Good Q1, compelling valuation add to IOC’s allure on Dalal Street

MUMBAI: Indian Oil Corporation ( IOC) is likely to attract investors' attention given the commissioning of its new refinery at Paradip, better than expected performance in the June quarter and inexpensive valuation among all the oil marketing companies (OMCs). The company's net profit in the June quarter was nearly two times the street's estimates and equivalent to 64% of the total projected profit for FY17. This makes case for sizeable earnings upgrade.

IOC surprised the street in the June quarter with an inventory gain of Rs 7,480 crore. While it is a one-off factor, its refining segment may show robust growth due to the commissioning of the Paradip refinery.

The refinery will have a Nelson complexity index of 12.2, a tad closer to 12.5 for Reliance Industries' Jamnagar refinery. The index measures the efficiency of a refinery. The Paradip refinery is expected to touch 90% utilisation in the last quarter of the current fiscal and may contribute nearly 20% to the company's profit in FY19. The company's management has guided for an operating cost of around $1.8 per barrel. Hence, on the basis of the mid-cycle refining margins of $6-8 per barrel, the new refinery may add Rs 7-11 to EPS.
The company is also improving the extent to which its refineries are able to extract petroleum products from crude oil, known as distillate yield. The combined effect of a new refinery and upgraded old refineries is expected to be an increase in GRM to $5.7barrel in FY19 from $3.7barrel expected for FY17.

IOC's enterprise value ( EV) is 4.3 times operating profit before depreciation (EBITDA) based on FY18 expected earnings compared with that of peers at around 5.4. Over the next two years, the company's return on equity is expected to match that of another state OMC and therefore the valuation differential is expected to converge.