Financial Analysis of Pakistan State Oil for

the period July 2017-June 2020

SUBMITTED BY
• Nida Hameed Khan
• Amin Merchant
• Umm e Laila Abbas
• Swaleha Arshad
• Amna Khan
• Maria Rashid
• Adil Iqbal
• Amir Khan

FINAL TERM REPORT – BUSINESS FINANCE 1

INSTITUTE OF BUSINESS ADMINISTRATION |
Profitability Ratios
Profitability ratios are metrics that are used to assess a company’s ability to generate earnings relative to
its revenue or other factors. These ratios are also employed as an effective financial tool to analyze how
effectively the organization is using its assets/resources to generate value for shareholders.

The more commonly used profitability ratios are

• Gross Profit Margin

• Net Profit Margin
• Return on Assets
• Return on Equity
• Return on Capital Employed

For our analysis of PSO’s profitability ratios, we have selected the following ratios.

Gross Profit Margin

The gross profit margin of PSO was recorded as 1.1% in 2020 (3.1% in 2019). The revenue has
decreased by approximately 4% over the period whereas the cost of goods has decreased by
approximately 2%. Gross profit ratio has declined primarily due to significant inventory losses during
the year on account of decline in international oil prices.

However, compared to one of its major competitors, the gross profit margin was always
significantly lower of the past few years. Although PSO managed to decrease its cost of products
sold as compared to the previous year, the net sales declined alongside as well and by a greater
amount, leading to a relatively sharper decline in gross profit margin in 2020 .
Net Profit Margin
Net Profit Margin (NPM) is the variation of profit margin ratio that assesses the company’s ability to
generate earnings after taking into consideration Cost of Goods Sold (COGS), Operating and
other expenses (E), Interest on debts (I) and taxes (T). For simpler understanding, NPM can be
inferred as how much of each dollar/rupee collected in revenue is translated as profit. It helps the
stakeholders to evaluate whether operating costs and other expenses are being contained or
not.

The operating expenses decreased to Rs. 14.7 million (FY19: Rs. 17 million), with a major decrease
reported in reversal for impairment on financial assets and other expenses. Other income
increased during the year to Rs. 10 Million as compared to Rs. 7 Million in FY19, primarily due to
income from financial assets such as interest / mark-up received on delayed payments. However,
due to the decrease in sales in FY20, the net profit ratio declined into a loss. The net loss ratio vs.
net profit ratio in FY19 occurred mainly due to significant inventory losses during the year on
account of decline in international oil prices and increase in finance cost on account of higher
average policy rate of SBP in FY20.

The net profit margin of PSO stood at -0.6% in 2020 as compared to 0.9% in the last year, doing
better from its competitor where profit margin turned into a loss from 2018 and onwards. This could
help PSO earn a competitive edge over its competitor. Although Shell had a higher Gross Profit
Margin, PSO seems to be doing better in terms of Net Profit.
Return on Assets
The return in assets of PSO in 2020 was -1.9% which was better than that of Shell’s which was
recorded as -8.8% in the same year. However, a negative return on asset implies that the assets
may not be efficiently managed, seeing how the company is making a loss in the current year.
Over the years, the return on assets for PSO was gradually declining, however, with the increase
in international oil prices and the decline in revenue led to the return on assets to become
negative.

Return on Equity
Return on Equity is a measure of management's ability to generate income from
the equity available to it. PSO’s return on equity declined to a negative 6% in 2020 (9% in 2019)
due to loss during the year. The total equity of the company decreased by 5% while the company
also incurred a net loss of Rs. 6 million in 2020 leading to the return on equity to become negative.
However, comparatively, the return on equity of Shell was worse off due to consistent net loss for
the past 3 years.
Weighted Average Cost of Capital (WACC)
The weighted average cost of capital (WACC) is a measure of the firm’s total cost of capital
including debt financing and equity. As each section of financing has a separate risk associated
with them, the expected rate of return and subsequently its cost is different. The capital in question
involves common stock, preferred stocks, bonds, or any long-term debt.

WACC can be calculated by individually calculating the cost of debt of each component of the
capital structure namely

1. Debt
2. Preferred Stocks (SP)
3. Common Equity (Ec)

WACC = (% of debt) (Cost of Debt) + (% of SP) (Cost of SP) + (% of Ec) (Cost of Ec)

The cost of debt is the rate at which the firm is repaying its debts. The cost of equity, on the other
hand, is the rate of return that the firm pays to its common and preferred stockholders as dividend.

WACC for PSO (2018-2020)

The interest paid against debt financing has been on an increasing trend from the year 2018-2020
as can be seen from the quantitative analysis below. PSO is a heavily debt-financed organization
and therefore the company is perceived as a high-risk investment venture for common
stockholder. Yet, the risk is marginalized by state security and as a result, the only factors that
affect the company’s performance are political and macro-economic policies. The analysis
shown below describe the yearly changes in the capital structure and WACC.

