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 |
Contents
About Pakistan State Oil..............................................................................................................................3
Financial Highlights and Ratio Analysis of PSO 2017-2020.......................................................................3
Financial Highlights of PSO 2017-2020..................................................................................................3
Liquidity Ratios.......................................................................................................................................4
Current Ratio.......................................................................................................................................4
Quick Ratio..........................................................................................................................................5
Cash Ratio...........................................................................................................................................5
Cash Conversion Cycle........................................................................................................................6
Solvency Ratios.......................................................................................................................................6
Debt to Asset Ratio..............................................................................................................................6
Equity Ratio.........................................................................................................................................7
Interest Coverage Ratio.......................................................................................................................8
Profitability Ratios...................................................................................................................................8
Gross Profit Margin.............................................................................................................................9
Net Profit Margin................................................................................................................................9
Return on Assets................................................................................................................................10
Return on Equity................................................................................................................................11
Investment Ratios..................................................................................................................................11
Dividend Yield..................................................................................................................................11
Dividend Payout Ratio.......................................................................................................................13
Gearing Ratio........................................................................................................................................14
DuPont Analysis....................................................................................................................................15
Weighted Average Cost of Capital (WACC).........................................................................................16
WACC for PSO (2018-2020)............................................................................................................16
Free Cash Flow to the Firm (FCFF)......................................................................................................18
FCFF Calculation for PSO (2018-2020)............................................................................................18
Free Cash Flow of Equity......................................................................................................................20
Free Cash Flow of Equity for PSO (2017-2020)................................................................................20
Beta Coefficient.....................................................................................................................................21
Cost of Equity........................................................................................................................................22
Capital Asset Pricing Model (CAPM)...................................................................................................23
Working Capital Management Policy....................................................................................................24
Receivables Management..................................................................................................................24
Current Assets Investments Policy....................................................................................................25
Inventory Management......................................................................................................................25
Conclusion.............................................................................................................................................26
References.............................................................................................................................................26
About Pakistan State Oil
Pakistan State Oil (PSO) is a Pakistani state-owned petroleum corporation that is involved in the marketing and
distribution of petroleum products. It was founded on December 30, 1976,[1] after Pakistan's government took over
the management of Pakistan National Oil (PNO) and Dawood Petroleum Limited, Esso Eastern and renamed into
POCL (Premier Oil Company Limited) for marketing of Petroleum Products. PSO is the first public company in
Pakistan to pass the PKR 1 trillion revenue mark. Pakistan State Oil has been a member of the prestigious  World
Economic Forum since 2003. The network boasts of more than 3,600 filling stations. Being the largest fuel
marketing company of Pakistan, it controls over 60% share of the total oil market with customer portfolios including
dealers, government agencies, autonomous bodies, IPPs and other corporate customers.

In addition to marketing, PSO has an extensive network of import, storage, and distribution of a range of petroleum
products including gasoline, diesel, fuel oil, jet fuel, LPG, CNG and petrochemicals. Besides supplying fuel to
national power utilities like WAPDA and K-Electric, PSO is the sole furnace oil supplier to all Independent Power
Projects (IPPs) in Pakistan with a share of over 80% in furnace oil market. Moreover, PSO is also playing its due
role in meeting the growing energy demand of the country. 

Financial Highlights and Ratio Analysis of PSO 2017-2020

Financial Highlights of PSO 2017-2020

(in PKR '000)

2020 2019 2018 2017
Ne t Inc o me (6,465,552) 10,586,553 15,461,257 18,225,625
Op e ra ting Co sts 14,688,505 17,113,224 15,263,097 13,616,041
To ta l Asse ts 341,718,126 417,079,525 402,562,332 392,442,964
To ta l Lia b ilitie s 228,657,125 297,898,838 292,109,857 289,593,362
To ta l Eq uity 113,061,001 119,180,687 110,452,475 102,849,602

The financial position of PSO shows a declining trend in its profitability as can be seen from the net income figures.
The loss recorded in 2020 can be largely associated to the COVID pandemic. The company decreased its assets as
well its liabilities which shows an efficient performance in its asset management policy. An analysis based on the
different financial metrics is discussed next.

