CONTENTS

RATIO ANALYSIS................................................................................................................................ 1 TIMES INTEREST EARNED RATIO .............................................................................................. 1 DEBT RATIO ..................................................................................................................................... 1 DEBT-EQUITY RATIO ..................................................................................................................... 1 DIVIDEND YIELD ............................................................................................................................ 1 DIVIDEND PAYOUT RATIO ........................................................................................................... 1 ANALYSIS ............................................................................................................................................. 2 CAPITAL STRUCTURE ....................................................................................................................... 3 UP GRADATION PROJECT ................................................................................................................. 5 DIVIDEND POLICY.............................................................................................................................. 6 COMPARISON, RECOMMENDATIONS, AND SUGGESTIONS ..................................................... 7

RATIO ANALYSIS
TIMES INTEREST EARNED RATIO 2006 2007 2084,814 579,034 EBIT 40,999 81,718 Interest charges TIE ratio 50.85% 7.08% DEBT RATIO Total liabilities Total assets Debt ratio 2006 29,080 12,004,399 0.0024% 2007 14,696,830 2008 23,772,076 2009 4,105,936 32,566,845 0.126% 2010 3,171,710 30,859,716 0.102% 2008 3843,209 613,313 6.26% 2009 (3038,602) 2477,467 -1.22% 2010 (794,756) 1134,272 -0.7%

DEBT-EQUITY RATIO Total liabilities Shareholders equity Debt-equity ratio DIVIDEND YIELD Annual dividend per share Price per share Dividend yield DIVIDEND PAYOUT RATIO 2006 Dividend (in thousands) Net income (in thousands) Dividend payout ratio 380 1,344,942 0.028% 2007 100,000 250,814 39.87% 2008 50,000 2,110,744 2.36% 2009 --(4,576,563) --2010 ---(2,974,457) --2006 0.013 10 0. 13% 2007 2.86 10 28.6% 2008 1.43 10 14.3% 2009 --10 --2010 --10 --2006 29,080 4,551,548 0.0063% 2007 4,805,083 2008 6,805,905 2009 4,105,936 2,179,342 1.88% 2010 3,171,710 (795,115) -3.98%

ANALYSIS
The Debt Management Ratios for Pakistan Refinery Limited (PRL) are generally low. The reason for this is the 100% equity capital structure that the company follows. The company uses debt only to finance its working capital and no long-term debt is used to finance the projects of the company. For this reason, the TIE ratio, Debt ratio and debt to equity ratio are low; however, this is not a unique situation for PRL. Most of the companies in the industry follow the same structure, where equity dominates the capital structure of the company. Although the capital structure is mainly responsible for the low debt management ratios, however, the negative debt to equity ratio in the year 2010 is because of the negative equity. In 2009-10, PRL incurred heavy losses, due to which it ran out of the reserves and had to support the losses with the money its shareholders provide it with. When we analyze the dividend payout ratio, we observe that due to the losses incurred, PRL has not been paying the dividend to its shareholders for the last two years. Other than the exception of the last two years, the company is bound to distribute dividends from an amount less than or equal to Rs. 100 million only. This is because, the government of Pakistan, in 2002 announced and imposed the dividend capping policy upon the petroleum marketing companies. According to this policy, petroleum-marketing companies are bound to pay maximum of 50% of the equity in the year 2002. At that time, the equity of PRL was Rs. 200 million. Therefore, PRL can only pay a maximum dividend of Rs. 100 million to its shareholders. For this reason, the payout ratio of the company is inconsistent and varies from 0.028% to 2.36% in just three years. The losses incurred in the last two years, discontinuous in the dividend and the capping policy by the government all contribute to the variable nature of the debt and dividend ratios of the company. Moreover, it is the same reason due to which the company does not use debt financing to finance its projects however, the company plans to go for debt financing for expansionary and up gradation projects in the near future. However, if the financial situations of the company do not get better than the present state, the company would have to finance its projects through debt financing.

