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OIL INDIA: Steady growth, rich reserves



      

- Oil India (OIL), a predominant onland E&P player, with >90% of its reserves in the North East, is now foraying into offshore as well as overseas acreage.

- Operationally, the company is on a strong footing with (a) high share of oil (55% in 1P and 62% in 2P) in its reserves, and (b) RRR of >1 for last 7 years to deliver consistent production growth.

- We initiate coverage with a Buy rating and target price of INR590. Ad hoc subsidy sharing is a key near-term concern.

Valuations attractive; expect secular production growth; gas price hike a long-term trigger: OIL trades at 60% discount to global peers on EV/BOE (1P basis), and we expect the gap to narrow as policy initiatives reduce the ad hoc element in subsidy. Further, since FY05, OIL clocked net realization and earnings CAGR of 9% and 18%, despite ad hoc subsidy regime. On the operational front, we expect 4% oil and 7% gas production CAGR over FY11-14. The likely gas price hike in FY15 would be a long-term trigger.

Under-recoveries at all-time high – no option but to go for reforms: Mark-to-market under-recoveries are at an all-time high level of USD30b, and the government has very few options. Given its precarious finances, price hikes in near term are inevitable, notwithstanding political pressure and inflation concerns. In the meantime, government is going ahead with its long-term policy initiatives of targeted subsidy through pilot projects. We expect them to be eventually implemented nationwide resulting in lower subsidies.

Healthy oil/gas reserve ratio; RRR consistently > 1: OIL's reserve mix is favorable with oil contributing 62% of its 2P reserves and 1P reserves being only at 53% of 2P reserves, indicating a large scope for increase in 1P. Further, its reserve replacement ratio (RRR) has consistently remained above one, and the lower F&D cost of USD5.5/bbl proves its competence in current operating area.

Cash deployment a near-term trigger: For a long time, OIL's high cash reserve (INR136b as on Sep 2011, 70% of assets, 50% of market cap) has been a major positive (but impacting RoE). However, now, this has turned into a concern due to likely forced PSU share buyback by the government. We believe the key reasons for OIL's delay in cash deployment are (1) turmoil in the Middle East and North Africa (MENA) region, and (2) high oil prices driving up valuations of target acquisitions. Even as a special dividend is welcome, we also expect OIL to announce an overseas acquisition shortly. Overseas earnings would also act as a natural hedge against subsidy-sharing.

Initiate coverage with Buy: We value the company at INR590/share based on average of three methodologies: (1) P/E of 9x FY13E, (2) 4.5x FY13E EV/EBITDA and (3) DCF (WACC of 11.6%). The stock trades at >50% discount to its global peers on EV/BOE (1P basis). The stock trades at 7.1x FY13E EPS of INR64.2 and has an implied dividend yield of ~4%. We initiate coverage with Buy.