Liquidity Ratios
Liquidity ratios of a company are metrics that help you evaluate the ability of a company to meet its short-term debt
obligations. They mainly measure whether a company can pay off its short-term liabilities when they are due.
Liquidity ratios represent the number of times the short-term debt obligations can be covered by the company’s cash
and liquid assets.

Overall, the higher the liquidity ratios are, the higher the margin of safety a company must meet its current
liabilities. A value of liquidity ratios which is greater than 1 represents that short-term obligations can be fully
covered by the company. This indicates that the company is in good financial health and is not very likely to face
financial difficulties.

The most common liquidity ratios are:

 Current ratio
 Quick ratio,
 Cash ratio
 Cash conversion cycle

Current Ratio
The current ratio of PSO has been steady and has slightly increased over the span of 2017 to 2020 from 1.31 to 1.35.
This shows that the short-term obligations of PSO can be easily covered by the company. A current ratio of 1.35 in
the year 2020 shows the company is in good financial health. Moreover, the current ratio of PSO is almost double of
Shell’s current ratio which was 0.61 in 2020. This data shows PSO has a higher margin of safety to meet its current
liabilities as compared to Shell.

Current Ratio
1.60
1.40 1.35 1.32 1.32 1.31
1.20
1.00
0.75 0.81
0.80 0.69
0.61
0.60
0.40
0.20
0.00
2020 2019 2018 2017

PSO Shell

Quick Ratio
The quick ratio of PSO like current ratio has also been quite stable in the period of 2017 to 2020. PSO’s quick ratio
has had slight fluctuation from 1.07 in 2017 to 1.03 and 1.01 in 2018 and 2019 respectively. In comparison to Shell
which has a quick ratio of 0.32 in 2020, PSO’s quick ratio of 1.08 in 2020 is approximately 3 times higher. This
shows that PSO as a company has higher liquidity as compared to shell. This higher liquidity suggests that PSO is
not likely to face financial difficulties in paying off their current liabilities.
 Quick Ratio
1.20 1.08 1.07
1.01 1.03
1.00
0.80
0.60 0.48
0.40 0.32 0.32 0.32
0.20
0.00
2020 2019 2018 2017

PSO Shell

Cash Ratio
The cash ratio is another measurement of a company’s liquidity. This ratio of cash and cash equivalents to a
company’s current liabilities calculates the ability of the company to repay short-term debt immediately with cash or
near-cash resources. The cash ratio is far more conservative than other liquidity ratios as it only considers the
company’s most liquid resources hence its bound to be much lower than 1.

The cash ratio of PSO has increased slightly from 0.01 in 2017 to 0.02 in 2020 which is a positive sign. However,
the cash ratio of PSO in 2020 which is 0.02 is less than half of Shell’s cash ratio of 0.05 in 2020. This shows Shell
as a company has a relatively higher ability to pay off short-term debt immediately with cash or near-cash resources
than PSO.

Cash Ratio
0.10 0.09
0.08
0.06 0.05
0.05 0.05
0.04
0.02 0.02 0.02 0.01
0.02
0.00
2020 2019 2018 2017

PSO Shell

Cash Conversion Cycle

The cash conversion cycle is the number of days a company will take to convert its input resources into liquid
cashflow. This metric is used to measure how much time the company takes to sell its inventory and collect its
receivable in order to pay off its operation expenses without any delays.

As seen in the graph below, the cash conversion cycle of PSO has decreased in the period of 2017 to 2020 from 181
days to 133 days. This is a positive sign as the company has reduced number of days it takes to convert its resources
into liquid cashflow significantly.
When compared to Shell’s cash conversion cycle, PSO has had a higher cash conversion cycle of 183 days and 158
days in 2018 and 2019 respectively. Shell had a much shorter cash conversion cycle of 109 days and 118 days in
2018 and 2019 respectively. However, in the year 2020 PSO manages to reduce its cash conversion cycle to 133
days which is quite close to Shell’s cash conversion cycle of 129 days for the same year.

Cash Conversion Cycle

200 183 181
180
158
160
140 133 129 135
118
120 109
100
80
60
40
20
0
2020 2019 2018 2017

PSO Shell

Solvency Ratios
Solvency ratios are a key metric to measure a company’s ability to pay off its long-term debt obligations. This
metric is often used by business lenders to evaluate a company. A solvency ratio represents whether the company’s
cashflow is sufficient to meet the long-term liabilities of the company hence these ratios help us analyze the
financial health of a company.

