Stake sale by ONGC, govt key overhangs for IOC

While these will weigh on the stock price, it could be a good entry point for long-term investors

The share price of Indian Oil Corporation (IOC), after scaling highs of Rs 450.65 on May 16, has continued moving down. Trading at Rs 368, it is down 18 per cent from the peak.

This is despite positive developments on the business front, including implementation of daily fuel pricing that benefits oil marketing companies (OMCs) like IOC. Even crude oil prices have continued to remain soft, another positive, though some disappointment did come with oil products being kept out of the goods and services tax (GST) ambit.

The bigger concern, however, has been on the merger of OMCs with upstream (exploration and production) companies Oil and Natural Gas Corporation (ONGC) and Oil India. Amplified with the in-principle nod for ONGC acquiring the government's stakes in Hindustan Petroleum (HPC).

However, that could be good news for long-term investors. The Street's concern remains elevated from the fact that ONGC, to fund the HPC acquisition, might offload its 13.8 per cent stake in IOC. A CLSA note on ONGC acquiring stake in HPC said IOC's stock might be hurt the most. They said the government owns 57 per cent in IOC and already has plans to monetise some of this stake. This, along with ONGC if it plans to sell its 13.8 per cent stake, might see overall supply of about $6 billion (Rs 39,000 crore) or about 20 per cent stake in the IOC counter in the near to medium term. Which could act as a huge overhang for the stock.

 

Analysts at Nomura say the 13.8 per cent stake in IOC worth Rs 25,000 crore had largely been regarded as a strategic holding; ONGC has not been able to sell (and likely not allowed by the government) it in the market, despite a strong run in the IOC stock price. Thus, to meet its large funding need for the HPC acquisition, it is likely that ONGC would sell this stake, with government approval. However, the analysts add, it is prudent for ONGC to sell its IOC stake in tranches (and for the government to defer its planned three per cent divestment) to ensure no sharp decline in the stock price.

The other overhang is that within the oil space, IOC could be the next big company which might be asked to acquire smaller Oil India under the proposed integration plan, say analysts.

All these uncertainties will weigh on IOC's stock price, despite good business prospects. Its new refinery at Paradip, now stabilised, is expected to drive the refining capacity and margins, and thereby earnings. By Capitaline data and analysts' estimates, operating earnings are expected to rise 24 per cent in FY18 and another nine to 10 per cent in FY19. In addition, IOC's upcoming liquefied natural gas terminal in Ennore is scheduled to commission in June 2018.

Despite these concerns over supply of shares in the market, most analysts maintain their positive stance and target prices (their estimate of where the stock could rise till) in excess of Rs 450 for the share. Motilal Oswal Securities has a target price of Rs 459, Antique Stock Broking's is Rs 460 and Elara Securities at Rs 484. Long-term investors could use corrections to time an entry into IOC.