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Almost a year back, I had done a case study on Indian Oil Corporation Ltd. The study was an exercise to find a correlation (if any) between company’s share price and its book value per share. And surprisingly, this graph showed something interesting. To cut the long story short, it clearly showed that share prices of IOCL (almost) never stayed below its book value for too long.
So with prices hovering near 200 and adjusted book value of 250+, it seems that it might be a good time to look at this stock again.
The first thing which I decided to do was to update the graph between IOCL’s share price and book value per share. And as expected, this is what I got…
|IOCL || Worth A Second Look|
During the last 15 years, share prices of IOCL have dropped below its book value only thrice. Once during the dot com bust of 2000-01, in crash of 2008-09, and now. And presently the Price/Book Value stands at a pathetic 0.75.
But this does not mean that prices cannot fall any lower. They can go down further. But also, the chances of Book Value going down are very remote. Even if we assume a nominal 5-8% annual increase in book value, the price at which shares are available seems to be quite cheap.
So why is it that IOCL is available at such low P/BVs? We can discuss and debate about various possibilities. But I feel that it makes more sense to find indicators which support the view that shares are indeed available at cheap prices. Or rather try to find reasons which might suggest that our hypothesis is not correct. Let’s see…
I have experience of working in oil industry and I feel that Oil Marketing Companies are currently trading at huge discounts to their intrinsic value. I agree that government is the sole decision maker in these PSU companies and we know how the government operates. And this fact in itself would shave off a decent chunk of intrinsic value from the shares of this company. 🙂
|Crippled By Politics & Government|
But you cannot deny the presence of massive refineries and oil pipelines. And just to give you all an idea of cost of building refineries, just head to this link to see costs of various projects being taken up by these Oil Marketing Companies. Just the cost of putting up a new refinery is in excess of Rs 30,000 crores!!
But on stock exchanges, the entire company which owns 10 such refineries is available for just Rs 50,000 crores. And I haven’t even taken the cost of laying more than 11,000 kms of oil pipelines. Nor have I taken into account the country wide network of retail outlets and a decent overseas presence in Mauritius and Sri Lanka!
And if one closely monitors the energy space, one would understand that it is now almost inevitable that subsidization of fuel would be handled more prudently by the government in years to come. And going forward, with reduction in subsidies by government & various caps on LPG cylinder’s domestic consumption, there is a decent possibility that OMCs like IOCL would benefit in the long run. But this would not happen overnight. And patiencewould be a key here. Agreed that with elections around, there might be temporary vote seeking measures like increasing the no. of subsidized cylinders, etc by the ruling parties. But things are changing on the energy administration space. And in due course of time, these subsidies would play much smaller role when people evaluate the oil companies.
(Caution: The paragraph which you just read is full of speculation).
Another indicator of stock’s undervaluation is the ongoing discussion on disinvestment. The Petroleum Ministry has summarily rejected Department of Disinvestment’s idea of a stake sale. The reason being quoted is huge undervaluation of shares. But govt seems to have decided for stake sale and may eventually go ahead with sale of its stake to other energy companies like ONGC, OIL, etc. In past too, government has resorted to the so-called cross-holding route to shore up its revenues.Or the government might try the ETF basket route (source). But all-in-all, this indicates that prices are quite low, and even if they were to go down a little further, which is of course possible considering the overhang due to disinvestment and other election-related-factors, it might be a good idea to accumulate this stock for long term. If not for appreciation, then for a decent dividend yield going forward.
Note – This post should not be considered as an advice to buy shares of company discussed above.
Disclaimer – Long term positions in IOCL.