February 27, 2011

Analysis : OIL India

About
Oil India an E&P company (oil exploration and drilling) which came out with an IPO in 2009. The company is a category – I, miniratna which allows them operational flexibility from the government (atleast on paper). The company operates mainly in the north-east with additional fields in Rajasthan and a few JVs in the foreign markets such as Iran, Sudan and Venezuela.


Financials
The company has delivered fairly good results over the last few years. The company has been able to deliver an ROE in excess of 20% from 2003 onwards (the year from which the results are available). If one excludes extra cash on the balance sheet, then the return on capital is in excess of 50%. The company is debt free and has excess cash to the tune of 30% of its market cap.

The company has delivered a topline growth of around 15% per annum for the last 8 years and net profit growth of 24% per annum during the same period. The company had a topline of around 8859 Crs and profit of 2610 Crs in 2010. The company has been able to generate a net margin in excess of 25% and fixed asset turns in the range of 1.7-2. The company operates with low working capital requirement and has also operated with negative working capital for a couple of years.

The company has been able to invest the internally generated cash to acquire new assets (exploration blocks in India and abroad) and thus maintain and grow its oil reserves at a decent rate.

Positives
The company has a great balance sheet. It has almost 9000 Crs of excess cash on its balance sheet. This cash can be used by the company acquire oil assets and thus grow the business.

In the oil and gas business, the only way to grow the business is to continuously acquire rights to new oil fields and carry out exploration (read drilling) activities. The nature of the business is such that a few of the exploratory wells will be unsuccessful (no oil or gas), but the successful ones will more than cover for it and more. In addition new technologies such as 3D seismic surveys help the companies in finding attractive places to drill so that the chance of finding oil or gas is higher (and lower the chance of drilling a dry well which is literally a sunk cost).

The company has been able to grow its oil reserves from 33 MMKL to 38.3 MMKL and gas reserves from 29.1 MMKL-OE to 37.9 MMKL-OE in the last 5 years. Higher the oil reserves, higher the oil & gas which can extracted and hence higher the topline and profits.
In addition to the above positives, the company has been able to improve its return on capital by increasing the total asset turns from around 0.95 in 2003 to almost 1.7 in 2010. The company also pays almost 35% of its profits via dividends

Risks
So whats not to like in the company? On the face of it the company has great margins, high return on capital, great balance sheet and good growth prospects (India needs more oil and gas).

There is one word for the key risk – Government of India. Currently OIL India shares almost 33% of the fuel subsidy with the rest being borne by the downstream company. If you have been following the news lately, you must noticed that oil recently crossed 100 $ a barrel. The state owned oil companies as a whole are losing money at the rate of almost 1lac crore/ annum (no it’s not a typo).

The India government has two options – raise the price of fuel or pay for the subsidy through the budget. The government may raise fuel prices by a bit, but it is a politically difficult decision. The other option is to take the subsidy on the budget and blow a hole in the deficit. The third option can be a mix of these two options and to get the upstream oil companies to share the loss.

If the downstream companies such as IOC, HPCL are bleeding money, how likely is it that the government will allow the upstream companies like ONGC and OIL to make decent profits? What stops them from increasing the subsidy burden?

The last time oil prices crossed 100$/ barrel (2008), the company was able to maintain the margins and the subsidy burden did not hurt the margins. So we have some level of comfort from the recent history, though the price spike was for a short period. We do not know how the government will react if the oil prices remain elevated for a long period of time.

Conclusion
I currently have no position in the stock. I am not able to evaluate the above risk. It may just be that I am over estimating the risk. At the same time one has to consider the possibility that oil could remain over 120 levels and the government may decide to increase the subsidy sharing, driving down the company’s profits.

If the above risk materializes and every other analyst is screaming a sell on the stock – it may be a good time to buy.

15 comments:

C said...

"If the above risk materializes and every other analyst is screaming a sell on the stock – it may be a good time to buy." ---- This is a fantastic conclusion :-)

Raja said...

Hi Rohit,

Are you following the Mphasis story ?
Have any views on the same ?

Regards
Raja

Sachin Purohit said...