Debt to Asset Ratio

The debt to asset ratio mainly depicts a company’s financial leverage. It measures to which degree a company’s
assets are financed by its liabilities (debt) as compared to its equity. This ratio is often used to measure the growth of
a company through the assets it has acquired over time.

The debt to asset ratio of PSO has decreased over a span of 4 years from 0.74 in 2017 to 0.67 in 2020. This means
the company’s assets which are financed by liabilities have decreased over the years which is a positive sign. PSO’s
debt to asset ratio of 0.67 in 2020 is much lower than Shell’s debt to asset ratio of 1.01 in the same year. This depicts
that PSO compared to Shell
has lesser assets financed by
Debt to Asset Ratio its liabilities as compared to
its equity.
1.20
1.01
1.00 0.92
0.87
0.80 0.71 0.73 0.74 0.74
0.67
0.60

0.40
0.20
0.00
2020 2019 2018 2017

PSO Shell
Equity Ratio
The equity ratio of a company shows how much of the company’s assets are funded by issuing stock as compared to
borrowing money. The closer an equity ratio is to 1, the more assets have been financed by stock rather than debt.
This ratio can depict the financial stability of a company in the long run.

As shown in the graph below, PSO’s equity ratio has been increasing over the years from 0.26 in 2017 to 0.33 in
2020 which is a positive sign. Moreover, PSO’s equity ratio is much higher than Shell’s equity ratio in 2020
although both the companies had an equity ratio of 0.26 in 2017.

Equity Ratio
0.35 0.33
0.30 0.29 0.27 0.26 0.26
0.25
0.20
0.15 0.13
0.10 0.08
0.05
0.00
2020
-0.01 2019 2018 2017
-0.05

PSO Shell

Interest Coverage Ratio

The interest coverage ratio mainly measures the number of times a company will be able to cover its existing interest
payments with its available earnings. The ratio is calculated by dividing EBIT by the interested expenses of a
company for the same period. The lower the interest coverage ratio is of a company, the more the company is
troubled by its debt expenses.

The interest coverage ratio of PSO has significantly decreased from 5.9 in 2017 to 0.6 to 2020. This shows that the
company is burdened by its interest payments. However, the interest coverage ratio of Shell has increased steadily
from 0.74 in 2017 to 1.01 in 2020. This is a negative sign for PSO as it is financially strained by its debt expenses.
 Interest Coverage Ratio
20.0
15.8
15.0

10.0
6.2 5.9
5.0
2.9
0.6 0.3
0.0
2020 2019 2018 2017
-1.8
-2.9
-5.0

PSO Shell

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.
Investment Ratios
Investment ratios, also known as market ratios, are analyzed to determine the share price and investment portfolio
strength of a company. Different metrics are utilized to infer the security for potential investors, return on
investments, profitability to stockholders, risk profiling of investment etc.

The most used market ratios are

 Earnings per share

 Price Earnings Ratio
 Price to Book Ratio
 Dividend Yield

To inspect the market ratios of PSO, we have chosen the following ratios.

Dividend Yield
Dividend yield measures the amount of cash dividends distributed to common shareholders relative to the market
value per share and is mainly used by investors to determine returns on their investments in a certain firm. A high
dividend yield indicates that the investors are receiving a large dividend compared to the market value of stock and
are therefore getting highly compensated for their investments as compared to lower yielding stocks.

Dividend per share

Dividend Yield=
Market Value of stock per share
PSO’s Dividend per share can be seen, in fig. 1, to have a declining trend for the past few years primarily because
PSO was paying off its debts (decreasing trend in Financial Leverage Ratio – fig. 2) and was performing poorly
(decreasing trend in Earnings per share – fig. 3). Further, PSO’s Market Value per share has also declined (fig. 1),
mainly due to decreased demand of PSO’s stock. Even then PSO has been able to maintain a fairly stable value of
Dividend Yield for the past few years as compared to its competitor Shell Pakistan (fig. 4).

In the year 2020, Oil and Gas Sector saw a very sharp decline in petroleum demand due to COVID-19 pandemic,
which impacted PSO’s financial performance as well. The company had to face a Net Loss, which is why it was
decided to not recommend any dividend for FY 20. For this reason, Dividend per share for the year 2020 was 0,
resulting in a Dividend Yield of 0.

