OMCs' stocks see mild recovery after petroleum minister's clarification

Surge in refining margins provides cushion for three state-run firms

The three government-owned oil marketing companies (OMCs) saw mild recovery in their stock prices on Thursday, after the petroleum minister assuring no interference in automobile fuels' pricing.

Earlier on Wednesday, the Street was concerned at news reports suggesting the three - Indian Oil Corporation (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum Corporation (HPCL) - would be asked to absorb higher global crude oil prices. As a result, their share prices fell by five to seven per cent, as the decade-old bogey of price controls appeared set to return.

The minister's clarification the same day (after trading hours) bodes well and provided relief. However, with no sign from the government on reduction in excise duty on fuels, uneasiness still prevails. The fact that after a steep fall on Wednesday, the stock prices only rebounded by 0.3-0.9 per cent on Thursday indicates the Street's concerns remain. Analysts at Kotak Institutional Equities say the government's intent to maintain higher excise duties, despite a sharp jump in fuel prices over recent months, might rule out any possibility of expansion in marketing margins, even in a reasonable crude oil price and exchange rate environment. And, thus, defy the thesis of higher (valuation) multiples for marketing profits.

This is not good news for the OMCs, which have benefited from an improving profitability outlook in the past couple of years and, consequently, been seeing earnings upgrades. Fuel pricing reforms such as decontrol of diesel and petrol pricing, and regular increase in kerosene and cooking gas prices in a phased manner, have all provided benefits. And, the daily pricing mechanism from this June was expected to have additional positive rub-off on the marketing margins. This margin is the difference between cost of the fuel for the company and the rate it charges a customer.
 

Now, given the uncertainty on marketing profits, it means a further re-rating of these stocks might not come easily. Among these three, HPC remains the most sensitive to marketing margins and is likely to take the biggest pinch if prices are controlled.

A sensitivity analysis by foreign brokerage Jefferies suggests for every 10p a litre change in automobile fuel margins, the impact on earnings per share is 1.5-3.5 per cent, with HPCL the most leveraged. Their sensitivity analysis on refining margins, on the other hand, suggests for every dollar per barrel change in these, the earnings improve by 10-13 per cent, with BPCL the most leveraged.

Thus, in the current environment when crude oil prices have been rising, refining margins are also expanding significantly and this is positive news. Though a re-rating might not happen in the near term, on the back of expansion in marketing margins as suggested by analysts, refining margins' expansion still bodes well.

Gross refining margins or GRMs during the September quarter had averaged $7.7 a barrel till the second half of August, higher than the $6.4 a barrel in the June quarter. The global benchmark Singapore GRMs thereafter surged further to $10.5-11 a barrel on September 1, with disruption in global supplies caused by Hurricane Harvey in America. This increase should drive the performance of the OMCs in the interim.

Beside, BPCL might benefit from its Kochi refinery expansion and IOC from a new refinery at Paradip in Odisha. HPCL has large capital expenditure lined up and this will deliver benefits only later. Analysts at Jefferies say they expect HPCL's earnings and returns on equity to fall, and net gearing to rise, as margins ease and capital spending spikes.

On BPCL, they remain comparatively positive and say earnings should rise for it as Kochi stabilises, though it might lag the Street's consensus. They prefer IOC, as its valuations are cheaper and the company is seen as more resilient.