OIL is the second largest national oil and gas company in India as measured by total proved plus probable oil and natural gas reserves and production. The company is primarily engaged in the exploration, development, production and transportation of crude oil and natural gas onshore in India. The company also processes its produced natural gas to extract LPG. Globally the company is present through the exploration of crude oil and natural gas in Egypt, Gabon, Iran, Libya, Nigeria, Timor Leste and Yemen.

Key Positives

- India's 2nd largest national crude oil producer as measured by total 2P oil and gas reserves and production.

- Mini Ratna Category 1 company based on operational efficiency and financial strength.

- CRISIL has assigned a grade of "4/5" to the OIL PO. This grade indicates that the fundamentals of the IPO are above average relative to the other listed equity securities in India.

- Accounts for estimated 10% of the domestic crude oil Production.

- OIL has total acreage of 160959 sq. kms out of which domestic acreage is 119686 sq. kms and 41273 is international acreage.

- OIL has a reserve replacement ratio of more than 1x.

- Debt free company with cash per share of Rs. 273 based on post issue equity.

- On the EV/BOE basis OIL is trading at 3.96x as compared to 5.04x for ONGC.

Recommendation

OIL is offering their shares at 11.7x its post equity earnings at upper price band which is in line with ONGC. On EV/BoE basis OIL is currently trading at 4.0x as compared to 5.0x for ONGC. This coupled with high reserve replacement ratio and aggressive development plans make OIL a good investment. Given the sizable acreage both in the domestic and international regions and given the reduced subsidy burden on account of changes in subsidy sharing mechanism further reaffirms growth prospects of the company. Therefore based on the growth prospects and reasonable valuations we recommend subscribing to the issue with long term investment objective.

Company Background

OIL is a public sector undertaking, which has been accorded "Mini Ratna Category I" status since 1997 by the Government of India (GoI) for its operational efficiency and financial strength. The company's estimated independent proved plus probable (2P) oil reserves, as well as 93.66% of its estimated independent natural gas reserves, are located onshore in the Upper Assam basin in the states of Assam and Arunachal Pradesh. Additionally, the company has independent natural gas reserves in the Jaisalmer basin in the state of Rajasthan.

As of 31st March, 2009, the company's 2P crude oil reserves were approximately 575.40 million barrels (mmbbls) and 2P natural gas reserves were approximately 63.41 billion cubic meters (bcm).

OIL is making a fresh issue of 2.40 crs shares and 0.2 crs shares will be allotted to the employees of the company. Through this sale of shares the company is expecting to raise Rs. 2512 crs at the lower band and Rs. 2777 crs at the upper band of the issue.

Furthermore the Government of India is diluting its stake in the company. GoI's stake in the company will come down from 98.13% pre issue to 78.43% post issue. GoI has transferred its 10% stake in the company to Indian Oil Corporation Ltd (IOCL), Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL) in the ratio of 5.0%., 2.5% and 2.5% respectively.

OIL owns and operates, as a common carrier for the company, Oil & Natural gas Corporation Ltd (ONGC) and Bongaigaon Refinery Private Ltd (BRPL), a 1,157 kilometer cross-country crude oil pipeline. The pipeline has the capacity to transport over 44 mmbbls of crude oil annually. OIL transported approximately 45 mmbbls of crude oil in FY 2009 to four public sector refineries in the North East region of India located in Digboi,

Numaligarh, Guwahati and Bongaigaon. The company also owns ten crude oil pumping stations and 17 repeater stations, spread across the states of Assam, West Bengal and Bihar. OIL also owns and operates a 660 kilometer petroleum product pipeline connecting Numaligarh Refinery Ltd (NRL) to Siliguri in West Bengal, which was commissioned in August 2008. OIL has interests in downstream activities through a 26% equity stake in NRL, a 10% equity stake in Brahmaputra Cracker & Polymer Ltd (BCPL) and a 23% equity stake in DNP Limited. The company also holds a 10% equity stake in a 741 kilometer pipeline construction project in Sudan that was completed in 2005.

Objects of the Issue

OIL is expecting to raise Rs. 2512 crs at the lower band and Rs. 2777 crs at the upper band of the issue. The company intends to use the proceeds of the issue for exploration and appraisal activities, Development activities in the producing fields and for purchase of capital equipment and facilities. The company has planned capital expenditure plans of Rs. 4559.8 crs out of which Rs. 2210.1 crs will be deployed in FY 2010 and the balance Rs. 2349.8 crs in FY 2011.

