Moody's Investors Service says that Indian Oil Corporation's (IOC, Baa3 stable) results for FYE March 2012 were softer than the previous year due to a decline in gross refining margins to $3.63 per barrel from $5.72.

The decline in margins was in line with the cyclical downturn in the refining industry, and the results -- which were announced on May 28 -- could have been worse, if the Indian government had not decided on May 21 to reimburse IOC in full for its fuel subsidy burden.

In FYE2012, the company incurred subsidy-related losses of Rs755 billion (USD13.6 billion), of which the government will reimburse Rs455 billion and upstream oil and gas companies the remaining Rs300 bn.

The announced full reimbursement has helped maintain IOC's consolidated EBITDA margin at 5.6% against 5.8% last year. If IOC had had to absorb the subsidy, its EBITDA would have fallen significantly.

Although neither the government, nor the upstream oil and gas companies have yet made the reimbursements, the results for FYE2012 have incorporated the anticipated payments on an accrual basis.

"In the absence of the payments, IOC's consolidated credit metrics for FYE2012 weakened with EBITDA/ Interest declining to 3.9x from 6.0x a year ago, debt/ EBITDA increasing to 3.3x from 3.1x, and debt/capital rising to 54% from 48%," says Vikas Halan, a Moody's Vice President and Senior Analyst.

"The deterioration was due to an increase in debt to fund the fuel subsidy and higher working capital requirements. We expect the debt balance --- which reached a record high of INR754 billion as of March 2012 -- to fall once the company receives reimbursement of Rs208 billion from the government. At the same time, the deterioration in the interest coverage ratio can be attributed to high interest rates," says Halan.

"The credit metrics, although weaker, are within our tolerance levels for the company's rating. The government's full reimbursement also supports the one-notch uplift incorporated into IOC's ratings for support from the
Government of India, which is rated Baa3 with a stable outlook," says Halan, who is also the lead analyst for the company at Moody's.

Recently, IOC was allowed to increase the price of motor spirit by 11%, an action which Moody's views as credit positive. But we remain concerned over the slow pace of deregulation for fuel prices as the current environment leads to high subsidy burdens for the state-owned oil marketing companies.

IOC's results were also adversely affected by the provision of Rs82 bn in disputed entry taxes, of which INR77 billion have been treated as exceptional items related to earlier years. The matter is currently under litigation.