Stock Review: Oil India Ltd (OIL)

 

 

Oil India has high cash reserves and a high returns ratio. Its prospects will get more attractive as the government deregulates oil pricing.

Measured by total proven and portable oil and natural gas reserves and production, Oil India Ltd (OIL) is India's second-largest oil and gas company. Its primary activities include exploration, development, production and transportation of crude oil and natural gas. In the last fiscal (FY10), OIL produced 3.57 mmt (million metric tonnes), which is equivalent to 25.8 million barrels of crude oil. It also produced 2,415 mmscm (million metric standard cubic metres) of natural gas. While the production of oil went up by 4.2 per cent, that of gas rose by 7 per cent compared to FY09. The company's revenue mix in FY10 was as follows: crude oil and natural gas contributed 97 per cent of total revenue; transportation contributed 2 per cent; and the rest came from the production of LPG.

 

Strengths

Gamut of E&P Assets: OIL's exploration and development areas include 32 blocks through 19 mining licences and 13 petroleum exploration licences. These are situated in Assam, Arunachal Pradesh, Uttar Pradesh and Uttaranchal. It also has production sharing contracts (PSC) in 30 blocks of Krishna Godavari, Krishna Cauvery and Rajasthan (places where oil has already been found). It also has participating interest in 17 exploration and development blocks overseas in Egypt, Gabon, Iran, and a few other countries. In all OIL has 26,660 sq kms of domestic and 41,273 sq kms of international exploration acreage.

High Success Ratio: The company's exploratory success ratio in FY09 was 50 per cent. Its average success ratio over the three years till FY09 was 69.3 per cent. This is particularly commendable when compared to the global average of about 30 to 40 per cent, or ONGC's 36.4 per cent.

The high success ratio has led to a high reserve replacement ratio (RR ratio, defined as the amount of proven reserves added to the reserve base during the year relative to the amount of oil and gas produced). For the past three years OIL has been able to maintain an average RR ratio of over 1.73.

Increased realisation from Gas Output: In FY10 the government increased APM (administered price mechanism) gas prices by 130 per cent from $1.79/mmbtu to $4.2/mmbtu. According to a report by IIFL, earlier even though gas contributed 35 per cent of OIL's production in terms of tonnes of oil equivalent, its contribution to revenue and operating profit was a meagre 7 per cent and 10 per cent respectively. According to IIFL's estimate, this more than doubling of gas realisation will improve its contribution to total revenue to 16 per cent in FY12E. On an annualised basis, this should lead to the company's earnings per share increasing by Rs14.40.

Strong Cash Balances: The company ended FY10 with cash in hand of Rs8,543 crore and free cash flow of Rs3,704 crore. This gives OIL both the ability to acquire more exploration assets and to climb up the value chain by acquiring small- or mid-sized oil producing companies.

Diversified Presence: OIL operates a crude pipeline of 1,157 kms in the North-East region for transporting crude oil to refineries. It also operates a pipeline from Numaligarh to Siliguri. Moreover, it has a 10 per cent stake in a 741-km pipeline in Sudan. It also produces LPG at a plant in Assam that has a production capacity of 50,000 tonnes per annum.

Downstream Investments: OIL holds a 26 per cent stake in Numaligarh Refinery Ltd. It has another 10 per cent stake in Brahmaputra Cracker and Polymer Ltd (BCPL) that will establish a gas cracker project in Assam. In addition, it has a 23 per cent equity investment in DNP Ltd. This company was incorporated for acquiring, transporting, and distributing natural gas in all forms.

 

Concerns

Subsidy Sharing: Upstream companies have to bear 33 per cent of the under-recoveries bill of downstream companies. As a result, OIL has been bearing 9-11 per cent of the total under-recoveries bill. For FY09 and FY10, the company paid out Rs3,023 crore and Rs1,549 crore as its share. This amounted to 37 per cent and 17.50 per cent of its total revenue respectively and equals Rs125 and Rs64 per share respectively. With oil prices going up, the slower the government acts on adjusting the price of diesel, kerosene and LPG, the poorer the investors of OIL will be.

Dependency: OIL depends heavily on a single pipeline for transporting its oil to refineries. Any disruption in the pipeline will strike at the heart of its operations. Furthermore, most of its revenue-earning assets are located in the North-East, many parts of which are plagued by security problems. The company needs to take extra precautions for the security of its installations.

 

Financial Performance

Over the past five years, OIL's bottomline has expanded at a steady rate of 16.96 per cent annually. This is the fastest rate of growth among all the leading oil companies. With the average price of crude at $68.53/bbl in FY10, net realisation stood at $56.2, down 1.1 per cent compared to FY09. But in rupee terms there was an increase of 4.36 per cent due to appreciation of the rupee against the dollar. And with the oil prices rising further, despite the subsidy burden net realisation will improve. According to an estimate provided by Prabhudas Lilladher, the company's EPS will grow annually by 17.34 per cent in FY11E and FY12E. An increase of $5/bbl in net realisation can push earnings up by 11-11.5 per cent in FY11E and FY12E.

OIL is committed to investing Rs8,400 crore over the next two years to augment its existing assets and production capabilities. It plans to raise its crude oil production by 2-3 per cent every year, while doubling its natural gas production over the next five years. The company was never too keen on production of natural gas, as there is very little demand for it in North-East India. But with the setting up of a regulator for the gas sector, and its plans to encourage gas distribution in cities, OIL is now trying to expand its natural gas production.

 

Valuations

Historically OIL has traded at a steep discount to global peers. The key reason has been the uncertainty in earnings caused by the subsidy burden. But in future the discount is expected to narrow down as the government steadily deregulates the sector (like the recent hike in the price of natural gas to non-core sectors from $4.75 per mmbtu to $5.25 per mmbtu).

Over the past five years, the company's EPS has grown at the rate of 16.96 per cent annually (which compares favourably with Reliance's 12.81 per cent and ONGC's 5.25 per cent).

Its RoE of 25.67 per cent for FY10 is almost at par with that of ONGC and the highest among the companies in this space.

At 0.72, the stock is trading at the second-lowest PEG (price-earnings to growth ratio) within the sector. It is trading at a P/E (price-earnings) ratio of 12.26.

Over the past one year, OIL has under-performed the Sensex by 3.7 percentage points. This stock is worth considering in the oil and gas space, and investors should look to accumulate it on dips.