Indian Oil: Fuelling growth

Indian Oil, the country’s largest public sector oil refiner and marketer, had a good 2015-16 fiscal year. The company’s consolidated profit more than doubled year-on-year to ₹11,219 crore despite a 21 per cent dip in revenue to about ₹3.54 lakh crore.

The strong profit growth was thanks to a few factors. The fuel pricing reforms — diesel decontrol and direct bank transfer of LPG subsidy — along with the rout of crude oil over the past two years slashed the under-recoveries of the oil marketing companies.

Indian Oil’s net subsidy burden in 2015-16 was just ₹9 crore compared with ₹1,200 crore in 2014-15. Its borrowings continued to reduce and interest cost dipped 13 per cent last year.

A favourable refining market environment helped too; the company’s gross refining margin (GRM) — the difference between price of its product basket and the cost of crude oil — rose to $5.06 a barrel in 2015-16 from $0.27 a barrel in 2014-15.

The GRM would have been higher, but for the heavy inventory loss booked by the company when crude oil was touching new lows last year.

Indian Oil’s inventory loss was higher than that of peers BPCL and HPCL, since many of its refineries are located away from the coast; this entails more transport time and higher levels of stock keeping.

The Indian Oil stock, which has rallied sharply over the past two to three years, has lagged its peers. There still seems good upside potential in the stock. At ₹468, it trades at about 10 times its trailing 12-month earnings, lower than the average 14 times in the past three years. Also, the company’s prospects look promising, thanks to a favourable pricing environment and recent big ticket expansions expected to pay off in the coming years. Besides, the company’s plans to expand refinery and petrochemicals capacity should improve margins and aid earnings growth. Investors with a long-term perspective can buy the stock.

In the near term, the rise in crude oil price since January should mean inventory gains for Indian Oil. This should help offset the recent weakness in the refining margins, which are inherently cyclical. While it is tough to predict crude oil prices, they are expected to be in the range of $45-$60 a barrel, given the global demand-supply dynamics. This is a comfortable level for the oil marketing companies with less risk from inventory loss and under-recoveries.

Demand for petroleum products in the country is expected to grow at a healthy pace. Over the medium to long term, Indian Oil’s recently commissioned 15 million tonnes (mt) Paradip refinery is expected to ramp up to full capacity by 2017-18.

This high complexity refinery should improve the company’s volumes and profitability. Besides, the company’s plans to expand and upgrade its existing refineries to raise total capacity to over 100 mt by 2022 from about 80 mt currently should help.

So should the aggressive investments in petrochemicals over the next few years; the business contributes about a third of the company’s operating profit and provides a hedge against volatile oil prices and refining margins.

Besides this, the company is adding to its formidable pipeline network and has 45 per cent stake in the upcoming 5 mtpa gas regasification plant in Ennore, Tamil Nadu.

It is also adding to its small presence in the upstream business by making use of low prices to acquire stakes in hydrocarbon assets abroad.

With a comfortable financial position (debt-to-equity ratio at 0.7 times), funding is not a constraint.