CAPITAL STRUCTURE
Pakistan Refinery Limited (PRL) is an equity premium company. If we talk about long-term debt and equity, PRL does not have long-term debt policy hence any long-term debt. Normally they go for working capital financing and for that, banks help them in financing working capital. There is also short-term loan of one year that is used for working capital financing. As far as capital structure is concerned, PRL is an equity-based company and currently they do not have any long-term financing. However, with the projects coming up in future, they might go for long-term financing. The share capital is 350 million and borrowings are done through loans, which finance the working capital. Equity financing is needed for the expansion in projects, such as the current up gradation project at PRL and in coming years they might need long term financing. During the last five to ten years, financing has been done for short term borrowing mainly. During our analysis, we observed that in 2010, their equity became negative. Negative equity means that the reserves have become zero and as losses continue to increase, equity become negative. Due to depressed refining margins, unfavorable refinery product pricing mechanism, financial issues and exchange losses the, Company incurred substantial losses during the year ended June 30, 2009 and in the current year resulting in erosion of the reserve balance. PRL incurred a loss after taxation of Rs 2.98 billion during year ended June 30, 2010 and its accumulated losses are Rs 1.14 billion as at June 30, 2010 resulting into negative equity of Rs 795.1 million. Further, current liabilities have exceeded current assets by Rs 3.35 billion. Based on estimated future cash flows and profitability, PRL management believed loss and liquidity issues would be overcome in future. Furthermore, discussions are underway with government for revision of petroleum pricing mechanism favoring the industry, which will further add to profitability. Thus in 2010 accounts, it was observed that PRL went for almost 100% debt financing. For the last ten years, the same capital structure has been adopted by PRL. In industry structure, both National Refinery and Attock Refinery are equity financed while Byco is currently totally debt financed and its equity is in negative. According to our interviewer, Mr. Nauman, their capital structure is optimal, given the industry structure, firm size and nature of business. As far as the changing of capital structure is concerned, our interviewer informed us that PRL has no plans to change its capital structure. However due to expansion and up gradation project, global crude prices and margins of the refinery, they might change it. If margins further decline as they are currently declining, then they have to opt for long term financing strategy but if they become positive and situation gets, better then they will continue with the same capital structure. Sales do not affect their capital structure as their sales are guaranteed. Whatever they produce, is sold. Taxation can affect the capital structure if government changes the tax. Government did change the minimum tax rate from 0.5% to 1% last year and it increased their taxes and thus affected the capital structure. PRL and the whole oil industry took a stand against this tax increment and the government had to reverse the decision.

As far as asset structure is concerned, the up gradation project or any other major capital investment can affect its capital structure. However, the up gradation projects financing will occur in a year or two so it will not affect currently. PRL does not have much investment and do not go for long-term investments due to the huge volume of their payments. Whatever surplus they have they invest for short term, usually for 15 days. As far as the factors considered for financing a new project are considered, there are three factors that are kept in mind: shareholders money, profitability and financial institutions i.e. how much shareholders can contribute, how much profits can contribute towards the funding of the project and finally how much they can get from financial institutions. In 2008 PRL made Rs.2 million, in 2009, it lost Rs. 5 million, in 2010, it further lost Rs. 1 billion and in 2011, it has made a profit of around Rs. 300 million in nine months. Due to these fluctuations in a year, it cannot go on debt for a longer period. The point, at which PRL takes a decision for project financing, is the point at which the situation of the company acts as a driving factor for deciding how much percent company uses debt and how much percent equity. It is not reasonable to forecast about the future as many international factors are involved and the company has no control over these factors. Debts based are those companies that are very growth oriented like FMCGs. Such companies have regular projects coming up as they go for new products, new markets and thus require capital and practice debt financing option. PRL does not have such kinds of projects and it does not even need to market its products, as it knows its products will sell. They require capital for expansion, up gradation or acquiring equipment that can increase its current capacity.

UP GRADATION PROJECT
The Company is making a plant called up gradation Project that will reduce the sulphur content in diesel. The plant has been envisaged in accordance with the directives of Government of Pakistan and is mandatory to be completed by all refineries by 2012 failing in which will result in ban of sale of diesel by such refineries to Oil Marketing Companies. The setting up of plant is very costly as it is a project worth more than Rs. 30 billion for Pakistan Refinery. PRL has been incurring huge losses for the past couple of years due to International Oil Prices rising. However, they have spent approximately Rs. 1.3 billion on the project until Dec 2010. However due to worsening profitability situation and cash flow crisis faced by the company on account of Circular Debt, further investment into the project was severely hampered and no further amount was spend till Dec 2011. The auditors contended that since the asset will not be completed due to shortage of funds, the amount spend Rs. 1.3 billion should be written off as expense in Financial Statements rather than shown as Fixed Asset by management. Disagreement with the management erupted on this matter and since no mutual consensus could be reached, auditors had to qualify auditors report.