Dividend Yield
8
400 7
6
300 5
200 4
3
100 2
1
0 0
FY 2020 FY 2019 FY 2018 FY 2017

Dividend per share (Rs.)

Market Value per share (year end) (Rs.)
Dividend Yield (%)
Dividend Payout Ratio
The dividend payout ratio measures total amount of dividend paid out to shareholders relative to the net income of
the company. This ratio indicates return to shareholders versus how much the company is keeping on hand to
reinvest in growth, pay off debt, or add to cash reserves (retained earnings). A high value of Dividend Payout ratio
indicates that a large chunk of profits is being paid out as dividends while a low value indicates a high profit
retention.

Dividend per share

Dividend Payout=
Net Income per share
PSO’s declining Dividend payout ratio shows that for the past few years it has been retaining more of its profits
instead of giving them out as dividends. Further, for FY 20 Dividend Payout ratio stood at 0 since, as mentioned
before, no dividends were paid.

Further, PSO has maintained a better position than Shell Pakistan in terms of Dividend Payout Ratio for the past few
years.
Gearing Ratio
A gearing ratio is a measurement of financial leverage of a company, or the amount of business funding that comes
from lenders as opposed to company owners i.e. shareholders. In other words, how much of the business funding
comes from borrowed methods. Debt-to-equity, debt-to-capital and debt-service ratios are some of the more
commonly known gearing ratios. For our analysis of PSO, we have selected the debt-to-equity ratio.

The gearing ratio of PSO stands at 67% in 2020 as opposed to 74% in 2017. The gearing of PSO shows a downward
trend. The debt of PSO has decreased by 21% from 2017 to 2020, while the total equity has increased by 10%,
allowing the gearing to decline. To further improve the gearing ratio, PSO should either consider convincing their
lenders to convert their debt into shares or attempt to increase revenues. However, when compared to its
competitors, PSO seems to be doing better. The gearing of its competitor, Shell, continues to increase while that of
PSO is declining, although both had a similar gearing ratio in 2017.

DuPont Analysis
DuPont analysis is a useful technique used to decompose the different drivers of return on equity (ROE). The
decomposition of ROE allows investors to focus on the key metrics of financial performance individually to identify
strengths and weaknesses. There are three major financial metrics that drive return on equity (ROE): operating
efficiency, asset use efficiency and financial leverage.
DuPo nt Ana ly sis
2020 2019 2018 2017
Ne t Pro fit Ma rg in (0.006) 0.009 0.015 0.021
Asse t Tu rn o v e r 3.243 2.768 2.625 2.238
Eq u it y Mu ltip lie r 3.022 3.500 3.645 3.816

DuPo nt -5.7% 8.9% 14.0% 17.7%

The DuPont of the company resulted in an ROE of -5.7% during 2020 due to the loss recorded in the fiscal year. The
assets turnover ratio improved mainly due to a decline in the total assets by 18% while the sales decreased by 4%. It
can be emphasized that even though a higher asset turnover ratio is feasible for a potential investor, a deeper
analysis suggests that the higher ratio does not ascertain more efficient usage of the assets.

The net profit margin is seen to decline since 2017 which suggests that the company has not performed well during
the past few years. The ROE trend and the shift of other metrics is shown below.

DuPont Analysis of PSO 2017-2020

4.50

4.00

3.50

3.00
Net Profit Margin
2.50
Asset Turnover
2.00
Equity Multiplier
1.50
ROE
1.00

0.50

0.00
2020 2019 2018 2017
-0.50

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
Eq u it y 4,694,734 3,912,278 3,260,232
De b t 66,433,196 106,997,130 89,846,517
To ta l 71,127,930 110,909,408 93,106,749
Ta x Ra te 29% 29% 30%

% of debt 93% 96% 96%

% o f Eq u it y 7% 4% 4%

In t e re st / Ma rku p Pa id 13,427,312 8,939,012 5,123,344

C o st o f d e b t 20% 8% 6%
C o st o f Eq u it y 27% 31% 23%

In d u st ry Av e ra g e 15% 15% 15%

WACC 21% 9% 6%

2020 2019 2018

Risk Fre e Ra t e 7% 13% 7%
Ma rke t Risk Pre m iu m 15% 13% 12%
Be t a 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 next, 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.
 Fre e C a sh Flo w C a lc u la t io n s
2020 2019 2018
Ta x Ra t e 29% 29% 30%
EBIT 8,293,293 26,463,392 32,283,824
NO PAT 5,888,238 18,789,008 22,598,677

