For A Few Drops More

But at what price will the issue be most attractive for the retail investor?

Sometime within the next four months, if everything goes according to plan, oil major Indian Oil Corporation (IOC) will be hitting the markets with two issues. The largest commercial company in the country, the largest oil refiner and the only one from India to get into the Fortune 500 list now plans to tap the foreign and domestic markets with an estimated Rs 1250 crore of which around Rs 250 crore will form the local component.

It is a blue-chip, a core sector company that is the market leader in one of the most attractive sectors in the country. For the small investor it could be one of those stocks that are part of lore: I bought in then and am now selling off to part finance the family car.

 

But however deep dyed blue a blue-chip company can get, there is allways a price to get in and a point at which it is over-priced. In turn that necessitates an examination of the competition, awareness of general market conditions and industry or policy factors that may impact on the company.

In this article we have not focused directly on the company itself. Instead our perspective here is to determine the price at which the issue will be attractive for the retail investor, and the price beyond which they should stay away from it. That itself necessitates an examination of IOCs strengths and its potential.

The system and how it works

According to Avadhoot Sabnis, senior analyst, James Capel B&K, capitalization of fixed assets is the key profit -driver under the present pricing system . In other words the current system ensures that all aspects of the refineries industry are controlled, with the government acting as the only arbiter of all issues related to the sector.

In order to keep with our present focus a detailed examination of the structure is avoided. Refineries have to buy crude oil, the basic raw material, at pre-determined prices and sell products also at pre-determined prices. Moreover, they have no control over marketing of products, and all expansions require government sanction. Price of crude oil, the basic raw material, is the weighted average cost of production of ONGC and OIL plus 15 per cent post tax return on capital employed by the two, plus cess of Rs 900 per tonne, plus royalty of Rs 528 per tonne and a sales tax of 4 per cent per tonne.

This means that input costs are more or less fixed and so are profits. This may be necessary. Profits of the refining companies are determined by the Administered Pricing Mech-anism (APM). Refineries get a 12 post tax - per cent return on capital employed or net worth, whichever is lower. Capital emp-loyed is defined as weighted average of net fixed assets added to normative working capital( 80 days of inventory).

In making for future projections two main scenarios may have to be considered. One, that the government decides to completely liberalise the industry, and two, the current situation persists. If you are interested in getting into the scrip you cannot afford to ignore either of the two.

In actual fact the ground situation one or two years from now may be neither. The government is unlikely to remove all controls on industry or stay with the current situation. It is anticipated that liberalisation will occur in bits and pieces, for sectors in the industry.

What exactly is going to be the impact of total decontrol, if it happens, is unclear. There are many factors at work and many possible consequences. We look at two main factors: raw material prices and end-product prices.

The crude-oil market, for one, will become dependant on international price movements. Second, international players will bring finished products such as diesel, lubes, aviation fuel at competitive rates.

Some industry observers think that refineries in India, including IOC, could have their margins slashed and some could even go into the red. Directly opposed to their views are each and every one of the equity analysts this reporter spoke to. Sabnis says the possible returns...(in such a case) would be fantastic. WS Ravishankar, analyst, Chescor Holdings, thinks IOC stands to gain. Ajay Kejriwal, Jet Age Securities, is of the opinion that margins will increase for players who have better distribution networks, whereas other refineries may have problems . On that last count, (see chart) IOC stands only to gain.

So the consensus is that in case of further decontrol, partial or otherwise, IOC stands to benefit and will increase its profitability even further from the current projections. In that case the projected discounting figure will be reduced further and the scrip made more attractive. But it isnt possible to make reliable financial projections in such a scenario except to say that it should be for the better.

How the company may be affected

But is it possible is to analyse the inherent strengths and weaknesses of the company, or the physical factors as Sabnis calls them. A comparison with other industry majors has been made in the box; here we see how they will work for or against IOC company in case of total decontrol.

If crude procurement is decontrolled, IOC claims it may be a gainer because it is today the only canalising agency in the country for crude imports. As of date its standard method of procuring orders is through tenders; it has not participated in the aggressive commodity trading done by international majors. However, it says that being the only agency in the business it has the network, experience and a strong team to go along with it: the only one in the country. That may not borne out by realities. According to one Bombay based forex trader the hedging its a sarkari agency-nothing more.

Crude decontrol is also expected to push up input prices: but that is okay since it is expected that they can be passed on. The petroleum industry in the country is a sellers market and demand for the majority of products is price inelastic. Demand for oil products in FY96 was 72.7 million tonnes as compared to the refining capacity of 60 million tonnes. There has been a growth of 10 per cent in consumption in the past ten years.

Of course other refineries will also benefit, but IOC more than most. It has the largest refining capacity in the country ( 6 out of the countrys 14 refineries), the largest product pipeline network ( 3850 kilometres), the largest retail network and the largest market share( see box and charts for details), owns 10 out of the countrys 26 port handling facilities - and one when says