Any government oil/gas company is potentially a value trap. Again we are in a crude price uptrend and the government is under growing pressure to not raise prices of petroleum products. Though petrol/diesel prices may be allowed to float to some extent, kerosene and LPG won't rise. Yet in the latest budget, the government has projected a lower subsidy on petro/food/fertilizers. This could mean either:

1. The government will allow the prices to rise (sounds improbable)
2. Pay more attention to preventing theft/adulteration etc and thus a lower offtake of kerosene (The cash transfer subsidy mechanism does not come into play till June 2012)
3. Government will ask upstream oil/gas companies to share a higher burden of the under-recoveries

3. seems more likely than anything else. As a side-note, there was a gap of Rs.50000 Crores between what Pranabda projected last year as the total subsidy burden for 2010/11 and what he eventually paid. Yet he met his deficit targets. That's not some baba-bengali magic. He had 3g auction to absorb this underestimation. The current year does not have any such windfall.

I think PSUs that are at the mercy of government whims are better avoided. Balmer Lawrie though is different in the sense that the businesses it is into are not directly perceived to be causing inflationary pressure.

RAYHAAN said...

HI ROHIT,
kinda having a joel greenblatt hangover ( just read you can be a stock maket genius too.extremely awsome!, PLEASE PLEASE CHECK IT OUT IF YOU HAVENT) anyways prof greenblatthas pointed out to spinoffs as an area rich with mispricing, with that that in mind just saw the recent bio green industries demerger on the bse rss feed,the co. is persuing a demerger in a ratio of 1:1 between its kraft paper and duplex board division and bio fuels division.(sorry no a/c or a.r available yet) please have a look

Mohit Rathi said...

Rohit

I have this stock and dont intend to sell soon. You don't invest in IPOs so I think you missed out on this one at a cheap price (due to poor performance of NHPC IPO).

Cash on books should top 12000 crores this year (Close to 40% Market Cap).

The subsidy risk has always been there and will probably go down through the years with some deregulation and other tweaks.

The company's technical ratios related to search, extraction, etc. are world class.

Below 1200, I feel, its a very good compounding investment. You don't seem to have time horizons, so, I think you should place it on your buy list. MOIL (another recent IPO) is another stock in the same category. You should have a look.

Rohit Chauhan said...

Hi raja
havent looked at mphasis for a long time. is there something new there ?

rgds
rohit

Rohit Chauhan said...

hi sachin
you hit the nail on the heat. OIL india has very real risk ...it may be a low risk - but if the oil prices spike, then all bets are off.
rgds
rohit

Rohit Chauhan said...

hi rayhaan
yes goel greenblat book is great and spinoffs are a good opporuntity. for ex: kesar sugar had one ..let me look at the example you mention

rgds
rohit

Rohit Chauhan said...

Hi mohit
i agree on the all the fundamentals. its a great company ...i have compared the company with other US oil majors too like exxon mobil, chevron and the company compares well with them.

my issue is not with the company, but the majority shareholder - which treats this company as a piggy bank. i am not sure how the GOI will behave if oil spikes. they have managed to mess up HPCL, BPCL etc. what stops them from doing the same to OIL or ONGC. i dont have a good answer for that.

i will look at MOIL ...

as far as IPO are concerned, i generally stay away from them. it is usually trying to find a needle in a haystack as most are overpriced and the few which are not, the allotment is low

rgds
rohit

Navjot Kashyap said...

Hi Rohit,
You need to understand some things. Oil

industry has broadly 3 parts - exploration

and drilling, refining and distribution.

Most companies do not take part in all 3.The

risk involved in exploration and drilling is

limited to the cost of exploration and

getting land, drilling and other rights and

licences. So in order for an exploring

company to make profits it has to just make

sure that the amount spent on getting the

oil i.e. the crude oil is less then the

total price they sell the crude oil at. Not

a major risk. This company will make

truckloads of money when world crude oil

price heads north and they are allowed to

sell their crude oil at world market price.

But in India they are not allowed GOI sets

prices and contracts at rates to buy crude

oil for them. Even then risk is not much

although profits are limited. That is why

Oil India did not loose money in 2008 when

crude was at 150USD.
Second comes refining of crude to petrol,

diesel etc. like reliance industries, ongc

etc. They charge money on the amount in

volume of crude oil processed by them. They

don't buy crude oil, don't sell it, just

refine it. So, if crude goes from 20 USD to

200 USD they are least bothered. Because

their profits increase by increase in demand

i.e. the volume of crude they process not its price. Thats why Ongc, Reliance did not loose money in 2008.
The third is the distribution companies i.e. BPCL, HPCL..etc who buy crude oil..give it to refine to a refining company - collect the petrol, diesel and sell it through petrol pumps. These companies are roally screwed when crude price rises and they are forced to sell low.
So, my question is - Is Oil India only in exploring and drilling and not in refining and distribution and have no future plans to distribute. If yes, then it has NO crude oil price risk.Hi Rohit,
You need to understand some things. Oil

industry has broadly 3 parts - exploration

and drilling, refining and distribution.

