IIFL: Oil India : BUY with a target price of Rs1,750.

Further de-regulation to improve earnings visibility
Government of India has shown a strong intent to ease out the
subsidy burden on the upstream and downstream players in the
domestic oil and gas industry. Bold moves such as complete deregulation
of petrol prices and 8-10% hike in product prices have
been well appreciated by the street (10-15% stock price returns).
These steps have partially mitigated the overhang of uncertainty on
the earnings of these players to some extent. Furthermore, the
government has announced that even diesel prices would be
completely de-regulated in the due course. Any such moves will
enhance earnings visibility for companies such as Oil India Ltd
(OINL). For an increase of US$5/bbl in net realization for OINL, its
earnings in FY11E and FY12E will rise by 11% and 11.5%
respectively.
Strong cash flows to emanate from gas price hike
In another intrepid move the government hiked APM gas price by
130% to US$4.2/mmbtu. Prior to the move, despite gas contributing
to ~35% of OINL’s production in terms of tons of oil equivalent, its
contribution to revenues and operating profit was meager at ~7%
and ~10% respectively. With more than doubling of gas realization,
revenue contribution will improve to ~16% by FY12E. With entire
hike flowing down to the operating level, OPM is expected to expand
by 200bps over the next couple of years. Additionally, cash flows
should improve leading to better fund availability for its aggressive
exploration plans in the future.
Valuation discount to global peers to narrow down
Historically, OINL has been trading at a steep discount in terms of
EV/BOE in comparison to global peers. The key reason had been the
uncertainty in earnings caused by the subsidy overhang. We believe
the discount should narrow down as government initiatives have
improved earnings predictability for OINL. Furthermore, it is
expected to deliver better production growth rates for both crude oil
and natural gas. Its strong balance sheet (zero debt and cash of
Rs355/share in FY10) coupled with Rs24bn and Rs27bn worth free
cash flows in FY11E and FY12E, should provide financial muscle for
inorganic initiatives. We recommend BUY with a target price of
Rs1,750.