. Once the SWOT analysis is performed, Porter analysis actually answers the threat to the company in form of negative forces from its competitors. A change in any of the forces normally, requires a business unit to re-assess the marketplace given the overall change in industry information.
ACCOUNTING CONCEPTS TO ANALYZE THE FINANCIAL POSITION
Financial position of a company holds immense importance for its long-term survival. Adverse or bad financial condition often leads to liquidation or firm’s reliance on borrowings to survive. As managements strive hard to maintain the quality of the financial standing, it is equally important to protect the shareholders money employed in the business. To assess the financial position of PSO, the following accounting techniques have been considered:
1) Tests of Liquidity. A stress test of liquidity to monitor the firm’s capacity to honor its short-term obligation. These tests are important to see whether a company is maintaining an effective working capital cycle.
2) Tests of Solvency.To check the firm’s viability on a longer term horizon by analyzing the gearing ratio. These tests focus around the long-term debt of the company and how the company strategizes to grow over different time periods using debt.
3) Tests of Financial Efficiency. Utilization of assets determines the ultimate profitability levels of the company. Thesetests normally focus on use of fixed and current assets to generate revenue. Higher efficiency levels are desired as it ensures the optimum utilization of fixed assets and prevent any impairment on assets in the foreseeable future.
4) Tests of Profitability. To gauge the performance of the company over a certain time period to ascertain a firm’s attractiveness. The management closely monitors these tests to set the strategy for forward looking periods and build on competitive pricing strategies to outpace its competitors.
5) Shareholder value analysis.Equity investors have theriskiest stake in the company as the value of their holding fluctuates with the changes in fundamentals of the company. The analysis will prove useful in determining the value a shareholder can place on its holding.
FINANCIAL POSITION ANALYSIS OF PSO
The fiscal position of a company is defined by how a management lays out strategies to strengthen the balance sheet of a company. Sometimes, the external environment is harsh enough in impacting the balance sheet strength and is responsible for an ailing position. Nonetheless, the management should be proactive in mitigating the risks emanating from modification in the external environment and act in the best interest of shareholders.
PSO is the largest oil marketing company of Pakistan with the highest market share in both black and white oil. Being the national storage company of Pakistan, the company has been under a lot of pressure to continue its operations in a very ailing position. Last two years have been really tough for the company as huge trade debts mostly related to government, stand unpaid due to a weak economical fiscal space. This has led PSO to rely on short-term borrowings and meet its working capital requirements. Having said that,Below is a detailed financial analysis of the company which will reveal important facts.
Tests of Liquidity
To test the liquidity strength of PSO, the following ratios have been calculated:
Current Ratio:
A liquidity ratio is a ratio that measures a company’s ability to pay short-term obligations. The ratio is mainly used to give an idea of the company’s ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).
(Ref: http://www.investopedia.com/terms/c/currentratio.asp#ixzz1uJdVghuJ)
The higher the current ratio, the more capable the company is of paying its obligations. The Current ratio of 1 to 1.5 seems to be sound and safe. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. IMC is above than 1.5 consistently in financial year 2009 to 2011. However its competitor HAC is below the limit of safety which means that it is an alarming situation for the company’s liquidity position.
The Current Ratio for PSO during FY10 was 1.14 times which I believe in not a strong depiction of liquidity as it leaves very less room if there is a liquidity glut. The ratio was lower in FY09 to stand 1.07 times and was highest during FY08 registering 1.25 times. The CR ratio is not in a comfortable zone due to 1) Huge trade debts and 2) Slower recovery of trade debts. Most of the trade debts are government related and as the government has very strained fiscal space, the issue lingers on.
1) Acid test ratio. Acid test ratio excludes the amount invested in inventories as the concept is based on identifying the most liquid assets. For PSO, the inventory is pretty liquid as oil demand is inelastic. Nevertheless, the acid test ratio has been calculated to further stress test the liquidity position. As PSO is the largest OMC, the huge size of inventories result in an acid ratio of less than one. The acid ratio was 0.8 times during FY10 and has been on the highest levels since FY08. The ratio was 0.75 times and 0.57 times in FY09 and FY08 respectively. The ratio has improved due to management’s policy to hold a 14 day inventory as compared to previous policy of 21 days. The decision has been taken in light of strained liquidity position and lack of further bank borrowings. The acid ratio for PSO is on a very lower side which needs to be improved by converting trade debts into cash and shedding current liabilities.
Tests of Solvency
Solvency measures the proportion of borrowed capital in relation to owner’s equity capital invested in the business. The analysis is important as higher debt levels may create difficulty to honour interest payments which ultimately obstruct the dividend paying ability. Solvency tests are thus vital to observe various angles of financial management.
