Oil India: Worst priced in; best play on macro improvement

OIL India’s (OINL’s) stock has corrected by ~5% over the last 12 months, underperforming ONGC (+4%), despite similar issues of ad-hoc subsidy burden. The stock has de-rated significantly, trading at ~23% below its historical average and 40% below its peak valuations. Valuations are compelling at the current juncture, offering strong downside protection. Prabhudas Lilladher believe the recent sharp correction in the stock is technical in nature (impending FPO by the government). Macro risks in terms of high under-recoveries/higher upstream subsidy burden seems to be priced into the stock (stock discounts USD50/bbl of long term net realization in our DCF), whereas positives from macro (lower crude, appreciating currency) /micro (value accretive acquisitions, gas price hike) can push the stock substantially upwards from the current levels. Given the extremely attractive risk reward at the current market price, Prabhudas Lilladher upgrade the stock from ‘Accumulate’ to ‘BUY’, offering ~25% upside from the current levels.

- Significant relative de‐rating unjustified: Despite being superior to ONGC on most comparable metrics, OIL is currently trading at a ~13% discount to ONGC, higher than historical discount of ~7%. On most micro parameters, OIL scores over ONGC, better production growth profile over the last four years (5% CAGR versus 0%), higher exploratory success ratio (60-65% versus 30-40%), better free cash flow profile owing to higher proportion of developed proved reserves (91% versus 61%). Given OIL’s earnings sensitivity to macro variables, (ie USD1 decline in crude increases EPS by ~4%) is higher than ONGC, and the worst in terms of under recoveries/ higher upstream subsidy burden has been priced in, we prefer OIL over ONGC.

- Buy for absolute upside: Their DCF based valuation (long term net realization~USD60/ bbl from FY15) throws up Rs239/ share value of the Oil’s proved reserves, implying the market is ascribing zero value to probable (p2-p1) reserves and valuing cash plus investments at ~0.9x book, a reflection of the distressed scenario being discounted in the CMP.

Outlook and Valuation

OINL is currently at the lowest point in terms of 1-yr forward PE (7.1x) and 4.8x core earnings, coupled with a dividend yield of ~4.4%, offering an attractive risk-reward at the current price. Our DCF based valuation (long term net realization ~USD60/ bbl) throws up Rs239/ share value of the Oil’s proved reserves, implying the market is ascribing zero value to probable (p2-p1) reserves and valuing cash plus investments at ~0.9x book, reflecting the distressed scenario being discounted in the CMP. Given the extremely attractive risk reward at the current market price, Prabhudas Lilladher upgrade the stock from ‘Accumulate’ to ‘BUY’, offering ~25% upside from the current levels. Prabhudas Lilladher have shifted their valuation method from PE to a combination of DCF, PE and EV/EBITDA.

Posted in: OIL INDIA,STOCK ADVICE,STOCKTIPZ