C u rre n t O p e ra t in g Asse t s 282,212,459 372,274,484 365,086,785

C u rre n t O p e ra t in g Lia b ilit ie s 147,460,348 180,042,553 192,145,744
Ne t O p e ra t in g Wo rkin g C a p it a l 134,752,111 192,231,931 172,941,041
O p e ra t in g Lo n g t e rm Asse t s 9,993,564 8,187,159 7,327,476
To t a l Ne t O p e ra t in g Wo rkin g C a p it a l 144,745,675 200,419,090 180,268,517
Ne t In v e st m e n t in O p e ra t in g C a p it a l (55,673,415) 20,150,573 16,154,521

Fre e Ca shflo w fo r 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 m illio n )

2020 2019 2018
FC FF 61,561,653 (1,361,565) 6,444,156
Ne t Bo rro w in g (24,272,505) 8,631,191 (7,580,221)
In te re st Exp e n se 13,427,312 8,986,552 5,123,344
Ta x Ra t e 29% 29% 30%
Fre e Ca shflo w fo r Eq uity (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)
Beta Coefficient
The relevant risk of an individual stock is the amount of risk the stock contributes to a well-diversified portfolio.
The benchmark for a well-diversified stock portfolio is the market portfolio, which is a portfolio containing all
stocks
The relevant risk of an individual stock is measured by its beta coefficient, which is defined under the CAPM as:
“The amount of risk that the stock contributes to the market portfolio”. [1]

A beta coefficient can measure the volatility of returns of an individual stock compared to the systematic risk of the
entire market. In statistical terms, beta represents the slope of the line through a regression of data points. [2]

Beta is calculated as:

βi= ( δmδi )∗ρim

Where,

βi = Beta Coefficient of stock i

δi = Standard deviation of Stock i’s return
δm = Standard deviation of the market’s return
ρim = correlation between Stock i’s return and the market return
By using 36 months data for PSO and Market’s monthly stock prices (2018-2020) the beta coefficient has come out
to be 1.2797. This means that PSO’s beta is greater than the 1.0 average beta. Therefore, PSO’s returns tend to move
up and down (on average) by more than the market’s returns.

Beta (using 36 months data 1.2797

for monthly prices)
Slope 1.2797

Annual Beta
2020 1.1480

2019 1.2807

2020 1.4297

Beta for PSO

0.4

0.3
PSO Monthly Returns for 36 Months

f(x) = 1.28 x − 0
R² = 0.75
0.2

0.1

0
-0.3 -0.2 -0.1 0 0.1 0.2 0.3
-0.1

-0.2

-0.3
KMI 30 Monthly Returns for 36 Months
Note, however, that the points are only loosely clustered around the regression line. Sometimes PSO does much
better than the market, while at other times it does much worse. The R2 value shown in the chart measures the
degree of dispersion about the regression line. Statistically speaking, it measures the percentage of the variance that
is explained by the regression equation. An R2 of 1.0 indicates that all points lie exactly on the line and hence that
all of the variations in the y-variable are explained by the x-variable. PSO’s R2 is about 0.75, which indicates that
about 75% of the variance in PSO’s return is explained by the market returns of the explained variance of a typical
stock.

Finally, the intercept shown in the regression equation on the chart is −0.0038. This indicates that PSO’s average
monthly return was −0.38% less than that of a typical company during these 36 months, or 12(−0.38%) = −4.5% less
per year because of factors other than the general decline in stock prices.

Cost of Equity
As a rule of thumb, for a company to raise capital, it either opts for debt financing or equity financing. The capital
structure of any common organization comprises of the same and so does PSO’s. Below is a brief snapshot of the
capital structure of PSO from the year 2018 to 2020:

2020 2019 2018

Financing Mode
Amount % Amount % Amount %
Equity 4,694,734 7% 3,912,278 4% 3,260,232 4%
Debt 66,433,196 93% 106,977,130 96% 89,846,517 96%
Total 71,127,930 110,909,408 93,106,749

As per the above figures, the mix and debit and equity for PSO is on a 90/10 ratio however, we can observe an
increment in the equity portfolio in the year 2020.