The solvency ratios are discussed below:
1) Debt to asset ratio.Assets of a business are its revenue generating engines and this ratio identifies the burden the debt has on the asset base. If the ratio is below one, it means that its assets are financed more through equity rather than debt. If the ratio is above one, assets are considered to be financed more by debt than by equity. A company with a higher ratio comes under the definition of a highly leveraged company.
The debt to asset ratio for PSO at close of FY10 remained stagnant at 0.85 times as compared to FY09. During FY08, the ratio was 0.76 times. The ratio is just below one which means the equity of a business is more active in financing the asset base. The gap is very narrow for PSO to become a highly leveraged company, and as said earlier exorbitant borrowings due to liquidity problems can aggravate the debt levels. Therefore, management needs to make some strategy to keep the ratio below one. One way could be by reducing the inventory holding days to pay-off the liabilities and improve the ratio.
2) Equity to fixed assets. In essence the ratio is determining how much of a company’s fixed assets are owned by the company and how much are leveraged or financed through debt.
The ratio has been pretty volatile from FY08-FY10 where it also jumped to a level of 0.7 times primarily owing to a drastic fall in equity as the company reported a loss of Rs. 6.7bn. The ratio again came to a normal level in FY10 at 0.3 times as the equity of the company increased by Rs 9.0bn. Equity to asset ratio thus shows a restful picture, but as the business model is susceptible and sensitive to changes in the external environment, the risk to equity will continue to haunt the company. As the company operates in a highly regulated sector, it is not possible for it to cover this risk. Lately, the economic coordination committee has proposed to de-regulate oil prices which should bode well for the company in future.
3) Debt to equity. This ratio is indicative of the fact of the company’s strategy to grow business. The growth strategy varies among different companies and some are more aggressive than others. A company with high growth strategy is more reliant on external financing than its equity and will report higher gearing ratio. After analyzing PSO business model, one thing which is crystal clear is the fact that the company has very less room for growth. Being the largest OMC, it already has adequate oil installations to cater the nation’s oil demand. Despite of this, the company has the highest gearing ratio in the industry and the whole corporate sector of Pakistan.
The issue related to company’s higher debt to equity ratio is the “circular debt”. The company has excessive reportable debt on its balance sheet due to its helplessness regarding the circular debt issue because of which the company has a high build-up of trade receivables and equally high build-up of trade payables. Below is the flow chart which should make clear the problem the company is facing these days.
Source: PSO annual account for FY09
As shown in the graph, there are multiple government and private organizations which owe money to PSO, but due to non-payment by the government and other organisations to Pakistan Electric Power Company (PEPCO), the PEPCO is not able to release funds to be received by PSO. As PSO purchases oil products from refineries, due to shortage of liquidity, it is not able to clear the amount due to oil refineries.
The resolution of circular debt is very important in the sense that the fate of upcoming power plants is attached to this issue. According to our estimates, if oil prices remain at current levels, Rs175-200bn would be required to purchase additional 5-6mn tons of furnace oil. Thus, the prevailing Rs100-110bn circular debt needs to be resolved so that the OMCs have enough liquidity to meet the additional requirement.
Due to this circular debt problem, company relied heavily on short-term borrowing which resulted in higher financial charges.
As the above situation has bloated the debt levels of the company, the Debt to equity ratio for the company is presently 5.9 times which two years back was only 3.1 times. The resolution of circular debt is only possible if government responds to the situation.
Source: PSO annual accounts
Tests of Profitability
These tests are necessary to check the performance of the company from a broader perspective. As internal and external factors keep impacting the financial position, the management needs to take steps necessary to preserve the profitability or performance of the company. To perform analytics on PSO’s performance, following measures have been considered:
1) Return on equity. Shareholders wealth is represented in form of equity they have invested in the business and the ratio measures the return the company has generated on the amount invested. Ideally, every shareholder wants a higher return on its equity so that he/she gets the due share from it. As PSO is a highly regulated company, the margins on the oil products are fixed by OGRA. Therefore, the company can generate higher ROE through increase in volumetric sales as the pricing of the product is dependent on OGRA’s ruling.
Being an oil company, the company is sensitive to changes in oil prices. During FY09 when oil prices crashed from it all time high of $ 130/barrel, PSO reported a heavy LAT of Rs 6.7bn on account of inventory losses. During FY10 when oil prices recovered, the company again turned profitable and reported a PAT of Rs 9.0bn. Similarly, when the international oil prices were at all time high during FY08, the company reported an all time high PAT of Rs 14bn. Therefore, it is evident that PSO’s performance is highly dependent on international oil prices movements.
