Investors with a long-term perspective can buy the shares of Indian Oil, the country’s largest public sector oil refiner and marketer. Like its peers BPCL and HPCL, the fortunes of Indian Oil too have improved significantly with the fuel pricing reforms implemented over the past couple of years.
Under-recoveries, the bane of the PSU oil marketing companies (OMCs), have been cut down substantially, thanks to the rout of crude oil, diesel decontrol and transfer of LPG subsidy to customers’ bank accounts.
Besides, unlike in the past, the subsidy sharing mechanism for 2015-16 has been announced by the government in advance; with the OMCs to be fully compensated, a major overhang has been removed. Ergo: the borrowings of these companies, earlier high due to delays in government compensation, have come down sharply. Interest cost has followed suit. Indian Oil’s interest cost reduced nearly 30 per cent in 2014-15 and by 35 per cent year-on-year in the June 2015 quarter.
Low crude oil price has also cut down working capital requirement and reduced fuel losses of the OMCs in the refining process. With oil price likely to remain subdued due to weak global demand and oversupply conditions, these benefits should continue. On the other hand, diesel price decontrol provides OMCs legroom to add to their marketing margins.
These benefits have seen the OMC stocks rally sharply over the past two years; Indian Oil has nearly doubled. But the stock has slipped about 12 per cent since August end. Besides the 10 per cent offer-for-sale by the government that month, choppy market conditions and weakness in diesel margins played a role in the recent fall. But this presents a good opportunity for patient investors. At Rs.404, the stock discounts its trailing 12-month earnings by 11 times, a tad lower than its average 5-year valuation.
The company’s long-term growth prospects seem bright, thanks to the fuel pricing reforms and the expansion plans underway. Key among this is the soon-to-be-commissioned 15 mtpa Paradip refinery in Odisha.
The refinery may take a few years to break even, but it should add significantly to Indian Oil’s capacity, refinery complexity and margins in the long run.
Besides this, the company is adding to its formidable pipeline network, has 45 per cent stake in the upcoming 5 mtpa gas regasification plant in Ennore, Tamil Nadu, and plans to intensify its oil and gas exploration foray. With debt levels well under control (debt-to-equity ratio is less than one time), funding is not a constraint.
Inventory losses due to the rout of crude oil took a toll on the profit in 2014-15. But the company more than doubled profit in the recent June quarter compared with the same period last year. Higher gross refining margin, inventory gains and negligible subsidy burden helped.
Earnings could be volatile in the near term due to weak diesel margins. But the business is inherently cyclical with periodic ups and downs that tend to average out. In the long run, expansion initiatives and a favorable pricing environment should give a boost to earnings.