COMPANY UPDATE Sumit Pokharna sumit.pokharna@kotak.com +91 22 6621 6313 OIL INDIA LTD (OINL) PRICE: RS.615 RECOMMENDATION: BUY TARGET PRICE: RS.685 FY16E P/E: 8.4X We expect Oil India Ltd (OINL) to likely create significant value from its current large oil and gas reserves, solid exploration abilities, expected lower subsidy burden, potential domestic natural gas price hike, global foray in oil and gas exploration, etc. Based on the recent developments in the oil and gas ministry, we expect domestic natural gas price to be hiked and implemented from Q3FY15. The extent of domestic gas price hike is not yet clear. However, based on the media sources, we expect the gas price to be meaningfully higher from current levels, going forward. Summary table (Rs mn) FY14E FY15E FY16E Net Sales 91,267 117,370 136,164 Growth (%) -4.4 28.6 16.0 EBIDTA 38,567 51,626 66,866 EBIDTA margin (%) 42.3 44.0 49.1 PBT 43,711 52,664 65,669 Net profit 29,420 35,106 43,999 EPS (Rs) 48.9 58.4 73.2 Growth (%) -18.1 19.3 25.3 CEPS (Rs) 60.8 67.5 83.5 BV (Rs/share) 340.7 378.8 426.4 DPS (Rs) 21.5 17.5 22.0 ROE (%) 13.77 15.36 17.10 ROCE (%) 11.60 16.53 23.6 Net Cash (Debt) 15,138 38,840 53,037 NW Capital (Days) 40.5 43.2 42.5 EV/Sales (x) 3.88 2.82 2.33 EV/EBIDTA (x) 9.2 6.4 4.7 P/E (x) 12.6 10.5 8.4 P/BV (x) 1.8 1.6 1.4 P/CEPS (X) 10.1 9.1 7.4, Kotak Securities - Private Client Research Subsidy burden to lower going forward: We highlight that subsidy-sharing mechanism will likely be the key to OINL's earnings and stock performance. We expect OINL to benefit significantly from a more favorable subsidy-sharing scheme versus the current uncertain one and falling gross under-recovery. Retail fuel under-recovery is expected to be lower mainly due to monthly diesel price hikes, lower crude oil price and stable currency. However, no major reforms/price hikes expected in cooking fuels. We expect OINL to report an EPS of Rs. 58.4 for FY15E and Rs.73.2 for FY16E. We recommend BUY (earlier Accumulate) rating on OINL with a revised price target of Rs. 685/share (earlier Rs.613). Our positive stance on the stock stems from attractive valuations at 8.4x FY2016E EPS given potential benefits in the medium term-(1) higher crude oil and gas realizations led by declining fuel subsidies and increase in domestic gas prices in the medium term and (2) gradual recovery in production volumes given high 2P reserves. Key developments: Crude oil and natural gas production increased post the Assam disruption. The same will be reflected in Q2FY15 and onwards. This will also improve its earnings. We have modeled oil and gas production of ~3.6 MMTPA and ~2.7 BCM for FY15E broadly in line with OINL's management guidance. OINL is expected to drill higher yield horizontal wells, and the crucial Baghjan to Duliajan Tankfarm pipeline is targeted for completion by Sep'14. The management also expects annual run rate to rise to over 3.8 MMTPA by Q3FY15 from the current 3.5 MMTPA. Gas production would continue to improve, though Brahmaputra Cracker and Polymer (commissioning by FY15-end) would take time to consume the full requirement of 1.35 mmcmd. OIL's key domestic green-field assets in KG basin and Mizoram are under drilling. The management expects results of the drilling of the first exploration well in KG to be declared in FY15. OIL aims to drill around six exploration wells in KG/MZ in total, with two wells planned each for the two blocks in FY15. OINL is planning to invest Rs.30 bn in FY15E and Rs.35 bn in FY16E for domestic activity. In FY15, the Company has planned to drill thirty-one exploration wells. Of the three wells that have been drilled in Q1FY15, one has struck oil. The Company is also looking for acquisitions of producing blocks in a range of 10 mn boepd, and has placed a joint bid for Murphy's Malaysian assets. Carabobo is not commercially producing due to technical issues. Till date, OINL has spent more than Rs. 3 bn. Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2