The ROE for the company was negative one year back in FY09 and showed a negative 32% return due to reportable loss. The company had the highest ROE in FY08 of 45% and reported a positive ROE in FY10 as well when it stood at 32%. Thus, the ROE figure is dependent on ultimate profitability of the business which in turn is dependent on oil price movements. Since, another possibility of crash in oil price seems remote, I perceive healthy ROE for PSO in near future.
2) Return on assets. The ratio is widely used by the management of the company to judge the quality of assets and their ability to generate consistent returns. The ROA figure is important in context of checking the performance of assets to generate profitability. Poor or old assets may not be able to generate enough revenues and a lower ROA may mean that the management should consider modernisation or replacement of assets.
The assets of the company generated a return of 4.5% in FY10 as compared to a negative return of 4.4% in FY09. The assets generated the highest return during FY08 of 11% on account of highest profits. The ROA for the company could be further improved if the company is able to increase its volumetric sales. PSO has the widest strategic oil distribution network. This network comprises of 29 storage depots and 9 installations, 860,000 MTs of capacity i.e. almost 81% of the total national storage, numerous pipe lines network and equity partnership in White Oil Pipeline Project (WOPP) from Karachi to Mehmood Kot. Having a strong distribution network, I believe PSO has the ability to generate double digit return on assets.
3) Gross margins. Gross margins are an important verification tool to measure the operating performance of the company. Companies with very high sales often have low gross margins as the absolute amount is far greater. PSO has regulated oil margins in the vicinity of 3-4% which are then impacted by oil price movement. As margins are fixed for PSO, any write down in inventories negatively impact the gross profit of the company.
The gross margin for PSO was above 6% during FY08 due to two reasons. Firstly, higher international oil prices and secondly higher fixed margins. The margins were capped at a lower lever at close of FY09 which has further dented the performance of the company at gross levels and increased the company’s reliance on positive inventory gains.
The gross margin was just below 4% during FY10 and was only 0.5% during FY09 due to crash in oil prices. As margins are now fixed at a much lower level, I believe PSO will find it difficult to maintain gross margins and they might settle around 3.5%. Therefore, PSO should use aggressive marketing techniques to boost volumetric sales in order to generate higher profitability.
4) Net margins. Net margins calculate the relative profitability to sales and indicate the cost control a management has. High gross margin should ideally generate ample PAT but if the management has mediocre control over its expenses, the net margins may not reflect a good picture.
The net margins for PSO have been volatile in last three years and as the company reported a loss in FY09, the net margin was negative 1.1%. The company has maintained its operating costs over last three years which averaged Rs 9.0bn. Therefore, a dip in net margins is due to higher finance costs which was has increased from just Rs 1.3bn in FY08 to Rs. 9.8bn in FY10. As explained earlier, the company is under severe liquidity crunch which has coerced it to reply on bank borrowings which as a result has resulted in bloated finance cost. The net margins as a result now hover around 1.2% during FY10 which were almost 3% in FY08. In case the circular debt issue is solved, the company is expected to report higher net margins going forward.
Tests of Financial efficiency
Financial efficiency determines the company’s operational strength in managing the assets of the organization and efficient management often leads to lower liquidity risk and higher profits. Financial efficiency is thus a catalyst for a successful business as it primarily focuses on the opportunity cost a business faces.
To test the financial efficiency of the company’s assets, the following measures have been relied upon:
1) Inventory turnover. The management of a company is most concerned about its inventory turnover figure as it parks substantial amount of money in it which has a high opportunity cost. The days it takes to clear off the inventory assists in managing the short-term liquidity position. Inventory is frequently the largest component of a company’s working capital, so if inventory is not being used up by operations at a reasonable pace, then a company has invested a large part of its cash in an asset that may be difficult to liquidate in short term. Accordingly, keeping close track on the rate of inventory turnover is a significant function of management.
The inventory days for PSO have come down to 30 days during FY10 from 49 days during FY08, though it was at its lowest during FY09 when it stood at 24 days. The period has fluctuated in-line with the fluctuation in oil prices. E.g. lower oil prices in FY09 resulted in lower inventory days whereas all time high prices led to an increase in turnover days to 49. As oil prices recovered in FY10, the ratio decreased to 30 days. It is an interesting observation that a company has reported higher profits with a higher inventory holding period as compared to a lower holding period. As oil prices are expected to show a nominal decline, it is expected that holding period will remain at present levels of 30 days.
