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Value in serendipity; upgrade to Buy

* We consolidate Numaligarh Refinery into Oil India with a revised Sep’22E SOTP TP of Rs255 (previously Rs165 for Mar’22E). OIL’s core outlook is positive with crude at USD70+ and gas prices on an uptick. We do not build in any output growth despite management’s optimism.

* Although we believe NRL’s acquisition should have been 100% with the Assam govt allotted OIL’s share instead, the effective 69.6% stake is also material. OIL stands to benefit from NRL’s massive excise duty-driven earnings and its ongoing 3x capacity expansion.

* It is difficult to assume NRL’s current 50% excise-reimbursement benefit would continue indefinitely (though OIL management believes so). Nonetheless, we value NRL using DDM at Rs76/share, assuming 25% excise-reimbursement on expanded capacity.

* We bake in USD65 Brent/4.5 APM for the long term and value S/A using DCF now. OIL should receive Rs13-15bn in annual dividends from NRL and IOCL in the next 5 years; these, if upstreamed, could result in a 45%+ payout and a 7% yield at CMP. Upgrade to Buy from Hold.

NRL’s excise duty-driven GRMs a material anomaly, OIL an inadvertent beneficiary: BPCL’s upcoming disinvestment and Assam Accord restrictions have made OIL an unintended beneficiary of NRL. NRL’s product slate is strong with a 90% auto-fuels share in output and a normalized 10-year average GRM of USD8/bbl. However, opex/bbl is also USD8+ due to staff cost, freight, duties and power & fuel being much higher than peers like MRPL and CPCL.

This is the reason why 50% excise duty retention was provided to Northeast refineries. But with auto-fuel excise being raised to Rs30/ltr+, NRL’s earnings surged in recent years. In FY21, NRL’s book gross profit of Rs57bn (USD39/bbl) had ~Rs49bn of excise duty benefits. With NRL going for a 3mmtpa to 9mmtpa expansion, if benefits are retained, profits can jump from Rs31bn in FY21 to Rs100bn in 7-8 years. It is difficult to build a long-term scenario.

Northeast transport fuel demand should reach 5-6mmtpa by the time NRL expands to 7mmtpa+ of output; hence, NRL has to continue selling in the rest of India (it has signed a deal with BPCL). NRL is also setting up a 1mmtpa HSD export pipeline to Bangladesh.

We see OIL as a dividend play over longer term, standalone outlook stable: On the back of multiple scenarios for NRL over the long term, we build in a 25% excise duty benefit on expanded capacity and value it using DDM (12% WACC, 0% TG) as that would be the real economic benefit for OIL. Despite B/S turning net cash in the long term, we cap our DPR at 50%. Adjusted for Rs63bn of acquisition debt, we arrive at Rs76/share value for NRL. We value OIL S/A using DCF and expect it to benefit from higher oil and the upcoming gas price rise.

OIL’s management is optimistic on Baghjan (3mmscmd of gas uptick by FY25) and has identified five fields for raising crude output. However, OIL should see a 5% standalone FCFF yield and with Rs13-15bn of dividend income, it can have a 45% payout - an attractive 7% yield. If OIL intends a back-ended deleveraging, then at a 70% DPR, yield comes to 12%. The stock trades at 3x Sep’23E consol PE. We upgrade OIL to Buy with an OW stance in EAP.

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