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IOC: Paying for the policies…

Nov 30, 2004

Performance summary
Indian Oil Corporation, the country’s largest downstream petroleum sector company, posted a decent growth in the top-line in 2QFY05 with nearly 20% while the bottomline dipped by over 31% as a result of a freeze on pricing by the government in the face of rising input costs. Being a major player in the LPG segment, IOC took the largest hit on the subsidies front as LPG prices zoomed to over US$ 467 per tonne, as retail prices remained relatively unchanged.

What is the company’s business?
IOC is the country’s largest downstream oil refining and marketing company accounting for over half the number of retail outlets along with its subsidiary IBP. Indian Oil is also the country’s largest refiner, with ownership of 10 out of the 18 refineries in the country. It imports over 33% of the crude oil imported by the country and has nearly 55% market share in the petroleum products segment.

(Rs m)2QFY042QFY05Change1HFY041HFY05Change
Net sales 265,684 317,646 19.6% 542,736 634,152 16.8%
Expenditure 242,097 299,030 23.5% 502,349 588,895 17.2%
Operating profit (EBDITA) 23,588 18,616 -21.1% 40,387 45,258 12.1%
EBDITA margin (%)8.9%5.9% 7.4%7.1% 
Other income 4,799 4,552 -5.1% 6,997 5,847 -16.4%
Interest 847 1,281 51.3% 1,996 2,547 27.6%
Depreciation 4,595 6,164 34.2% 9,147 10,990 20.2%
Profit before tax 22,945 15,723 -31.5% 36,241 37,569 3.7%
Tax 4,878 3,328 -31.8% 8,727 10,452 19.8%
Profit after tax/(loss) 18,068 12,395 -31.4% 27,514 27,117 -1.4%
Net profit margin (%)6.8%3.9% 5.1%4.3% 
No. of shares (m) 1,168.0 1,168.0   1,168.0 1,168.0  
Diluted earnings per share (Rs)* 61.9 42.4   47.1 46.4  
Price to earnings ratio (x)  10.5    9.6  
(* annualised)      

What has driven performance in 2QFY05?
Import parity boom:  During 1HFY05, diesel sales have improved by over 8% as compared to a flat trend being witnessed in the previous years. Further, petrol also witnessed over 5% growth during the same period. Diesel accounts for nearly 40% of the petroleum product sales. At the same time, other products such as LPG continued its double-digit growth. Strong volumes, coupled with high realizations at the refinery gate on the back of import parity pricing helped IOC post a 20% growth in realizations.

(%) of sales2QFY042QFY051HFY04 1HFY05
Consumption of raw materials31.6%33.4%34.3%35.8%
Purchase for resale49.9%53.6%50.1%49.6%
Staff cost1.4%1.2%1.4%1.2%
Other expenditure8.2%6.0%6.7%6.2%

Hit on both sides:  A higher than proportionate expenditure during the 2QFY05 resulted in operating margins dip by 300 basis points. To put things in perspective, crude oil prices increased by nearly 50% during the quarter (US$ 45 per barrel as against US$ 29 per barrel in FY04). Further, IOC having a larger market share in LPG and kerosene resulted in higher under-recoveries as the government reduced its share of subsidies in the face of rising costs. However, as a consolation, duty cuts in these products resulted in some savings. On the petrol and diesel front, IOC was selling diesel at a loss per liter in major cities on the back of rising global prices resulting in higher refinery gate prices on one hand, and the freeze in retail consumer prices on the other. Also a positive that the company owns over 40% of the refining capacity within the country helped curb losses as strong refining margins of US$ 7.2 per barrel (US$ 3.6 per barrel in 2QFY04) helped compensate.

Subsidy effect trickles down:  Higher operating costs coupled with higher subsidies resulted in the bottomline dipping by over 31% during the quarter. But for the strong refining margins, the company could have witnessed losses. A dip of 5% in other income followed by a surge of 51% in interest costs and 34% in depreciation resulted in the drop in the bottomline.

Quarterly performance
Sales 310,937 315,472 316,506 317,646
(%) YoY growth 1.5%0.3%0.4%
Op. profit 36,533 25,734 26,641 18,616
(%) OPM11.7%8.2%8.4%5.9%
Net profit 24,034 18,499 14,722 12,395
(%) NPM7.7%5.9%4.7%3.9%

Quarterly sigh:  The current quarter has resulted in a dip as compared to the previous three quarters whereby the company witnessed steady performance. During the 4QFY04, the company witnessed a dip on the back of price freeze and rising crude oil prices. At the same time, the petroleum industry witnessed strong volumes growth and the trend has continued although prices have failed to keep in line.

What to expect?
At Rs 447, the stock is trading at a price to earnings multiple of 10.5 times annualized 2QFY05 earnings. Given the current measures taken by the government towards price hikes and duty cuts, IOC shall witness a decent growth on the back of high refining margins compensating for marketing losses. Further, crude prices have showed signs of softening, although currently near US$ 40 per barrel (Indian mix), which would help IOC curb losses in petrol and diesel sales. Going forward, in a developing economy, the petroleum sector is likely to trace the economic growth and IOC, being the largest company in the sector has an edge. However, political ramifications have a large role to play as far as profitability is concerned.

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