19 August 2011

Indian Oil -- High subsidy pushes bottomline into red :: Macquarie Research,

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Indian Oil
High subsidy pushes bottomline into red
Event
 IOCL announced a 1Q FY12 net loss of Rs37.2bn, which, when adjusted for
the limited subsidy reimbursement by the government, was ~10% below our
estimate due to mildly lower GRMs. First-quarter earnings for oil marketing
companies (OMCs) are typically the worst for the year (especially during high
crude prices regimes) due to large subsidy payouts being delayed by the
government; but they are not representative of earnings potential as subsidies
get finalized on an ad-hoc basis at year-end. We maintain our OP with a TP of
Rs412, and we recommend the stock as a cheap (1.3x FY12E P/BV)
countercyclical play in volatile, bearish market conditions.
Impact
 GRMs at US$4.7/bbl up 57% YoY; refinery volumes +7.7% YoY: High
product cracks (>US$15/bbl for gasoline and middle distillates diesel and jetkerosene)
kept GRMs healthy. However, they fell sharply QoQ due to a lack
of crude inventory gains that boosted GRMs in 4Q FY11.
 Upstream shared 33%, government 35%; net losses of Rs77bn for 1Q
FY12: The government allocated Rs82bn cash to IOCL (Rs150bn total to
OMCs), while upstream sharing reverted to the usual metric of 33% (from 38%
in 4Q FY11); hence, IOCL had net losses of Rs77bn for 1Q FY12. We expect
OMCs to share Rs80bn (7% of under-recoveries) in FY12 (Rs45bn by IOCL).
 Subsidy reduction to US$18bn possible through multiple drivers: The
increase in retail prices of petro products and duty cuts on auto-fuels and
crude in July have reduced FY12 under-recoveries by ~30% to US$26bn. A
recent sharp fall in crude prices of ~11% (Fig 10) has slashed diesel underrecoveries
to almost nil, while gasoline has entered over-recovery (Fig 7). At
the current run rate, we think FY12 under-recoveries could fall to ~US$18bn.
 Intensification on proposals for structural shift away from subsidy:
Political consensus is being built regarding reducing the quantum (through
limiting subsidised cylinders to 4-6/year) and ambit (through targeting them at
income groups above Rs0.6m/year) of the LPG subsidy and moving to a
cash-based subsidy transfer, possibly by 2012. Dual-pricing of diesel is
another proposal to curtail subsidies for passenger cars. All these measures
not only alleviate the burden on OMCs’ incomes, but also reduce the linked
working capital (and hence interest costs).
Earnings and target price revision
 No significant change to earnings. TP maintained at Rs412.
Price catalyst
 12-month price target: Rs412.00 based on a Sum of Parts methodology.
 Catalyst: A further decline in crude prices, subsidy reforms.
Action and recommendation
 We continue to believe that oil marketing companies offer a safe haven in
falling markets. With global macro-uncertainties looming large and crude
prices cooling on the back of that, OMCs provide an Indian domestic
consumption-linked investment avenue that is inversely correlated to falling
markets and crude.

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