Most companies do not take part in all 3.The

risk involved in exploration and drilling is

limited to the cost of exploration and

getting land, drilling and other rights and

licences. So in order for an exploring

company to make profits it has to just make

sure that the amount spent on getting the

oil i.e. the crude oil is less then the

total price they sell the crude oil at. Not

a major risk. This company will make

truckloads of money when world crude oil

price heads north and they are allowed to

sell their crude oil at world market price.

But in India they are not allowed GOI sets

prices and contracts at rates to buy crude

oil for them. Even then risk is not much

although profits are limited. That is why

Oil India did not loose money in 2008 when

crude was at 150USD.
Second comes refining of crude to petrol,

diesel etc. like reliance industries, ongc

etc. They charge money on the amount in

volume of crude oil processed by them. They

don't buy crude oil, don't sell it, just

refine it. So, if crude goes from 20 USD to

200 USD they are least bothered. Because

their profits increase by increase in demand

i.e. the volume of crude they process not its price. Thats why Ongc, Reliance did not loose money in 2008.
The third is the distribution companies i.e. BPCL, HPCL..etc who buy crude oil..give it to refine to a refining company - collect the petrol, diesel and sell it through petrol pumps. These companies are royally screwed when crude price rises and they are forced to sell low.
So, my question is - Is Oil India only in exploring and drilling and not in refining and distribution and have no future plans to distribute. If yes, then it has NO crude oil price risk.

Rohit Chauhan said...

Hi navjot
your argument is true when the pricing is set by the market and there is no government forcing companies to share a subsidy burden. My point is - how do you evaluate the risk if the pricing is government controlled and the oil sector companies share the subsidy

for argument sake lets say oil goes to 150 and stays there for 12 month (not unimaginable scenario ..though low probability)

how long can the government bleed the downstream companies ? till they have 0 net worth ? after that what ? - raise prices or take something more from the upstream companies

the government is only looking to get re-elected and does not care for the shareholder. you can witness the madness in the sugar industry which is highly controlled.

2008 had a spike for 8-10 month..my concern is what happens when the spike lasts longer

btw - the first statement -there are several companies out of india such as exxon mobil which cover the entire value chain. if you are interested in the O&G sector, read the AR of these companies. will give a good insight

rgds
rohit

Raja said...

Hi Rohit,

Yes. there is li'l bit of news there. Let me try to give you li'l bit of heads up.

There seems to be a reported corporate governance issue and bad quarterly results which has taken the stock down from close to 700 levels in last week of Feb to below 400 levels today. They reported a 3% increase in sales and 15% drop in profit QoQ in their recent quarterly earnings. The reported drop in profit is attributed to the news of some (trade?) discounts given in pricing to hp (parent company - accounting for 68% of the revenue)

That event was followed up by some clarifications from mgmt such as the one given here (main point in the interview is only 1% of decline can be attributed to the trade discount):
http://www.moneycontrol.com/news/business/mphasissayswillnotdropratecardforparenthp_527502.html

From what is common knowledge about the way hp services unit works is this. The country from which a particular business contract originates, that countries hp unit bills the customer in local currency and tries to get the job done from low cost countries like India and pays the low cost country resources a fixed price based on man day effort required quote etc. That's why most of these MNC unit's here in India are called cost centers who never make any profit.

Given this model, i don't know how long they can put up with the pain of having a unit here which tries to have it's own profit and loss account, shareholders to deal with and still have close to 70% of the unit's revenue billed to itself.

So, am just thinking may be some day Mphasis will go the erstwhile digital Globalsoft way which hp de-listed in 2003 roughly 5 years after hp took over compaq(parent of digital). It's been 3 years now since hp took over EDS(parent of Mphasis).

Will love to hear if you have any views on the same.

Regards
Raja

Rohit Chauhan said...

Hi raja
i am not understanding your comment. is it referring to OIL india or some other company ?

rgds
rohit

Raja said...

Oh!!

I thought you will be able to link the comment to my earlier one on this post regarding Mphasis :)

You had asked if there is any news, and i provided the news :)

Regards
Raja

abhishek singh said...

It necessary to know about the value of resources.
Thank you,
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