(in '000)
2020 2019 2018
Equity 4,694,734 3,912,278 3,260,232
Debt 66,433,196 106,997,130 89,846,517
Total 71,127,930 110,909,408 93,106,749
Tax Rate 29% 29% 30%

% of debt 93% 96% 96%

% of Equity 7% 4% 4%

Interest/Markup Paid 13,427,312 8,939,012 5,123,344

Cost of debt 20% 8% 6%

Cost of Equity 27% 31% 23%

Industry Average 15% 15% 15%

WACC 21% 9% 6%

2020 2019 2018

Risk Free Rate 7% 13% 7%
Market Risk Premium 15% 13% 12%
Beta 1.33 1.33 1.33
The WACC for PSO for the year 2020 is 21% which is a sharp increase from 2019 with a value of
9%. This infers that the company had to pay more in terms of interests during the year 2020 and
that the cost of acquiring capital was significantly higher. This was largely due to the recession
faced by oil companies during 2020. The average industry WACC for Oil and Gas industry in
Pakistan was rated at 15%.
Free Cash Flow to the Firm (FCFF)
FCFF is one of the more important financial metrics that is used by investors and analysts alike to
determine the investment risk and the intrinsic value of the firm. Free cash flow to the firm or free
cash flow represents the cash flow that can be distributed after deductions due to accounting
for depreciation expenses, taxes, investments and working capital take place. If FCFF is positive,
a firm has amount remaining after all its expenses. However, a negative FCFF indicates that the
firm did not generate enough revenue to cover its expenses.

FCFF can be calculated as following

FCFF= Net Income + Non-cash charges + (Interest × (1−Tax Rate)) – Long term investments –
Investments in working capital

FCFF Calculation for PSO (2018-2020)

PSO recorded a loss before tax of PKR 5,134 million during the year 2020 due to the oil recession of
COVID-19. This contrasted with the profits recorded during 2018 and 2019. As has been explained
above, the interest expense has increase during the period 18-20 and so the company’s EBIT has
also seen a declining trend. The FCFF metric is affected by the EBIT, NOPAT and the net investment
in operating capital during the year. It can be seen from the analysis below that PSO has increased
its long-term assets while the current operating assets decreased.

As would be seen below, PSO boasts of a high FCFF for 2020 which infers that company’s cash
flow structure has been managed smoothly. Trade debt has decreased during the years 2018-
2020 which is a positive sign and a decline in receivables suggests that recovery has been smooth.
 Free Cash Flow Calculations
2020 2019 2018
Tax Rate 29% 29% 30%
EBIT 8,293,293 26,463,392 32,283,824
NOPAT 5,888,238 18,789,008 22,598,677

Current Operating Assets 282,212,459 372,274,484 365,086,785

Current Operating Liabilities 147,460,348 180,042,553 192,145,744
Net Operating Working Capital 134,752,111 192,231,931 172,941,041
Operating Long term Assets 9,993,564 8,187,159 7,327,476
Total Net Operating Working Capital 144,745,675 200,419,090 180,268,517
Net Investment in Operating Capital (55,673,415) 20,150,573 16,154,521

Free Cashflow for Firms (FCFF) 61,562 (1,362) 6,444

PSO’s FCFF increased to PKR 61 million at FY 2020 close and this represents that the firm has
enough funds available to utilize for its stockholders, retained earnings, capital expenditures and
for preferred stocks.

FCFF FOR PSO 2020-2018

70,000
61,562
60,000

50,000

40,000

30,000

20,000

10,000 6,444

-
(1,362)
(10,000)
2020 2019 2018
FCFF in PKR millions 61,562 (1,362) 6,444
Free Cash Flow of Equity
Free cash flow of equity (FCFE) and Free cash flow of the firm (FCFF) are two important examples
of Liquidity ratios. Liquidity ratios are used to determine a debtor’s ability to pay off current debt
obligations without having the need to raise external additional capital. They determine the
margin of safety by pitting the liquid assets against the short-term debt obligations.

FCFE analyses the availability of cash that is available to the equity shareholders of an organization
after all expenses, debts and retained earnings are paid-off. The main components in FCFE
calculations include net income, capital expenditures, working capital and debt. It can be
inferred through calculations whether the company has used its cash flow to pay dividends
and/or repurchase stocks or it has used external funding (debt and retained earnings) to pay-off
its shareholders. The investor would want to see dividend payments made entirely out of FCFE
rather than external financing as it poses a lower risk and instills higher trust in the operations of the
company.

FCFE can be calculated by the formula given below

FCFE = Cash from Operations – CAPEX + Net Debt Issued

Free Cash Flow of Equity for PSO (2017-2020)

PSO’s FCFE is affected by the net borrowings, the interest expense and FCFF. The free cash flow to
the firm as calculated above increased during the year 2019-2020 and as a result the company
had enough funds to pay-off its stockholders. The FCFE for 2020 stood at PKR 27,756 mil which was
an exponential increase from 2019. Even though the FCFF in 2019 was negative, PSO paid off its
stockholder through the increased borrowing as can be seen in the data below.

(in PKR million)

2020 2019 2018
FCFF 61,561,653 (1,361,565) 6,444,156
Net Borrowing (24,272,505) 8,631,191 (7,580,221)
Interest Expense 13,427,312 8,986,552 5,123,344
Tax Rate 29% 29% 30%
Free Cashflow for Equity (FCFE) 27,756 889 (4,722)

FCFE of PSO from 2018-2020

30,000

25,000

20,000

15,000

10,000

5,000

(5,000)
2020 2019 2018
FCFE 27,756 889 (4,722)