Saturday, February 4, 2012

>Indian Oil Corporation Limited: The entry tax jolt

IOCL lost UP entry tax case in Allahabad High court, liability of INR84bn: Allahabad High Court has dismissed IOCL's petition and upheld the UP Entry Tax Act 2007, whereby UP govt is entitled to levy an entry tax/octroi on crude oil at 5% (USD5.5/bbl at current oil prices) for its Mathura refinery. IOCL
will have net liability of INR84bn (refer table on page 2) including last ten-year demand with interest. Hon'ble Supreme Court while accepting the review petition has asked IOCL to deposit 50% of the accrued tax liability (INR42bn) and furnish bank guarantee for the balance within next few months. Hon'ble Supreme Court has also asked IOCL to pay the tax at the prevailing rates for the future period till the review petition is decided.

 Entry tax - an irrecoverable item for refiners, to make Mathura refinery unviable: Entry tax has been an irrecoverable item for refiners and not included as part of the refinery transfer price (RTP) as it is based on import parity price and does not include local taxes. Entry tax burden of USD5.5/bbl is huge with respect to average USD6.1/bbl GRMs made by Mathura refinery (8mmtpa) during FY09-11 and an average net margin of USD3.9/bbl.

 Full price hike in marketing looks difficult, we expect 2.5% underrealisation: IOCL will require MoP&NG approval (largely political clearance) for raising prices on regulated products in UP to cover this additional tax. On nonregulated products, IOCL will face the problem of substitution, as products imported from nearby states will attract entry tax in UP, which can be fully set-off against VAT. We believe that when Central Govt. itself is looking to raise prices of regulated products, it would be very difficult for IOCL to separately raise price in UP to pass through the entire entry tax leading to irrecoverable expense of ~2.5%.

 Impact on earnings: IOCL has to provide for this entire liability of INR84bn in one go, wiping off FY12e earnings. Also payment of INR42bn in next few months will increase interest liability by INR3.4bn in FY13e. Assuming 2.5% less pass through, IOCL recurring EBITDA would be impacted by INR7.4bn annually (INR2.1/sh post tax) on IOCL's recurring earnings.

Valuation and outlook
 Downgrade to HOLD: Considering Hon'ble SC doesn't reverse High Court order, we have reduced our earnings for FY12-14e. We have revised our valuation methodology and now value IOCL at an average of: i) FY12e 0.8x BV at INR174/ share; and ii) FY13e 10x EPS at INR200/share (FY13e revised EPS of INR20). We value listed investments at INR80/share. We downgrade the stock to HOLD in light of the above changes with a revised target price of INR267/share (earlier INR314/share).

To read the full report: Indian Oil Corporation Limited