2) Receivable collection period. Another significant asset of a company’s balance sheet and in case of PSO is its receivables. Receivables amounted to Rs. 117bn in FY10 as compared to just Rs. 33bn during FY08. The amount had shown humongous increase as the circular debt issue lingers on. The lingering issue of circular debt is expected to further result in pile-up of trade receivables, thereby worsening the liquidity position.
The days outstanding has marched to 58 days during FY10 from 48 days and 25 days from FY09 and FY08 respectively. The management is partly to be blamed for such a build-up as it did not take strong stand by halting oil supplies to its customers. I used the word partly blamed because PSO is semi government owned and is under a lot of political pressure to continue supplying oil to power stations which consume most of the nation’s oil demand.
Presently, the company is baring high opportunity cost of this build-up and to cover the cost, it has now started to impose penal mark-up on outstanding receivables which is also creating a pressure on debtors to speed-up the payments. PSO was slow in re-acting to this situation and I believe that the only escape PSO has is to factor its trade receivables.
3) Total Asset turnover. The asset turnover ratio simply compares the turnover with the assets that the business has used to generate that turnover. In its simplest terms, we are just saying that for every £1 of assets, the turnover is £x. In short, the ratio determines the utilization levels of the assets employed in the business.
PSO is growing steadily in terms of turnover and its asset base and therefore it is evident from the derived numbers that the turnover has remained in the band 3.6-4 times. The ratio stood at 3.67 times in FY10 which is low compared to 4 times and 3.9 times in FY09 and FY08 respectively. For a company like PSO, net sales will continue to grow as the nation’s oil consumption is on an upward trajectory; therefore the total asset turnover is expected to follow the trend.
4) Interest coverage ratio. The ratio is a measurement of the number of times a company can pay its finance costs. The higher ratio mirror strong capacity to meet interest payments and vice versa. As the debt burden of PSO is immense, the ratio is very important to analyze the capacity PSO has to meet the finance costs.
Due to immense amount of debts on the balance sheet, the interest coverage for PSO was only 2 times in FY10 and was negative in FY09 as the company reported an operating loss. The repayment capacity has worsened in last two years as excess borrowings are making it difficult for the company to meet its obligations. The same ratio was hovering around 16 times in FY08 which reveals that the company is under enormous pressure. As the circular debt issue lingers on, the interest coverage ratio is expected to remain very low which is an alarm bell for the company.
Shareholder value analysis
Equity holders of a company hold the most risky investments in the company as they tend to lose all their money in an event a company files bankruptcy. Moreover, as their shares trade on the stock exchange, adverse market movements impact the value of their investments. Therefore, shareholders in conjunction with other ratios use some of the ratios to value their holdings in the company.
SNAPSHOT OF SHAEHOLDER RATIOS
Source: PSO annual accounts
Above is an analysis of PSO’s share and its return over last three years. As the company is undergoing liquidity crisis, the dividend payout has suffered since FY08. The company totally skipped FY09 dividend as it made a loss during that year. The dividend for FY10 was also on a lower side. Looking at a longer history reveals that the company has maintained a higher payout ratio but as it faces cash shortage, it has disappointed equity holders and will continue to do so in future. Similarly, the dividend yield is abysmally low at 3.2% in an environment where the risk free rate presently offers 12%. Therefore, the investment cannot be considered a high return one.
Similarly, the shareholders have witnessed more than 40% erosion in share price as fundamentals of the company show weakness. The price to earnings also depicts low confidence in share price as it is at the lowest level of 4.74 times at a time when the oil stocks at the Karachi stock exchange trade at a multiple of 8 times.
Analyzing the shareholder ratios, one can say that presently investment in PSO is not expected generate future returns and alternate investment can be considered where the dividend yield is higher than 7%.
Financial comparison of PSO with SHELL
ANALYSIS OF FACTORS AFFECTING PSO BUSINESS MODEL
All organizations have one goal, to maximize profits. The process of maximizing profits depends on the accuracy to analyse demand and provide appropriate supply. There are however many external factors often classified as macro and micro which affect this goal. Every changing factor in an economy affects any business, and every incident and factor affects the working of a particular business. This is the very reason why strategic analysis is important to look out for incidents and economic factors affecting business.
SWOT Analysis
Strengths • Widest network covering all major cities of Pakistan and a market share of around 67%.
• The one and only importer of crude and furnace oil in Pakistan.
• Largest oil storage facilities.
Weaknesses • A victim of circular debt which has coerced it to rely on bank borrowings.
• No backward integration like other OMCs which also have refinery business.
• Too much reliance on inventory gains from positive movement in oil prices.
Opportunities • On the agenda of being privatized. This shall bode well for the company.
• Business diversification Opportunities such as the moving to the Oil refining and oil exploration business.
