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The Oil India (OIL) stock has seen upgrades by brokerages CLSA and Kotak Institutional Equities on undemanding valuations and likely improvement in production in FY16. Analysts believe the stock, down 29 per cent in six months, factors in negatives such as uncertainty in subsidy sharing and a lower crude oil price.
“We believe the stock is adequately pricing in concerns on lower net crude price realisations, production growth and the royalty issue on onshore fields post the recent stark under-performance versus the broader markets”, says Tarun Lakhotia of Kotak Institutional Equities. Lakhotia, who believes inexpensive valuations and a good dividend yield of five per cent will provide adequate support on the downside, has upgraded it from ‘Add’ to ‘Buy’, with a target price of Rs 615.
The government has announced it will share a part of the subsidy burden in the March quarter. This could provide short-term relief to upstream companies such as Oil and Natural Gas Corporation Ltd (ONGC) and OIL. However, a clear formula for calculating the subsidy burden between upstream companies and the government on a long-term basis is desirable and will be a strong catalyst for these stocks. For now, with the diesel price deregulated, both these companies’ earnings will be more correlated with Brent crude oil prices, resulting in higher earnings predictability.
Operationally, a key concern around Oil India has been weak production trends. The annual oil production fell from 3.9 million tonnes (mt) in FY12 to 3.5 mt in FY14. While annual natural gas production has remained stable at 2.6 billion cubic metres (bcm) in this period, it forms only 12 per cent of revenues. Positively, production of oil, which contributes 83 per cent to revenues, is expected to be stable in FY15, and inch up to 3.6 mt in FY16 and to 3.7 mt in FY17. Natural gas production, too, is expected to move up to 2.7 bcm this financial year to 2.9 bcm in FY16 and to 3 bcm in FY17. Revision of gas prices every six months will have some influence on earnings from this segment.
In this backdrop, the OIL scrip, which has underperformed the S&P BSE Sensex over the past year, gaining a mere 1.76 per cent, could see the trend improve. The stock now trades at 8.1 times FY16 estimated earnings, or a discount of 15 per cent to peer ONGC, which trades at 9.5 times FY16 estimated earnings. This gap could narrow on improving prospects of OIL, say analysts.
