FPO Review: Indian Oil Corporation’s (IOC)

Oil marketing behemoth Indian Oil Corporation's (IOC) stock rallied 9 per cent last week, racing ahead of its peers as well as the BSE Oil & Gas index, which was up 5per cent during the same period. News about its upcoming follow-on public offer (FPO) and its foray into city gas distribution (CGD) were the key triggers behind this rally. However, the rising crude oil prices are a concern as they could inflate the subsidy burden of IOC as well as other oil marketing companies (OMCs).

Offer on track

Last week, IOC received the government's nod to roll out its FPO in January 2011, which would see the government selling 10 per cent of its 78.9 per cent holding in the company. Notably, news reports suggest the pricing will be around Rs 440-450 ashare, which would make it the largest public offer (Rs 20,000 crore), surpassing Coal India which garnered Rs 15,000 crore in October 2010. Given that the pricing is pegged way higher (1720 per cent) than IOC's prevailing market price, it was not surprising to see the IOC stock jump last week. However, the actual pricing will influence the stock performance.

Growth plans

More importantly, the amount of under-recoveries and the subsidy-sharing mechanism in its core marketing business are the key variables influencing IOC's profitability. After partial deregulation of retail fuel prices in June, the government has been silent about the next phase of deregulation, especially diesel prices. Quicker deregulation will boost the company's profitability, which seems distant for now, say analysts.

Meanwhile, IOC has opened 450 new fuel outlets this financial year and will add 450 more pumps by March 2011. It has doubled its capacity in Panipat (Haryana) to 12 MTPA (million tonne per annum), which will improve the petrochemical revenues on account of a higher naphtha throughput. Its annual crude oil refining capacity will go up from 60 MTPA to 80.7 MTPA by 2012.

IOC is foraying into new segments. It aims to invest Rs 900 crore for a 26 per cent stake in Nuclear Power Corporation's 1,400-MW atomic power plant in Kota, Rajasthan. Also, IOC along with ONGC plans to foray into the CGD business. However, these should contribute only in the long run.

Valuations

Crude oil prices have increased 12 per cent since the partial deregulation. The average price till date has been $85 a barrel in the current quarter as against $77 in the first half of 201011. At this average price, the full-year under-recoveries are estimated at Rs 65,500 crore versus Rs 31,900 crore in the first half of 2010-11 and Rs 46,100 crore in FY10. OMCs shared 26 per cent of the gross underrecovery (IOC typically shares 55 per cent of OMC's share) in the first half of FY11. While this ratio could continue, clarity on the issue is expected by March 2011. While the government is unlikely to fully reimburse OMCs for selling petroleum products below international prices, IOC will be the least affected due to its diversified portfolio.

While OMCs are awaiting clarity on diesel deregulation, analysts believe the government is unlikely to deregulate in the near term because of higher oil prices, impact on inflation and the forthcoming state elections. Barring the uncertainty over subsidy sharing, analysts believe IOC's valuations should benefit from the improvement in earnings quality, a better cash cycle and lower debt levels.