OMCs beat Street on timely subsidies, lower interest cost, underrecoveries

Gains for IOC, BPCL and HPCL are expected to continue, led by diesel price reforms; stocks look fairly valued

Oil marketing companies (OMCs) Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) passed Street expectations in the March quarter driven by timely subsidy payout and discounts by upstream companies. Lower interest costs helped. While BPCL and IOC came out with their results on Thursday, HPCL announced it a day ago.

Higher gross refining margins (GRMs) and lower net underrecoveries boosted HPCL's profit.

Underrecovery is the difference between the cost and selling price of the fuel sold by the OMCs.

BPCL and IOC's profits were driven by savings in interest and employee costs. For IOC, a one-time income of Rs 536 crore (income on recovery of additional surcharge towards Uttar Pradesh entry tax) more than offset the 45.2 per cent fall in other income to Rs 598 crore.

Higher upstream discounts helped the OMCs. While IOC absorbed net underrecoveries worth Rs 1,083 crore in 2013-14, these were Rs 480 crore for HPCL. Due to the ongoing gradual diesel price rises, the total (gross) underrecoveries for 2013-14 reduced 15 per cent year-on-year to Rs 72,938 crore for IOC, 10.4 per cent for HPCL to Rs 32,500 crore and 11.6 per cent for BPCL to Rs 34,463 crore. ICICI Securities analysts in a note on HPCL said, “We expect a 36 per cent decline in OMC under-recoveries to Rs 89,000 crore by 2015-16, factoring deregulation in diesel prices in H1FY16.”

Dayanand Mittal, oil and gas analyst at Ambit Capital, said, "OMC's results were better than expected because of timely compensation. Refining margins, too, look reasonable in the light of global GRMs. We believe GRMs will continue to trade at a discount to global GRMs, given the old refineries of the OMCs. This discount could narrow as OMCs upgrade their refineries. While BPCL is a play on its exploration and production (E&P) portfolio, upside potential is higher at HPCL."

IOC, BPCL and HPCL have outperformed the Sensex over the past few months. While HPCL will gain the most from diesel price deregulation, most analysts have BPCL as their top pick given the prospects of its E&P portfolio. The Street is positive on all three OMCs, but near-term upsides are limited given the target prices.

Analysts at Motilal Oswal Securities expect underrecoveries to fall 48 per cent in 2015-16 versus Rs 139,900 in 2013-14 due to the diesel price deregulation. This means the OMCs will be able to determine prices of petrol and diesel based on market forces such as crude oil price and rupee movement.

Once price is deregulated, the interest cost and working capital requirement will come down resulting in better profits and higher return ratios. Also, they will be valued by the Street based on their core business' strengths and weaknesses.  

Rohit Ahuja, analyst at ICICI Securities, said, "It is almost a certainty deregulation would be achieved by the first half of FY16. We expect 40 per cent decline in interest costs for HPCL till 2015-16 from current levels, as underrecoveries decline and efficiencies improve. Bhatinda (in Punjab) refinery is expected to turn profitable in 2015-16 and is critical, given it contributes Rs 59/share (or 12 per cent) to HPCL’s sum-of-the-parts value."

Interest costs fell 28.4 per cent year-on-year to Rs 998 crore for IOC, 35.4 per cent to Rs 205 crore for BPCL while those of HPCL were up 17.2 per cent to Rs 199 crore. In the quarter, BPCL and HPCL processed 6.05 million tonne (mt), up 4.1 per cent year-on-year, and 4.34 mt, up 0.5 per cent, respectively, crude oil. IOC's refining output was 13.57 mt, down 1.2 per cent.