Sales tax dispute turns Essar Oil into 'high risk' bet for Citi

Essar Oil has been downgraded to neutral/high risk by Citi Investment Research with a revised target price of Rs 69 per share against its earlier price of Rs 120 per share. It is currently trading at Rs 70 per share.

“Our downgrade is on the back of heightened risks to the investment case post the adverse Supreme Court ruling, and the increased need for capital, which could drive material dilution in the event of the review petition not eliciting a reversal of judgement,” said the firm in its report on the downgrade.

 The Supreme Court’s judgement in January caused a lot of heartache to the Essar Oil’s management after it was ordered to cough up Rs 6,309 crore in sales tax to the Gujarat government after it lost a case seeking benefits of a deferment scheme.

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While Essar Oil has appealed against the order, they could fall into more trouble if the order is upheld.

The heart of the case revolves around this: under the “Capital Investment Incentive Premier/Prestigious Units Scheme 1995-00”, the company was availing an interest-free sales tax deferment. The sales tax was deferred as part of a capital investment scheme in Gujarat after it agreed to build a refinery there in 1999.

However, due to circumstances beyond its control, Essar was unable to complete setting up the refinery on time.

If the Supreme Court’s decision is upheld, then it will have to repay a huge chunk of tax that was deferred - Rs 6,300 crore - to the Gujarat government.

While the company management has expressed confidence that the ruling will not trigger a default, things could turn ugly if any one of the situations play out:

•Essar is asked to pay interest on the sales tax deferred, which could amount to another Rs 1,750 crore.

•An accelerated repayment schedule in case the review petition is rejected.

•A further deterioration in the global refining environment on the back of new supply/lower demand for petroleum distillates due to a global crisis.

•Delay in ramping up increased capacity.

•Essar is refused permission to exit the corporate debt restructuring scheme.