Macquarie : Indian Oil -Near-term earnings slipping on subsidy; Reasonable valuations

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Indian Oil
Near-term earnings slipping on subsidy; Reasonable valuations

Event
 IOCL announced a PAT of Rs16.3bn for Q3FY11, which was materially lower
than our estimates due to a higher than expected subsidy burden and lower
than expected inventory gains. We reduce FY11-13 earnings estimates by 3-
8% on higher subsidy burden expectations due to spiralling product prices,
and cut our TP to Rs416 (-12%). However the Oil Marketing Companies
(OMCs) are potential safe-havens in falling markets. We maintain Outperform.

Impact
 GRMs at US$6.3/bbl; Volumes +7% YoY on Panipat refinery expansion:
While GRMs declined 3% QoQ and were mildly below expectations due to
lower inventory gains, throughput (13.3 MMT) was up 7% YoY due to the
expansion of the Panipat refinery, which was completed last quarter.
 Retail sales up 4.6% YoY; Under-recoveries rose 35% QoQ to Rs37bn:
With auto-fuel demand growing in excess of 10% YoY, retail sales of IOCL
have risen 4.6% YoY to 17.3 MMT. With increased crude prices and growth in
sales, IOCL’s under-recovery YTD burden has risen to Rs57bn, despite a lastminute allocation of Rs 18bn by the Govt, in addition to Rs44bn in Q2.
 Increased under-recoveries to dampen-earnings: Crude prices have been
spiralling up, with Brent having touched US$101/bbl on the back of demand
pickup, aided by concerns on continuity of trade through the Middle East
(especially Egypt) due to socio-political unrest. High product cracks (US$ 14-
16/bbl for middle distillates Diesel, Jet-Kerosene) have further exacerbated
under-recoveries for OMCs, with Diesel margins hovering at a negative Rs7/lt.
We estimate OMCs shall bear Rs 67bn (8%) of Rs750bn expected total under
-recoveries in FY11E vs Rs56bn in FY10 (IOCL to share ~Rs37bn).
Earnings and target price revision
 IOCL FY11E PAT reduces ~3% for every increase of 1% in under-recovery
share of the OMCs. We cut FY11-13E PAT estimates by 3-8% on the back of
increase in subsidy-sharing assumption for the Oil Marketing Companies from
~5% to 8%, partially offset by improved petrochemical margin outlook. The
value of investments of IOCL has also declined by ~Rs10/sh. Consequently,
IOCL’s SOTP has been reduced to Rs416 from Rs473 earlier.
Price catalyst
 12-month price target: Rs416.00 based on a Sum of Parts methodology.
 Catalyst: Diesel price hike / deregulation
Action and recommendation
 With inflationary concerns preventing price hikes, and a high fiscal deficit
raising risks of a higher subsidy share for OMCs, the stocks have already
declined 21-36% in 4 months. OMCs are good defensives, and IOCL is
available at cheap valuations of 1.3x FY12E P/BV and 8.2x FY12E PER.
IOCL’s FPO next year could necessitate regulatory triggers to boost earnings.