We forecast OIL's net oil realization to rise to US$ 65/bbls from US$ 47/bbls in FY14. We have assumed a conservative gas price hike to US$ 7.0/mmbtu, effective Oct-14. Our positive view on OINL is premised on: 1) Relatively under-exploited resource base; 2) quality assets with relatively low finding and development costs; 3) resilient production growth; 4) strong balance sheet; 5) an attractive valuation; and 6) OINL's potential to maintain a reserve replacement ratio (RRR) of 1. 2P oil reserves at 80mmt. Reserve-replacement ratio in FY14 stood at 1.4. Key risks & concerns Uncertainty over under-recovery sharing could impact valuations. Nationalization of foreign assets (like in Venezuela) by the respective government can significantly impact the valuations of the Company. Significant drop in crude prices and sharp rupee appreciation remains the key downside risks to earnings. OINL has been producing oil from its Assam discoveries from last few decades with recovery factor more than 50%. We believe incremental crude oil production will be more expensive. OINL is initiating significant exploration activity in the NELP blocks, which increases the risks of failures and hence material dry wells write-offs. This can impact earnings and cash flows in the short-run. Any higher rate of royalty imposed by government of India. Key Developments: 1). Clarity in gas pricing and resolution of the subsidy issue would be a material positive for upstream companies. We expect domestic natural gas price to be hiked and implemented by Oct'14 based on the recent developments in the oil and gas ministry. The extent of domestic gas price hike is not yet clear. However, based on the media sources, we expect the gas price to be around US$7.0/mmbtu as against earlier government's recommended price of US$8.2/mmbtu. We believe the new expected price is still remunerative and will boost oil and gas production in the country. We are also hopeful that the new gas price is likely to be same for different producers. The government is also mulling over implementing the sectoral gas pooling, wherein allocation of domestic gas to non-priority sectors (refineries, steel, etc.) would be diverted to priority users (power, fertilizer, LPG, CGD). 2). Oil India's monthly crude oil and gas production details We have modeled oil and gas production of ~3.6 MMTPA and ~2.7 BCM for FY15E broadly in line with OINL's management guidance. OINL is expected to drill higher yield horizontal wells, and the crucial Baghjan to Duliajan Tankfarm pipeline is targeted for completion by Sep'14. The management also expects annual run rate to rise to over 3.8 MMTPA by 3QFY15 from the current 3.5 MMTPA. OINL's crude oil production has seen meaningful ramp-up post-strike called by the All Assam Students Union. OINL's Assam block has meaningful contribution to the total crude oil production. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 3
OINL's monthly total oil production OINL's monthly oil production from Assam block Gas production would continue to improve, though Brahmaputra Cracker and Polymer (commissioning by FY15-end) would take time to consume the full requirement of 1.35 mmcmd. In the recent past, OINL's gas production declined to disruptions in Assam. OINL's monthly total gas production OINL's monthly gas production from Assam block 3). Government focus on production ramp-up: The new petroleum minister has asked OINL and ONGC to focus on increasing the production of crude oil and gas, technological advancements, etc. The government will help them through policies. We expect with proper policies in place, Oil India will manage to ramp-up production in the medium to long term. OIL's key domestic green-field assets in KG basin and Mizoram are under drilling. The management expects results of the drilling of the first exploration well in KG to be declared in Q2FY15. OIL aims to drill around six exploration wells in KG/MZ in total, with two wells planned each for the two blocks in FY15. The Company is also looking for acquisitions of producing blocks in a range of 10 mn boepd, and has placed a joint bid for Murphy's Malaysian assets. 4). Government proposes oil cess for subsidy As per media sources, the oil ministry proposed to rationalize the subsidy-sharing mechanism for upstream oil and gas exploration companies (ONGC and OINL). We believe this will reduce the subsidy burden on upstream PSU companies. The ministry may consider OID (oil industry development) cess paid as part of subsidy share. In return, the companies would need to pay royalty to the states on the full price of crude and not the discounted rate offered to government refiners. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 4