Threats • New competitors entering the market with fresh capital and adequate liquidity.
• Government planning to move towards alternative sources of energy; such as coal and hydel generation projects.
• Operates in a highly regulated sector which has led to margin reductions in the past.
Porter’s five forces analysis
Supplier Power
As PSO is the largest oil marketer in Pakistan and has the largest oil handling capacity, it is in a position to control the domestic supply of oil in the country. Recently, PSO halted supply to major power producers in the country on account of non-payment as PSO is the only OMC which can meet their oil requirements.
Threat of new entrants
The Government is taking initiatives to attract more oil companies in Pakistan which is a major threat to PSO as it holds the major market share in oil products. The relaxation in rules and regulations for new entrants are the biggest threat for the company at the moment.
Bargaining power of buyers
Pakistan meets is oil requirements through imports, therefore, buyers or consumers of oil are on the behest of OMCs and regulatory authorities such as OGRA. Therefore, buyers don’t have any bargaining power.
Threats from substitutes
Pakistan’s most of the energy requirements are met through oil. Recently the Government has signed contracts with the private sector to extract coal for the Thar fields which are regarded as one of the largest coal deposits in the world. Moreover, the government is also focussing on building more dams to produce more hydel electricity. These two steps are likely to have a negative impact on PSO as oil consumption collapses. There is no immediate threat but after a period of 5 years, PSO will face issues.
Competitive Rivalry
OGRA is the single regulatory authority which determines domestic oil prices. As prices are regulated, there is no intense rivalry among competitors.
CONCLUSION WITH RECOMMENDATIONS
After conducting a thorough financial and business analysis, it can be concluded that PSO is largely dependent on changes in the external environment and business has moderate or low growth in ensuing years. PSO is under immense liquidity pressure which has not only bloated its finance costs but has also impacted the dividend paying ability of the company. Though, the situation seems to be very complex, the business model has various internal strengths if capitalized can result in superior profits.
On the external front, PSO is facing various challenges as follows:
a) Circular debt taking toll on PSO. The lingering issue of circular debt, which apparently seemsout of PSO’s control, is impacting the operational performance of the company. After analyzing the issue, I believe that the management should consider factoring some of its trade debts to improve its liquidity position.
b) Volatile Oil prices. Fundamental changes in global economy has resulted in volatile oil prices which at times favour the company but does impact it badly when oil prices slide. Therefore, to mitigate the risk from changes in oil prices, I recommend the management to employ hedging strategies and make the function of treasury more effective.
c) Fixed oil margins. The government has recently fixed oil margins at a much lower level which has a negative impact on company’s profitability. Fixation of margins is in the hands of regulatory authorities which is an inherent business risk. Therefore, it is recommended that PSO should employ aggressive marketing techniques to boost its volumetric sales.
The dire financial position of the company is mostly related to liquidity issue for which the following are my recommendations:
a) Factor trade debts. To date the trade debts on the company’s balance sheet amount to Rs. 117bn which are approximately 4 times the size of the company’s equity. To release strain on the business model, I recommend the management to factor some of its debt so that the company can pay-off its liabilities and enhance its dividend paying ability.
b) Fight case for increased margins. As the business faces various risks, the management should take up the issue of low margins with the regulatory authorities to improve its liquidity situation and decrease its reliance on positive oil price movement.
Despite all the negativity, the fact that PSO is the largest oil storage company cannot be neglected. We expect higher furnace oil (FO) demand and resolution of circular debt would be the two major earning triggers for the company. According to estimates, FO demand is expected to increase by 5-6mn tons during next 4-years which will be 60-75% higher than existing FO demand. The jump in demand would come from 1) Recently approved 2250MW FO based rental power plants, 2) Upcoming IPPs of 3500MW capacity and 3) Existing dual-fuel (gas+oil) thermal power plants. Since the entire additional demand will be met through imports (due to refinery constraints), PSO will remain the major beneficiary as it 1) Handles more than 90% of the country’s oil product imports, 2) Has a vast storage network and 3) Has the largest distribution network.
APPENDICES
Appendix 1- Balance Sheet
Appendix 2- Profit and Loss Account
Appendix 3- Ratios Methodology
Appendix 4- Ratio Results
Appendix 5- Sample Questionnaire
Name of the person being questioned: Mr. Iftikhar Ahmad- Head financialreporting
a) PSO is under severe liquidity crisis these days due to non-payment from Power Producers. Do you see any near term solution? Well, it is difficult to predict the actual timeline but the government of Pakistan is planning to issue bonds to clear the dues. Until then it is difficult to find a solution.
b) The government has recently reduced margins on oil products, how do you see this?
