Indian Oil Corporation: Fuelling capacity

Shrugging off demonetisation blues, the stock of Indian Oil Corporation, resumed its rally over the past month or so. The stock is now touching its all-time highs, more than tripling over the past three years. This has been backed by a strong turnaround in its performance, aided by fuel pricing reforms, the rout of crude oil and expansion initiatives.

The company’s profit more than doubled year-on-year in 2015-16 and again almost doubled in the half-year ended September 2016. As a result, the stock, despite its huge rally, is not pricey. At ₹352, it trades at about 11 times trailing 12-month earnings, a tad higher than its three-year average of about 10 times and in line with its five-year average.

Investors with a long-term perspective can buy the stock. The company’s prospects seem promising. An enabling pricing environment, significant benefits from the Paradip refinery, expansion/diversification moves, and strong financial position should help Indian Oil benefit from the healthy demand potential for oil and gas products in the country.

The fuel pricing reforms over the past few years — petrol and diesel decontrol, direct bank transfer of LPG subsidy, and gradual hikes in kerosene and LPG prices — brought about structural benefits for the public sector oil marketing companies. Their subsidy burden was eliminated, borrowings and interest cost reduced sharply, and marketing margins improved.

From ₹1,200 crore in 2014-15, Indian Oil’s subsidy burden fell to ₹9 crore in 2015-16 and to nil in the first half of 2016-17. Borrowings also came down, with consequent reduction in interest cost — down 13 per cent year-on-year in 2015-16 and 6 per cent in the first half of 2016-17.

Also, Indian Oil’s gross refining margin (GRM) — the difference between the price of its product basket and the cost of crude oil — improved from $0.27 a barrel in 2014-15 to $5.06 a barrel in 2015-16, and to $7.19 during April to September 2016. All of these have contributed to the company’s strong financial performance.

Recent price hikes in petrol and diesel suggest that market-linked pricing is here to stay and the Centre is unlikely to backtrack on fuel price reforms.

Also, it seems unlikely that oil price will rise sharply beyond $60 a barrel, given the global demand-supply dynamics, especially the possibility of US shale oil production coming back strongly around these levels. In the near term, higher oil prices could mean inventory gains for oil companies. It also helps that GRMs have been healthy in the December quarter. But this is cyclical with ups and downs.

In the coming years, Indian Oil’s refinery and petrochemicals capacity expansions should aid margins and earnings growth. The 15 million tonnes (mt) Paradip refinery, commissioned last year, is operating at about 65 per cent capacity and is expected to ramp up to full capacity in 2017-18.

This state-of-the-art refinery will add to the company’s volumes, give a boost to its overall GRM, thanks to its high complexity, and add to geographic reach in East and South India. Besides, the company plans to expand and upgrade its existing refineries to raise capacity to over 100 mt by 2022 from about 80 mt currently.

It is also exploring the possibility of setting up a mega-refinery (60 mtpa) on the west coast in collaboration with HPCL and BPCL; Indian Oil will hold half the stake. The company is also expanding its petrochemicals business which has high potential and acts as a hedge in tough refining markets.

Indian Oil is also investing to expand beyond the downstream business. Through its subsidiary, the company recently acquired stake in a couple of Russian upstream assets in joint venture with subsidiaries of BPCL and Oil India. Indian Oil has 45 per cent stake in the upcoming 5 mtpa liquefied natural gas (LNG) terminal in Ennore, Tamil Nadu, and has entered into an agreement to take up 39 per cent stake in the 5 mtpa LNG terminal being set up in Dhamra, Odisha.

A strong balance sheet with debt-to-equity of less than one time gives the company enough headroom to raise funds.

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