Exploration & Appraisal Activities

Oil is currently conducting exploration activities in 16 blocks located in Assam, Arunachal Pradesh and Rajasthan under PELs granted by the GoI, and 12 NELP blocks, where the company is the operator in the states of Assam, Arunachal Pradesh, Mizoram, Rajasthan, Orissa, Andhra Pradesh and Pondicherry. Additionally, The company is also involved in exploration activities in certain overseas blocks.

Development Activities in Producing Fields

With regards to the development activities in producing fields OIL is currently focused in the areas falling under 19 PMLs in Assam, Arunachal Pradesh and Rajasthan. In the company's nomination blocks, it propose to drill 44 wells in FY 2010 and 46 wells in FY 2011 respectively and plan to spend Rs. 469.1 crs in FY 2010 and Rs. 527.8 crs in FY 2011 on these activities.

The total expenditure on drilling activities for the company's nominated blocks is Rs. 996.9 crs. Additionally, the company also intends to drill 4 wells in FY 2011 at an estimated outlay of Rs. 24.9 crs in its NELP blocks, where OIL is the operator. Furthermore, the company will contribute Rs. 23.8 crs towards its proportionate share in the cost of drilling during FY 2010 for blocks, where the company is the non-operator.

Purchase of Capital Equipment & Facilities

In order to boost the company's E&P operations, Oil is planning to invest in purchase of capital equipment, contracts relating to creation of infrastructure, surface facilities and service contracts. Accordingly, the company expects to spend Rs. 686.3 crs will be spent during FY 2010 and FY 2011. The company has already placed orders worth Rs. 310.5 crs as on August 18, 2009.

Investment Rationale

Sizable acreage both in the domestic and the international basins

As of June 30, 2009 OIL hold Petroleum Exploratory License (PELs) as operator covering a total area of approximately 26,660 sq kms, of which 21,293 sq kms were acquired through the NELP bidding process and the remaining 5,367 sq kms of which were acquired on a nomination basis. All such PELs cover acreage in the Upper Assam and Assam-Arakan basin, the Krishna-Godavari basin and the Rajasthan basin, each of which are basins with proven commercial production or known accumulation of hydrocarbons. The PELs in which the company has a participating interest as non-operator cover total exploration acreage of 88,205 sq kms, of which 82,175 sq kms were acquired through NELP and the remaining 6,030 sq kms of which were acquired through joint ventures. The company has obtained participating interests in 41,273 sq kms of exploration acreages overseas in Egypt, Gabon, Iran, Libya, Nigeria, Timor Leste and Yemen. Furthermore in order to develop this acreages OIL has capex plans of approximately Rs. 2,828 crs to be spent over the next two years.

Monetization of natural gas resources in the Upper Assam basin to drive growth going forward As of March 31, 2009, OIL has 2P natural gas reserves of approximately 63.41 bcm of which 93.66% are located in the Upper Assam basin, which is a basin with proven commercial production. Historically the company has not chosen to develop these resources due to lack of viable demand of natural gas in Assam. However, for the year ended December 31, 2008, domestic consumption of natural gas exceeded domestic supply by 26% and going forward the company believes that the demand for natural gas within the Indian market is likely to increasingly exceed natural gas production. The company intends to improve its utilization of natural gas by reducing gas flaring principally through the implementation of advanced technology and techniques and through upgrading and expanding of its distribution network. OIL has entered into a MoU in September 2008 with IOCL to supply gas to its refinery in Guwahati, Assam and to develop gas pipeline infrastructures for transmission of gas from the Krishna-Godavari basin blocks and for the marketing of gas to small customers through retail networks. With respect to the MoU, the company also intends to explore the possibility of joint participation with IOCL in the development of city gas distribution projects in the northeastern, south-eastern and central states in India as well as in other countries.