DIVIDEND POLICY
For all refineries, there is a capping for the dividend payments. The capping of the dividends started in 2002 and it says that a refinery cannot pay more than 50% of its capital as dividends. At that time, PRL had a capital of Rs. 200 million and can pay Rs. 100 million as dividends. Even if a refinery has a profit of Rs. 2 billion, then also it will pay Rs. 100 million as dividends. Normally what happened at PRL is that if it makes profits of more than 100 million then it pays dividends. In losses, it does not pay dividends. Byco also has not paid dividends due to losses however; NRL and Attock Refinery have as they are making profits. Profitability is the basic factor that is looked into before deciding upon the dividends. Other than that, cash flows also hold importance. According to the interviewer, cash flow is not an important factor as payment of 100 million as dividends is easy for PRL. From 2002, PRL is following a consistent dividend policy with a dividend capping of 100 million. Before 2002, it followed a different formula, which is that if it made profits more than 40% of the capital then it had to submit it to the government. Suppose PRL had capital of 200mn and it earned 100 mn, 40% of 200mn is 80mn then remaining 20 mn went to the government (200x40%=80, 100-80=20) and 80 mn was kept for the distribution. During the last two years, PRL has not paid dividends. It was a zero payer. However, for high and low payer, dividend formula is different at PRL. Before 2002 there was a capping of 10-40% i.e. if profit was less than 10% of the capital then government will finance the company to enable it to reach 10% of capital. If it was greater than 40% then the excess was paid to the government. So at times, it was a higher payer and at times lowers. Whether capping policy makes dividend policy optimal or not, depends on the international prices as PRL prices depend on it. International price is the company is selling price except for the diesel in which case government charges 7.5% deem duty on the international prices. Rs. 3 million that the company is getting as deem duty is kept as separate reserves and when it changes into special reserves, the company should go for expansion. The reason for capping is to prevent shareholders from distributing that Rs. 3 million as dividends. This policy is good for refineries as it pushes them towards profitability as well as towards expansion.

COMPARISON, RECOMMENDATIONS, AND SUGGESTIONS

As far as the capital structure is concerned, PRL, NRL and Attock Refinery all have equitybased structures while Byco has a debt-based structure due to its losses. In case of dividend, all are subject to capping however; dividend policy for attock is slightly different because it does not follow the investment planning. Therefore, there is not much difference in the industry. As far as the suggestions are concerned, we think government cannot produce a better policy than a capping policy or it might increase it from 50% to 100% but then pricing issue will arise and government might also have to remove the deemed duty which the refineries are getting and is helping them to expand. Capping and deemed duty are linked together. If government removes capping then it has to remove deemed duty as well. Oil refineries in Pakistan may face closure if government changes its policy on "deemed duty" which currently stands at 7.5% on HSD but 7.5% on HSD equates to 2.5% of total refinery production as HSD is 1/3rd of total refinery production in Pakistan. It is worthwhile to mention that on one hand, government is trying to induce investment in refining sector and on the other hand, it is considering changing policies, which would result in forced closure of existing refineries. Setting up a refinery is capital intensive with investment running into billions of dollars, so government should make consistent policies that are industry and investment-friendly. Government also needs to resolve the pricing issue. For example if refineries are buying crude oil for 100, they need to sell it at 120 or 130 to incur profits but their selling price is controlled by the government through a formula and thus result in a lower selling price. Therefore, government should revise the pricing formula in order to help the refineries cover at least their cost.

CAPITAL STRUCTURE POLICY & DIVIDEND POLICY FOR PAKISTAN REFINERY LIMITED

FINANCIAL MANAGEMENT TERM REPORT

SUBMITTED TO: Ms. SANA FATIMA

SUBMITTED BY: HADIA SIDDIQUI SARAH HAFEEZ

DATE: 2ND JUNE, 2011.

INSTITUTE OF BUSINESS ADMINISTRATION (IBA), KARACHI.