Indian Oil Corporation Offer for Sale Note By ICICI-Direct

The Government of India (GoI) has launched an offer for sale (OFS) of 24.28 crore equity shares of | 10 each of Indian Oil Corporation (INDOIL) aggregating to 10% of the total paid-up equity share capital. The current market price of the stock is | 395 and floor price is expected at 2-4% discount to the current market price. Retail investors will receive shares at a discount of 5% and are allocated 20% of issue size.

IOC, India’s largest national oil company

Indian Oil Corporation (IOC) is India's largest company by revenues, with sales of | 4,37,526 crore and PAT of | 5,273 crore for FY15. IOC has a dominant share in the petroleum products market, refining capacity and downstream pipelines capacity in India. The IOC group currently has a refining capacity of 65.7 mmtpa and its new 15 mmtpa Paradip refinery is set to commissioned by end of Sept this year. The market sales volume of IOC stood at 72.8 mmtpa in FY15, registering an increase of 2.4% YoY.

Lower crude oil prices to reduce under-recoveries

The government’s positive move to deregulate diesel prices last year was a major reform step for OMCs. It led to a decline in crude oil gross underrecoveries, with only kerosene and LPG prices under the regulatory regime. The government’s scheme of direct benefit transfer (DBT) for LPG cylinders is a step in the right direction and has led to lower gross underrecoveries. Given our assumptions on Brent crude at $60/barrel and exchange rate of | 63.5 per US dollar, we expect gross under-recovery of | 39314.2 crore and | 42429.9 crore in FY16E and FY17E, respectively. The government’s recent decision to cap its sharing of kerosene subsidy at | 12/litre and LPG at | 18/kg for FY16 and the rest by oil PSUs is a welcome move for OMCs. We now assume close to nil downstream subsidy share for both FY16E and FY17E of the total under-recoveries. Subsequently, we estimate net under-recovery of IOC at approximately nil in FY16E and FY17E against | 1200.5 crore in FY15.

Operational performance

IOCL reported a GRM of $10.8/bbl in Q1FY16, better than our estimates on account of higher inventory gains and due to higher product crack spreads. However, due to the sharp decline in oil prices and lower global refining margins QoQ, we expect GRMs in Q2FY16 to be subdued. We expect GRMs of $5.7/bbl and $4.4/bbl for FY16E and FY17E, respectively. We estimate throughput of 57.4 mmt and 64.5 mmt for FY16E and FY17E respectively. High marketing margins also led to strong performance from IOC in Q1FY16. However, going forward, marketing margins are expected to normalise over the next two years. We assume retail sales to increase from 72.8 mmt in FY15 to 77.6 mmt in FY17E. With an improvement in IOC’s working capital efficiencies on account of diesel price deregulation, DBT for LPG cylinders and decline in crude oil prices, we expect interest cost of | 3878.1 crore in FY17E against | 3435.3 crore in FY15.

Fairly valued; given the volatility in oil prices and refining margins

The new 15 mmt refinery complex at Paradip will be fully commissioned by end of Q2FY16. Even though the decline in fuel subsidies will improve the visibility of earnings; refining margins will be the key. At the current price of | 395, IOC is available at P/E of 11.7x and P/BV of 1.2x on FY17E numbers. Assuming floor price of | 385-390 and retail investors discount of another 5%, price comes to | 366-371 per share. The stock is fairly valued at the current market prices given the volatility in crude oil prices and refining margins. We value the stock at | 390 (based on average of P/BV multiple: | 405/share and P/E multiple: | 374/share).