IOC v/s Shell: How big is too big??? - Views on News from Equitymaster

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IOC v/s Shell: How big is too big???

Mar 16, 2004

As the second of our series on global comparisons of oil companies, we look into the performances of India's only Fortune 500 representative, Indian Oil Corporation (ranked 191) and the Netherlands based Royal Dutch/Shell. The two major companies follow a similar business model except for the fact that Shell has a presence in the upstream activities of exploration and production (E&P) along with shipping and trading.

(US$m) Shell* IOC**
Net sales 201,932 23,776
Sales per employee 1.8 0.7
Operating profit margin (%) 15.1% 8.4%
Depreciation % sales 5.5% 1.5%
Asset turnover (x) 2.0 4.5
Profit before tax 23,410 1,849
PBT margin 11.6% 7.8%
Net Profit 12,699 1,344
Net profit margin (%) 6.5% 5.7%
No. of shares (m) 3,315.7 1,168.0
Diluted earnings per share (US$) 3.9 1.2
*FY04 data, **FY03 data

Indian Oil Corporation (IOC): IOC is India's flagship oil marketing company with a market share of 56% in the petroleum products business and around 42% of the refining capacity, owning 10 out of the 18 refineries in India. It further owns 7,170 kms of cross-country pipeline network. The company owns over 8,000 petrol/diesel stations and along with subsidiary IBP, accounts for approximately 11,000 retail outlets and has a workforce of 31,500. Also, the company has geographically diversified with operations in foreign nations. It markets lubricants in Dubai, Nepal and other neighbouring countries and has recently ventured into the Sri Lankan markets for marketing of fuels.

Royal Dutch/Shell (Shell): Shell is a global company engaged in the business of energy and petrochemicals having a combined oil and gas production of 4 m barrels of oil equivalent (BOE) per day. Just to put things in perspective, ONGC's production is around 0.5 m barrels of oil equivalent (12.5% of Shell's daily output). Shell has major interests in more than 50 refineries in different parts of the world and has more than 55,000 service stations globally across 145 countries with a workforce of 115,000. It further has diversified into businesses such as energy solutions including transporting and trading oil and gas, marketing natural gas, producing and selling fuel for ships and planes, generating electricity and providing energy efficiency advice. To put things into perspective, the company produces 3.5% of global gas and approximately 3% of world oil produce.

It should be noted that Shell's operating margins are almost double that of IOC, largely due to the fact that the company derives a major chunk of its revenues from exploration and production, which has higher operating margins. Shell also has benefited from higher volumes, prices and robust refinery margins. For instance, it benefited from the demand supply gap created due to the Venezuelan supply disruptions besides the acquisition of Texaco and DEA (a German major) retail assets.

Having said that, the margins would have been better off, but for Shell's chemicals business, which suffered a loss to the tune of US$ 226 m largely due to restructuring and environmental provisions.IOC, on the other hand, had to bear the brunt of subsidies on LPG (Liquefied natural gas) and SKO (Superior Kerosene Oil). To a large extent, higher gross refinery margins and better volumes negated these subsidies.

As far as employee productivity parameters are concerned, Shell compares favourably in terms of sales per employee (1.8x as against IOC's 0.7x) largely due to the fact that Shell derives a major part of its revenues from the exploration and production (E&P) business, which is not highly manpower intensive. Shell's E & P business is a major contributor to its bottomline contributing almost 92% of the net profits.

Further, being highly capital intensive, its asset turnover ratio vis--vis IOC compares poorly (2x as compared to IOC's 4.5x). This is largely due to the fact that Shell's operations are on a higher scale as compared to IOC given that the company is into E & P, shipping, power generation and other highly capital intensive industries such as petrochemicals. Comparatively, IOC's assets are mainly into the downstream business, which is comparatively low capital intensive.

Given the fact that IOC is a major importer of crude in India, we feel that going forward, IOC shall integrate vertically in the value chain and expand its operations beyond domestic horizons. IOC already plans to pick up substantial stake in ONGC's wholly owned subsidiary ONGC Videsh (OVL) so as to acquire oil fields and equity abroad. The company has also planned a petrochemicals complex and has lined up investments to the tune of Rs 64 bn by the end of FY06.

Today, Shell is in a position to exploit the developments in the global oil markets and shall do so in the time to come. However, for IOC to be a major player, it has to integrate across the value chain of the business to become a major force to reckon with and to leave an imprint in the global oil industry.

Comparative Valuations:
Valuation ratios Shell IOC
Current price (US$) 40.5 10.7
P/E (x) # 10.3 9.3
P/CF (x) # 5.6 7.3
# Trailing 12 months

Currently Shell is trading at a P/E multiple of 10.3x its FY04 earnings while IOC is trading at a P/E multiple of 9.3x its trailing twelve month earnings. Though the valuation looks more or less same, despite Shell having presence in almost every aspect of the value chain of the energy business along with its global presence, it has become so as the company announced cutting down of its proven oil and gas reserves by 20%. The company recategorized upto 3.9 bn BOE in an internal review due to technical definitions.

However, Shell deserves a higher valuation vis-a-vis IOC, which has limited presence abroad. Further, Shell's chemicals business is a major concern in its portfolio. The chemicals segment created a dent of US$ 226 m in the company's net income in the last fiscal FY04.

Going forward, Shell is in a position to leverage its expertise across the energy segment and drive growth through its LNG business, which, to a great extent seems to be the fuel of the future. At the same time, IOC is gearing up to acquire stake in LNG businesses and shall utilize its vast expertise in the marketing aspects for further growth.


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