The first quarter of 2016 financial year just completed and CNX Nifty has given a negative return of 1.5% and CNX 500 has given a return of negative 1%. Same period Oil India has also given a negative return of 1.70%.

We rate this business as ‘A3’ in terms of its quality and performance ratings. To talk a bit more about quality and performance ratings, the letter ‘A’ stands for its overall business and Balance sheet quality from last 10 years. So we think that its Balance sheet is rich with good and quality assets. The number ‘3’ stands for its performance i.e. we look at its return on equity, operating margins as well as cash flow on a yearly basis.

‘A’ quality business with number ‘3’ performance rating is not an investment grade business for us. It just simply tells us that management is not using wisely their assets to make profits. We sold this business from our portfolio as it doesn’t matches with our funds risk profile at this time.

We also sold this business because we don’t think their performance will improve in the midterm (1 – 2 year). The 70% of revenues comes from crude oil sales for this business where it also absorbs the 45% burden of subsidy. Oil India produced 3.44 mmt of crude oil and the average sale price realised was US $84.25 and the exchange rate was Rs 61.15 per US dollar for the year 2015. The average per barrel sale realised price was Rs 2,870.38 for the 2015 year.

Now let us do a bit of maths, we think that Oil India will increase its production to approximately 3.7 mmt of crude oil by the next two years. We think the average price of crude oil per barrel will be US$ 60. We think that the exchange rate will be around Rs 63 per US dollar. This translates its realised sale price per barrel will be Rs 2,079 per barrel for the year 2016.

A drop of 28% in sales and a growth of average 8% in its sales will not increase its net sales. Sales will not tick up but expenses will and that will put more pressure on its operating margins and net profits.

The first quarter results will give us more clarity on the above figures that we are talking about. This is the classic example about when to sell stocks. Also it is important to do a bit of digging and research on the future prospects of this business.

As per consensus earnings forecast this business is trading at discount but we think that their estimates will start dropping down very soon as they release their first quarter results.

Our disclaimer: We do not hold any stock of Oil India anymore and we were lucky not to lose any capital of our investments.

Aziz Dodhiya is the co-founder of Valueoperations and Chief Investment Officer of Value Operations funds. To contact him please email him at aziz@valueoperations.com.