Oil India: On A Strong Footing

Oil India’s valuation at this offer price is closer to ONGC’s, which could limit its upside in the short term. But long-term investors may subscribe to it

THE IPO of Oil India offers an investment alternative to those seeking to gain from India’s oil sector. The valuation is similar to that of ONGC, which means investors cannot hope for much short-term gains. However, the company appears great for a long run investor.

Business:

Oil India (OIL) is a Category-I Miniratna public sector petroleum exploration and production (E&P) company operating out of India’s North-eastern region. Its daily production of crude oil at 68,358 barrels and natural gas at 6.2 million cubic meters represented nearly 10% of India’s total crude oil and 7% of natural gas production in FY09. Apart from its fields in the upper Assam basin, OIL holds stakes in 24 NELP exploration blocks domestically and 17 blocks overseas. The company’s proved petroleum reserves are estimated at 284.9 million barrels (mb) of crude oil and 39.2 billion cubic meters (bcm) of natural gas. The company also operates 1,157-km crude oil pipeline which can transport 44 mb oil annually. It also holds 26% stake in Numaligarh Refinery, 10% stake in the Brahmaputra Cracker project and 23% stake in Duliajan-Numaligarh pipeline project.

Over last five years, the company’s oil production has increased at a compounded annual growth rate (CAGR) of 2.8% to 24.95 mb, whereas, the natural gas production grew at 3.1% during the same period to 2.27 bcm in FY 09. For the Jun 09 quarter, the production stood at 6.34 million barrels of oil and 0.6 bcm of gas .

IPO Details:

The company is offering 2.4 crore equity shares of Rs 10 each to raise up to Rs 2,777 crore. The government of India, which currently owns 98.1% in the company, will sell an additional 10% stake to three oil marketing companies bringing down its stake to 78.4% of the post-issue equity. The company plans to invest around Rs 4,560 crore over FY10 and FY11 in E&P business. Out of this, Rs 752 crore will be spent on seismic data acquisition, Rs 2,075 crore on drilling a total of 73 exploratory wells. Another Rs 997 crore will be spent on drilling 90 developmental wells. Besides, the company will invest Rs 686 crore in equipment and creating infrastructure facilities.

Financials:

Oil India’s net profit has increased at a CAGR of 19.5% during FY05 to FY09 period, while the sales grew at 16.5%. OIL is a debt-free company carrying over Rs 6,500 crore of cash, which has resulted in 43% of its net profit coming from other income. The company enjoys substantial operating cash-flows, which exceeded Rs 2,900 crore in FY09.

In other words, the IPO proceeds will just add to the company’s cash pile and boost other income in the near term. Too much cash on the books will however depress the return on networth and thus act as a drag on the stock price. Oil India’s earnings are more sensitive to the movement in oil prices as its subsidy burden is substantially lower compared to ONGC. During FY09, Oil India had to offer just $26.1 per barrel discount as compared to $38.5 for ONGC.

Valuations:

At the higher price band of Rs 1,050, the company will be valued at 12 times its earnings for the 12-month period ended June 2009. ONGC, which is nearly 10 times bigger to Oil India, is currently trading at 12.8 times its consolidated annual profits. Amongst others, Cairn has just commenced production from its Rajasthan fields making its financials incomparable, while Hindustan Oil Exploration and Selan Exploration are too small for comparison purpose.

Risk Factors:

All the company’s petroleum reserves are concentrated in the upper Assam basin and are in a natural decline phase. The company has been highly conservative in expanding its reserve pool depending on small and medium size discoveries to ensure future production growth. Volatility in the crude oil prices will be an important concern going forward. Similarly, the subsidy share of Oil India could fluctuate wildly due to its ad-hoc nature.