Obviously it’s negative. We are facing severe liquidity crisis due to non-payments from power producers and government bodies and in a reduced margin scenario, the profitability may take a nose dive.
c) We have seen that international oil price movement has impacted profitability both negative and positive. Do you have a hedging mechanism in place? Yes we do plan to have one and things are underway where we require prior approval from the State bank of Pakistan. This will mitigate risk on profitability and smooth our earnings going forward.
d) PSO has humongous trade debts on its balance sheet. Does the management have solution to it? Yes we are thinking to outsource the collection of trade debts also known as factoring to generate liquidity. But, there are no immediate plans.
e) Recently, the Federal board of revenue (FBR) has imposed turnover tax of 1% on all companies and PSO having the largest turnover will be badly affected. What are your views on this? FBR has imposed a new tax which is a dampener for our earnings and for PSO it does not make any sense as our margins are already regulated and very low. We are fighting the case with FBR to exempt PSO from this tax and we are hopeful that FBR will revert this tax for PSO.
References
BOOKS REFERRED
• Ziglar, Z., 1975. See You at the Top. Gretna: Pelican Pub. Co.
• Ziglar, Z., 1982. ZigZiglar’s Secrets of Closing the Sale. New York: Berkley Books.
• Ziglar, Z., 1985. Raising Positive Kids in a Negative World. Nashville: Oliver Nelson.
• Ziglar, Z., 1986. Top Performance: How to Develop Excellence in Yourself and Others. New York: Berkley Books.
• Ziglar, Z., 1998. Success for Dummies. Foster City, Calif: IDG Books.
• Ziglar, Z., 2003. Selling 101: What Every Successful Sales Professional Needs to Know. Nashville: Thomas Nelson Publishers.
• Ziglar, Z., 2006. Better Than Good: Creating a Life You Can’t Wait to Live. Nashville: Thomas Nelson Publishers.
• Ziglar, Z., Norman, and Julie, Z., 2009.Embrace the Struggle: Living Life on Life’s Terms. New York: Howard Books.
• BPP, 2010. Business Analysis. 2010 ed. London: BPP Learning Media Ltd
• BPP, 2010. Performance management. 2010 ed.London: BPP Learning Media Ltd
• BPP, 2010. Financial reporting.2010 ed.London: BPP Learning Media Ltd
• BPP, 2010. Financial management.2010 ed.London: BPP Learning Media Ltd
ANNUAL REPORTS
• PSO, 2008. Faces of PSO, Annual Report 2008. [Online] Available at: http://www.psopk.com/investors/pdf/ar_2008_overview.pdf[Accessed 12 Oct 2010].
• PSO, 2009. Weaving the network of our nation, Annual Report 2009. [Online] Available at: http://www.psopk.com/investors/pdf/corporate_objectives.pdf[Accessed 15 Oct 2010].
• PSO, 2010. Energizing the nation, Annual Report 2010. [Online] Available at:http://www.psopk.com/investors/pdf/company_profile_2010.pdf [Accessed 20 Oct 2010]
OTHERWEBSITES REFERRED
• OGRA, 2010. Oil and Gas Regulatory Authority. [Online] Available at: 5 Oct 2010]
• Privatization Commission of Pakistan, 2003-2004. Government of Pakistan Privatization Commission. [Online] Available at:http://www.privatisation.gov.pk/[Accessed 8 Oct 2010]
• OCAC, 2010. Oil Companies Advisory Committee. [Online] Available at:http://www.ocac.org.pk/ [Accessed 7 Oct 2010]
• Ministry of Petroleum and Natural Resources, 2010.[Online] Available at:http://www.mpnr.gov.pk/ [Accessed 11 Oct 2010]
LOCAL NEWS PAPER ISSUES
• The Dawn Media Group, 2010.PSO threatens to stop oil import Article.Dawn[Online], 3 Nov 2010, Available at:
[Accessed 4 Nov 2010]
• Business Recorder, 2010.Receivables Top Rs 152bn, PSO close to financial collapse Article. Business Recorder [Online], 26 Oct 2010, Available at: http://www.brecorder.com/news/fuel-and-energy/pakistan/1116759:receivables-top-rs-152-billion-pso-close-to-financial-collapse.html [Accessed 26 Oct 2010]
Skills and Learning Statement
Word Count: 1883
Personal development planning is integral to the development, evidencing and verification of Graduate Skills. This section will reflect my experiences during the meetings with my mentor and how I have developed my skills during the whole process. As per the requirement of OBU, I and my mentor had three meetings to discuss the stages of RAP development. Before I document my experiences, I would like to give a brief introduction of my Mentor which is as follows:
Name of the Mentor: Mr. ArsalanAnwer
Occupation of the Mentor: Employee at PICIC Asset Management Company and a part time teacher.
