Indian Oil (IOC)

   AT A time when the government is actively considering a decision on deregulating fuel prices, investors should consider taking exposure to the industry. And what better stock to invest in than the industry leader, Indian Oil (IOC), particularly when it is attractively valued compared to its peers.

BUSINESS

IOC operates eight refineries across the country with a total refining capacity of nearly 50 million tonne per annum. The company controls nearly 55% market share in retail sales of petroleum products. It is also a leading producer of downstream petrochemicals such as linear alkyl benzene (LAB) and purified terephthalic acid (PTA) in India. The company recently commissioned 1.5 mtpa naphtha cracker and downstream units to produce polyethylene and polypropylene at Panipat. IOC controls a 52% stake in Chennai Petroleum, which has two refineries with a total capacity of 10.2 mt. It has also picked up stake in 12 domestic E&P blocks, which include 2 CBM blocks, apart from 9 blocks overseas. It has been losing heavily due to the government's policy to control retail prices petrol, diesel, kerosene and LPG despite rising crude oil prices.

GROWTH DRIVERS

The government's intent to act upon Kirit Parikh committee report is the most important growth driver for the company, which will emerge the biggest beneficiary of deregulation. The Centre's recent decision to revise APM gas prices and its aim towards cutting the fiscal deficit are indications that it is serious about decontrolling the retail fuel prices — at least to a certain extent, if not fully — that can reduce the industry's under-recovery burden. While the government continues to dither on price revisions, IOC has been expanding its nonoil portfolio, which contributed an insignificant Rs 360 crore to its FY10 profits. Its naphtha cracker and petrochemicals complex can go a great way in augmenting this. In the E&P business, hydrocarbons have been discovered in some of the blocks, where IOC holds a stake. In the next 2-3 years, IOC will see some revenues coming from this business. The company is setting up a 15 mtpa refinery with integrated petrochemicals complex at Paradip, which is scheduled to be commissioned by March 2012. It is also expanding the capacity of its Panipat refinery by 25% to 15 mtpa.

FINANCIALS

IOC has been one of the most stable public sector refiners in India, growing its net profit at a CAGR of 13.3% over the past five years, while sales grew at 13.6%. In the past seven years, after the erstwhile administered pricing mechanism (APM) was dismantled, the company has received nearly Rs 160,000 crore as assistance from upstream companies and the government and still it lost over Rs 30,000 crore on under-recoveries.

   Due to delays in receipt of assistance from the government and its practice of issuing it in the form of special oil bonds till last year, which had no buyers, IOC had to depend heavily on borrowed funds to run its day-to-day business. As a result, its debt-to-equity ratio, which stood at 0.6 in FY04, crossed 1 in FY09. The interest cost too rose at a CAGR of 50% to Rs 4,282 crore in FY09. FY10 was, however, significantly better with oil prices falling, which enabled IOC to curtail interest cost by almost 60%.

VALUATIONS

At the current market price, the scrip is trading at a price-to-earnings multiple of 7.7, which is lower compared to its peers, BPCL and HPCL. Considering the fact that the company historically commanded premium over its peers, thanks to its stability in profits, sizeable non-oil business and size, the low P/E is an invitation to long-term investors. IOC declared a dividend of Rs 12 per share, translating in a dividend yield of 3.5% — the highest among its peers. The market value of company's investments in the listed companies, such as Chennai Petroleum, ONGC, Gail and Petronet LNG, stands at Rs 23,700 crore, which is 28% of its current market capitalisation.

CONCERNS

The government's inability to introduce any solution to the issue of under-recovery in the near future could deprive Indian Oil of any immediate growth trigger.