Should you subscribe to IOC OFS?

Attractive pricing coupled with improving prospects make the offer lucrative

Indian Oil Corporation (IOC) is coming up with an offer for sale (OFS) on Monday where the government will sell 10% of its stake. Most analysts believe investors should subscribe to the offer. The company stands to gain from falling crude oil prices, diesel price de-regulation as well as direct benefit transfer for LPG. Post diesel price de-regulation, the visibility of earnings of IOC and its peers have improved significantly. Also, lower interest costs as well as removal of subsidy uncertainty will aid positively on their profitability as well as return ratios. The company's marketing margins are also likely to improve going forward.

"We believe that OMC’s could at least earn additional marketing margin of Rs 0.5-1 per litre and even if private players take market share as high as 15%, on a net basis OMC’s will benefit. A Rs 0.5 per litre increase in diesel marketing margin increases IOC’s EPS by 12%", write analysts at Motilal Oswal Securities in a recent note on the company. Any positive newsflow surrounding the profitability of its Paradip refinery will be another catalyst for the IOC scrip.

Most analysts polled by Bloomberg in the month of August so far are positive on IOC. Their average target price of Rs 463.7 indicates upside potential of 17.6% from Friday's closing price of Rs 394. At the floor price of Rs 387 per share, the upside is higher at 19.8%. After applying 5% discount for retail investors and assuming the offer for sale is made at the floor price, the upside is about 26%.

The IOC scrip has under-performed its peers such as Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation (BPCL) in the past one year due to relatively lower financial performance in FY15. Going forward, though the trend may change as analysts expect IOC scrip to catch up.

"We expect IOC's performance to improve going ahead as with more than 50% market share in fuel retailing and robust marketing margins, profitability of marketing segment would be strong. Thus, its steep valuation discount is unwarranted and catch-up is due", says Amar Ambani, Head of Research, India Infoline.

At Friday's closing prices, IOC trades at just 0.9 times FY16 estimated book value versus 1.4-1.5 times for HPCL and BPCL excluding investments and E&P. Delay in capacity expansions along with rising competition from private players are potential downside risks for the company.