Lower subsidy payout due to changes in policy to benefit going forward

In order to compensate the Oil Marketing Companies (BPCL, HPCL and IOC) for the under recoveries on sale of auto fuels and kerosene and LPG, a subsidy mechanism has been put in place by the government wherein the under recoveries are shared between Government of India in the form of oil bonds, Oil Exploration companies like ONGC, Oil and Gail in the form of discount given by them on sale of crude oil and the balance is borne by the OMC's themselves. For the upstream oil exploration companies their share of under recoveries is calculated on the basis of relative prior-year profits. However, there remains unpredictability as to the share of the under-recovery that is allocated to the upstream oil companies both individually and as a group. Recently the petroleum ministry issued a directive wherein it is stated that the upstream oil exploration companies like ONGC, Oil and Gail would only share the under recoveries on the Auto fuels and not LPG and kerosene. Due to this the total burden on upstream companies was only to the tune of Rs. 560.3 crs in Q1 FY10. Out of which approximately 76.6% was borne by ONGC. Going forward we believe the conscious effort by the government to lower the subsidy burden of the upstream oil exploration companies will lead to better operational and financial performance.

Consistent Growth in Production

OIL has witnessed consistent growth in production over the last three years. For FY 2009 OIL produced 24.95 mmbbls of crude oil as compared to 22.38 mmbbls in FY 2008 thereby registering growth of 11.5% y-o-y. In Q1 FY10, the company produced approximately 6.34 mmbbls of crude oil. Natural gas production stood at 2.27 bcm for FY 2009 as compared to 2.34 bcm in FY 2008 registering a decline of 3.0% y-o-y. For Q1 FY10, the company produced 0.60 bcm of natural gas. Furthermore, the company has witnessed consistent growth in its crude oil production. Average daily crude oil production has increased from 61302 bbls per day in FY 2008 to 68385 bbls per day in FY 2009. For Q1 FY10 average daily crude oil production was at 69619 bbls per day. Average daily natural gas production was 6.22 mmcm per day in FY 2009 as compared to 6.41 mmcm per day in FY 2008. For Q1 FY10 average daily natural gas production stood at 6.64 mmcm per day.

Risk Factors

Increasing Volatility in crude oil prices:

Fluctuations in crude oil prices may adversely affect the company's revenues and profits. In the past, international crude oil prices have been volatile and have fluctuated widely in response to changes in many factors. For example, after a period of a sustained and substantial increase in the price of crude oil that reached record levels in July 2008, the price of crude oil has declined significantly and has been highly volatile. Such fluctuations may result in fluctuations in our results of operations. We do not and will not have control over the factors affecting prices for oil.

Uncertainty over the subsidy sharing mechanism

Government of India does not have a clear subsidy sharing mechanism in place to compensate the OMC's for under recoveries due to selling of auto and cooking fuels below cost price. The government recently has stated that the upstream oil exploration companies will only share the burden of under recoveries on auto fuels and not on cooking fuel. This has resulted into lower subsidy burden on the upstream companies. In Q1 FY10 the total subsidy burden on upstream companies stood at Rs. 560.3 crs as compared to the total under recovery of Rs. 5437.4 crs. We believe any additional burden on the upstream oil exploration companies would impact operational as well as financial performance of the company going forward.

Valuation Recommendation & Peer Comparison

We believe ONGC is the best comparison for OIL considering the scope of the business and limitations faced by both the companies. Both OIL and ONGC being owned by the Government of India have to provide discount on sale of crude oil to OMC's.

OIL currently has 2P reserves of 974.2 mn boe as compared to ONGC which has 2P reserves of 9851.5 mn boe. In terms of revenues, OIL registered growth of 17.7% y-o-y to Rs. 7200.7 crs for FY 2009 as compared to 8.0% y-o-y growth registered by ONGC for FY 2009. Even on the margins front OIL has EBITDA margins of 44.8% for FY 2009 as compared to 40.4% EBITDA margins for ONGC. On the net level OIL has net margins of 30.0% as compared to 18.8% registered by ONGC in FY 2009.

On the valuation front both OIL and ONGC are trading at a multiple of 11.7x based on their respective FY 2009 diluted earnings based on the upper band. OIL has a P/BV of 2.69x as compared to 2.24x for ONGC. On the EV/BOE basis OIL is trading at 3.96x as compared to 5.04x for ONGC.

We believe the company has grown reasonably well historically and will continue to maintain the growth trajectory and margins going forward. Based on the above factors we recommend subscribing to the issue with long term investment objective.