In this section we will be shedding some light on the Cost of Equity for PSO from the year 2018-20. Since PSO has
issued common stocks to its shareholders, we will be determining the Cost of Common Stock throughout these three
years.

To produce reasonably good estimates for cost of equity, the following three models/methods can be applied:

1. Capital Asset Pricing Model (CAPM)

2. Discounted Cash Flow Method
3. The over-own-bond-yield-plus-judgmental-risk-premium Approach

For this analysis, we would be using the CAPM approach to determine cost of equity for PSO.

Capital Asset Pricing Model (CAPM)

Capital Asset Pricing Model (CAPM) is an important tool which is used to analyze the relationship between risk and
rate of return. In order to estimate the cost of common stock, we will proceed with the following variables:

1. Risk-free rate of return

2. Current Market Risk Premium
3. Stock’s Beta Coefficient

After acquiring all the above three mentioned variables, we would be placing them in the following equation to get
cost of common stock:

Cost of Common Stock: Risk-free rate + (Market Risk Premium)*(Stock’s beta)

 2020 2019 2018
Risk-free Rate 7% 13% 7%
Market Risk Premium 15% 13% 12%
Beta 1.3 1.3 1.3
Cost of Common Stock Equity 26% 30% 22%

Note:

1. In order to estimate the risk-free rate, we have taken percentages approximately close to the yield of
Pakistan 6M treasury bill
2. The value of Beta has been taken as an average of the mentioned 3 years.

Working Capital Management Policy

Working capital management policy is a business strategy designed that ensures company operations are running
efficiently by monitoring and using its current assets and liabilities to the best way possible. PSO strives to lower its
days of working capital at the same time ensuring to maintain minimum level of inventory required to fulfill the
demand in unforeseen situation to avoid business loss. The difficulty in working capital’s management is one of the
factors that are responsible for the low profitability. Thus, better planning, organization and controlling of working
capital must be taken into an account because the right utilization of optimum amount of working capital increases
the net operating margin to the greater extent.
Receivables Management
PSO has 60% for Pakistan’s total market share it deals with government agencies, autonomous bodies, independent
power projects and other corporate customers. At the end of the financial year 2020, the receivables from the Power
Sector stood at Rs. 101.4 bn against Rs. 120.2 bn in FY19 reflecting a reduction of Rs. 18.8 bn. However, during the
year, receivables from SNGPL increased steeply from Rs. 64.7 bn to Rs. 97.6 bn. During the financial year 2020,
average borrowing of the Company stood at Rs. 105.8 bn vs 116.4 bn in FY19. The company also received
significant amount under Late Payment Surcharge from HUBCO and KAPCO.

To manage liquidity challenges, the Company is taking the following measures:

 Exploring and suggesting modalities and proposals to GOP & its customers from the Power Sector, PIA
and SNGPL for earliest resolution of long-outstanding receivables and further build-up in future
 Focusing on cash customers.
 Venturing into new business models/lines. Despite the challenging liquidity position in FY20, the Company
managed to discharge its debts on time except for few payments which were delayed due to default in
payments to PSO by SNGPL.
 PSO is actively following up with the customers and respective authorities for the settlement of long
outstanding dues, meanwhile managing its working capital requirement through commercial banks and
keeping the spread to minimum.

Current Assets Investments Policy

PSO has moderate current assets investment policy. It focusses on prudent management and utilization of working
capital, while ensuring availability of adequate credit lines. PSO tries to generate Operational cash flow via business
growth. The company continuously repairs and improves its current infrastructure.

Inventory Management
The PSO stretches from Karachi to Gilgit. With 9 installations and 23 depots located across the country PSO's
storage capacity of approximately a million metric tons represents 68% of the total storage capacity owned by all the
oil marketing companies. PSO’s commitment to its customers is the primary objective of its core existence. Its
stringent supply planning process, reliable and diversified sourcing, adequate inventory reserves, reliable
infrastructure and efficient logistics across the country are successfully always contributing towards meeting
customer demand. However, the demand and supply equilibrium is affected when other OMCs maneuver their
procurement and sales strategies to take advantage of arbitrage opportunities in the market, thus creating
unprecedented onus on the Company’s supply chain in trying to maintain the equilibrium.

Conclusion

References