Qualification: ACCA Member
Reference: A friend
Meetings with the Project Mentor
First Meeting
Date: 6thSeptember 2010
Venue: CAMS College Library
I met Mr. ArsalanAnwerfor the first time on 21st August 2010 to discuss the general approach to the RAP and to settle on the topic for the thesis. The first few minutes were spent on the introduction where we both introduced each other. As Mr. Arsalanis a part time teacher, he still has academic knowledge through with which he was able to understand my position very well. Apart from the academic background, his practical knowledge was also useful.
The first meeting was very comprehensive where we discussed the strategy to prepare the project. Before the strategy was discussed, I and my mentor had an initial discussion on the topic for the RAP. My mentor and I both agreed on Topic 8 due to its relevancy to my studies and because of the adequacy of information available.
The second round of meeting was oriented towards the planning part where important thoughts were brought into consideration. One of the considerations was the timeline in which each section was targeted for completion. Other considerations were the sources of information, the type of business and financial analysis and the discussion of the industry in which the subject company is operating. My mentor also enquired whether sufficient planning has been done or I required further input from him. After the second round I had documented all the important points of the meeting to construct the pillars of the report.
The programme of the next meeting was agreed upon and these were the tasks which were to be completed:
1) Present a processed document for an initial review.
2) Identify all the sources of information.
3) List down any limitations which were encountered during the process.
4) List down all the accounting and business techniques.
5) Present a conclusion section along with recommendations on the subject company.
Second Meeting
Date: 25th October 2010
Venue: CAMS College Library
Our second meeting took place after I produced the first initial draft of the research project. I communicated my research process to Mr. Arsalan and also made sure I referred to the targeted tasks set during the first meeting. The meeting was focussed on the pace with which the project was being completed and for scrutinizing the sources of information, analysis techniques and the overall objectives of the project. Mr. Arsalan read my whole document and was not too satisfied with the presentation of the project. He made a few comments to improve on my presentation skills which I wrote down on a note pad so that I take a corrective action to make the report more presentable.
During the discussion, I raised some of the limitations I came across while producing the RAP. The first limitation was lack of information of all the oiltraders active in the market as there are many small oil traders whose information is not available. The second limitation was inadequate information on monthly import price data for oil products which made it difficult for me analyze the trend on a monthly basis. Mr. Arsalan advised me to forgo the information of small oil traders as they constitute a very small proportion of total production. For the pricing data, he advised me to base my analysis on a yearly basis as the project was also being analyzed on a y-o-y basis. Other than that Mr. Arsalan was satisfied with my research work and was happy that I had done an in-depth analysis of PSO.
The discussion was also centred on the schedule of the project as ample time was needed to proof read the document and courier it in a professional manner.
The third point of discussion was proper referencing of the project as Bsc Info pack has strict guidelines to follow the Harvard Referencing style to pass the project. He told me to ensure that I follow the guidelines and properly document all the evidences of sources of information.
After discussing all the key points and going through the entire draft document, I asked Mr. Arsalan for some time to take corrective actions and to make a final power point presentation outlining the objectives, analysis and conclusion of the project.
Third Meeting
Date: 11th November 2010
Venue: Mentor’s Office
The final meeting between me and my mentor took place at his office where arrangements for the presentation were in place. Originally, I had taken permission to use the presentation room of CAMS College, but due to unavailability of the same we decided to meet at his office where arrangements were in place.
The agenda for the third meeting was to demonstrate a presentation on power point using multimedia. Along with Mr. Arsalan was one of his office colleagues who also sat in the presentation. As presentation requires good communication and interpersonal skills, I had spent lot of time to rehearse the same to maintain effortless conveyance of message embedded in the presentation.
The presentation for my RAP was as follows:
The question and answer session began after a 15 minute presentation and both Mr. Arsalan and his colleague threw a variety of questions to analyze whether the project met the requirements. I confidently replied to all the questions with little hiccups, though they were manageable.
After the question and answer session, Mr. Arsalan congratulated me for preparing a detailed analysis and asked me whether I had any questions. As I was satisfied withthe conclusion I thanked my mentor for being a wonderful guide throughout the project.