We believe this will bring in clarity on expected return on projects and will boost investment in E&P projects. The new subsidy sharing mechanism would be placed before the cabinet soon for its approval along with the other proposal to decontrol diesel prices. We need to wait for more clarity on the same. Key assumptions: Oil and gas sales volume. We model crude oil sales volume at 3.5 MMTPA in FY15E, 3.5 MMTPA in FY16E and 3.6 MMTPA in FY17E versus 3.47 MMTPA in FY14 and 3.68 MMTPA in FY13. The flat crude production volume in FY15 reflects lower volumes due to the strikes and blockades in the North-East region and also declining production from mature wells. However, the management has indicated that in the medium term production volumes to grow supported by higher 2P reserves and implementation of EOR/IOR techniques in OIL's extant producing fields. Similarly we model gas volumes at 6 mmscmd for FY15E, 6.3 mmscmd in FY16E and 6.8 mmscmd in FY17E versus 5.7 mmscmd in FY14. Subsidy amount We have assumed a decline in subsidy discount for upstream oil companies to US$ 49.5/bbls, US$ 38.1/bbls and US$ 36.6/bbls in FY15E, FY16E and FY17E, respectively versus US$59.3/bbls in FY14. Crude price realizations We assume crude oil prices at US$ 105/bbls for FY15E, US$ 103/bbls for FY16E and US$ 102/bbls for FY17E. However, we would focus more on OIL's net realized crude price and our long-term crude price assumption. We assume net crude oil prices at US$ 55/bbls for FY15E, US$ 65/bbls for FY16E and US$ 65.4/bbls for FY17E. Natural gas price We model domestic gas price of US$ 5/mmbtu in FY15E, US$ 7/mmbtu in FY16E and US$ 7/mmbtu in FY17E for OIL India. Exchange rate We assume rupee-dollar exchange rate for FY15E, FY16E and FY17E at Rs.60/US$, Rs.59/US$ and Rs.58/US$. Capex assumption OINL is planning to invest Rs. 30 bn in FY15E and Rs. 35bn in FY16E for domestic activity. In FY15, the Company has planned to drill thirty-one exploration wells. Of the three wells that have been drilled in 1QFY15, one has struck oil. Valuation & Recommendation- SOTP Our BUY rating and target price of Rs 685, comprises: Core business valued at P/E of 9x FY16E core EPS. We believe PE captures the uncertainty relating to the under-recovery, so we value OINL on a PE basis (value per share of Rs. 526). OINL's investment in Venezuela (value per share of Rs.70) Investment in refinery is considered at book value (value per share of Rs.20) Investment in IOC at 30% discount to current price. (value per share of Rs.51). The company is not interested in selling its recently acquired stake in Indian Oil Corporation. Cash at Rs.18/share (considered at a ~30% discount). Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 5
We recommend BUY on Oil India Ltd with a price target of Rs.685 Our positive view on OINL is premised on: We expect OINL to report an EPS of Rs. 58.4 for FY15E and Rs.73.2 for FY16E. We recommend BUY (earlier Accumulate) rating on OINL with a revised price target of Rs. 685/share (earlier Rs.613). Our positive stance on the stock stems from attractive valuations at 8.0X FY2016E EPS given potential benefits in the medium term-(1) higher crude oil and gas realizations led by declining fuel subsidies and increase in domestic gas prices in the medium term and (2) gradual recovery in production volumes given high 2P reserves. Our positive view on OINL is premised on: 1) Relatively under-exploited resource base; 2) quality assets with relatively low finding and development costs; 3) resilient production growth; 4) strong balance sheet; 5) an attractive valuation; and 6) OINL's potential to maintain a reserve replacement ratio (RRR) of 1. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 6