Buy Indian Oil Corporation Ltd For Target Rs.92 - HDFC Securities
IOCL’s marketing sales have improved from April 2020 lows but are still lower YoY. Fuel demand in July fell MoM due to localised lockdowns and monsoon. From September, fuel demand has improved MoM and in the first half of October, fuel demand has risen to pre Covid levels. Post excise duty hike in May 2020, IOC increased retail prices by Rs 9-12/litre, which has led to steady marketing margins. Rising prices and/or reducing subsidies on LPG cylinder augurs well for the IOCL. Deregulating LPG would boost the working capital of IOCL. However, the government’s resolve would be tested if oil prices spike.
Global demand recovery is likely to remain capped in the near term with concerns over high inventory and further delayed recovery in Jet fuel demand. We expect crude throughput of 63.4/71.1mmt and GRM of USD 3.4/3.9 per bbl in FY21/22E as the economy recovers. OMCs are currently making marketing margin of ~Rs 3.5-4.5/liter on petrol-diesel, which is slightly higher than the long-term average.
IOC expects to add 1000 outlets and also invest on upgrading existing outlets in fuel retailing. IOC is already setting up EV charging centers. Most of the new outlets will be added in class ‘B’ towns at a lower cost per outlet ~ typically Rs 0.50- Rs1 crore. The annual capex will go towards this expansion and support infrastructure like tankages, pipelines and surveillance as well as technology.
Valuations and Recommendations:
IOCL is well-placed to take advantage of the improved demand outlook as the economy opens up and can deliver overall throughput much higher than the industry average. As petroleum products are essential services, IOCL’s refining and marketing operations continued despite the lockdown and has got back to almost normalcy. Also we expect, further improvement in demand to normal levels, upon full lifting up of the lockdown and stabilisation of economic activity. However, the net sales may remain subdued in Q2FY21. IOCL’s refining margins are likely to bottom-out in its cyclical downturn, going forward. We expect recovery in both margins as well as volumes. Its strong operational profile driven by dominant market position supported by established marketing and distribution network and sizable refining capacity makes us positive on the stock.
IOCL’s value of investments and non-core assets (Chennai Petroleum Corporation Ltd, Petronet LNG, Lanka IOC, ONGC, GAIL, OIL India other subsidiaries and JVs) account for nearly its entire value, indicating that the market is ascribing no or negligible value to its core refining and fuel marketing businesses.
Oil Marketing Companies are trading at close to five year lows in terms of Price to Book & at valuations similar to regulated regime (2009 - 2014) which had structural issues like no pricing freedom and subsidy concerns. In the current period, the low GRM due to depressed global demand is compensated by high marketing margins. Moreover, BPCL’s privatisation (as and when it happens) has the potential to significantly re-rate refining and marketing business of HPCL and IOCL.
Investors could buy the stock at the LTP and add on dips to Rs 69 (valuing refining, marketing and pipeline and Petchem businesses at 4.0, 4.0, 4.5 and 4.0 times EBITDA multiple +value of other listed and unlisted investments). Based on SOTP valuation, Base case fair value of the stock is Rs 87 (valuing refining, marketing and pipeline and Petchem businesses at 5.0, 4.5, 5.0 and 5.0 time EBITDA multiple +value of other listed and unlisted investments) and the bull case fair value of the stock is Rs 92 (valuing refining, marketing and pipeline and Petchem businesses at 5, 5, 5 and 5 time EBITDA multiple +value of other listed and unlisted investments) over the next 2 quarters.
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