SUMMARY OF SKILLS GAINED DURING THE MEETINGS
The purpose of the meetings with the mentor was to develop an effective communication web which covers both listening/speaking skills and the interpersonal skills. As the experience involved lot of interaction with the mentor, I was in a continuing mode of developing the skills mentioned earlier. To assess the learning gained during the preparation of RAP; I have segregated my development of skills as follows:
Communication Skills
Communication skills are important to clearly convey the content of the message and to avoid any misunderstanding or confusion. Badly communicated message often suffers from bad impression and poor analysis reflecting inadequate and ill-prepared analysis. Therefore, communication skills are pivotal if one needs to achieve objectives efficiently.
During the preparation of RAP, I came across few individuals who were senior to me both in age and experience. For me the best thing could have been to effectively communicate my ideas to extract the best possible information. As I interacted with the persons during the RAP including my mentor, the evolvement of communication skills was evident. As I was communicating with people of professional calibre, I was initially hesitant and very careful in speaking due to which knowledge collation was being sacrificed. To overcome my hesitation, a plan was prepared where I designed a set of questions and involved my father in the question and answer session. As I enjoyed a comfort level with my father, the exercise taught me a lot how to communicate professionally to an unknown person. My mentor was also helpful in understanding my situation as he himself is a teacher and knew a student’s psyche.
To understand the communication process, please see the diagram below:
The communication model was developed by Shannon Weaver where the main source of disturbance is identified in the channel. When talking on the phone the noise could be poor line quality and similarly when talking in person, the disturbance could be in form of noise of other people. During my first two meetings which took place at CAMS library, there were a few instances where people walked in and out of the door which created some noise. To avoid the disturbance we moved onto another desk which was away from the door and communication was then effective. Similarly, during the third meeting while giving the presentation, there were unnecessary power outages which interrupted the flow of presentation. As this was inevitable, we waited for the power to come back and then we moved onto the presentation.
Interpersonal Skills
Interpersonal skills are a continuity of communication skills and involve using skills such as active listening and tone of voice, they include delegation and leadership. It is how well you communicate with someone and how well you behave or carry yourself.
During my third meeting when I demonstrated the power point presentation, I had the opportunity to build on my interpersonal skills which demanded that I keep the audience interest intact. To keep the audience interest intact during a presentation, it is necessary to demonstrate interpersonal skills. Though I need to learn a lot on this area but expressing the presentation did add good points to my interpersonal communication.
Apart from the main skills mentioned above, these were the other skills gained during the RAP development:
1) Application of Accounting and business skills. Being an ACCA student, I already had an understanding of the accounting and business techniques but undertaking RAP taught me the practical application of the same.
2) Writing skills. Good writing skills not only communicate the logic behind an analysis but are equally important to make a project worthwhile reading. By undertaking RAP, I can confidently say that I have improved manifold my writing skills.
3) Planning skills. Without planning the work one cannot achieve his/ her objectives. As RAP is a detailed analysis and requires both time and effort, planning was of utmost priority. The project therefore allowed me to gain excellent planning skills.
4) Technological skills. Numbers alone do not make sense unless they are presented in pictures or graphs. Undertaking RAP required use of spread sheets to prepare graphs and financial statements and therefore proved to be a fine angle to obtain technological skills. Moreover, the display of power point presentation required multimedia which again added to my technological awareness.
ROLE OF RAP IN ACCOUNTING KNOWLEDGE
ACCA qualification is a comprehensive model to gain accounting knowledge and its practical application in the RAP has of course given further clarity to my accounting knowledge. Building a case study requires analysis of both business and financial situation and how each other impact the value of shareholders. Through RAP, I have fetched knowledge of how changes in the business model affect the financial position of the company. Similarly, analyzing past trends, it was identified how financial mismanagement can lead to changes in the way a business is carried out.
Undertaking RAP has increased my accounting knowledge manifold as it has allowed me understand the business dynamics and its impact on the financial position of a company. Moreover, I feel that RAP will act as a catalyst for my future career development.
GLOSSARY
ACCA Association of Chartered Certified Accountants
CAMS College of accounting and management sciences
CL Current Liability
CR Current Ratio
FO Furnace Oil
FY Financial Year
GoP Government of Pakistan
HSD High Speed Diesel
IFRS International Financial Reporting Advisory
KSE Karachi Stock Exchange
LAT Loss after Tax
LPG Liquefied Petroleum Gas
MT Metric tonnes
MW Mega Watts
OBU Oxford Brookes University
OCAC Oil Companies Advisory Committee
OMC Oil Marketing Company
OMS Oil Marketing Sector
PEPCO Pakistan Electric Power Company
PSO Pakistan State Oil Company Ltd
RAP Research and Analysis Project
ROE Return on Equity
RS Rupees
SWOT Strengths, Weaknesses, Opportunities & Threats
WOPP White Oil Pipeline project
