OMCs: Burden sharing overhang remains

While oil marketing companies will benefit from the recent price rises and falling crude oil prices, the uncertainty on subsidy sharing would cap returns.

Riding high on the long-awaited fuel price rises, shares of the cash-starved oil marketing companies (OMCs) surged by three to six per cent, outperforming the broader markets which rose one per cent on Monday. Most analysts feel the recent measures would lead to short-term gains for the listed government oil companies.

“While the price hike has largely been discounted by the market, the reduction in customs and excise duty is an incremental positive surprise and we can see marginal upside in stocks in the short term,” feels Kotak Securities’ analyst Sumit Pokharna. Analysts have raised the 2011-12 earnings estimates for OMCs by one to three per cent. Any clarity on subsidy sharing and significant correction in crude oil prices will act as catalysts.
 

FALLING UNDER-RECOVERIES
Product	Units	Pre-EGoM	Post-EGoM
Diesel	Rs/ltr	12.7	5.6
LPG	Rs/cylinder	374	327
Kerosene	Rs/ltr	23.9	21.6
Total FY12E under- recoveries(Rs crore) *		1,38,500	95,300
* at avg crude price of $102/bbl                                        Source: Citigroup report

The price rises and duty cuts, though insufficient, would bring down total under-recoveries for 2011-12 by 29.4 per cent. Still, the gross under-recoveries are pegged at a humungous Rs 1,20,000 crore for FY12 (at the crude oil price of $112/bbl). Thus, a softening of crude oil prices would give a bigger relief to these companies in the longer term.

Last week’s International Energy Agency action in releasing 60 million barrels of crude oil from its emergency reserves could lead to a correction in prices. Enam analysts Amit Mishra and Prashant Tarwadi say that, historically, such moves result in a 15-35 per cent correction in crude oil prices in the following three months. Slowing global growth could also put downward pressure on crude prices, believe analysts. Brokerage house Citigroup expects crude prices to stabilise for the rest of the year at $90/bbl, thereby providing relief to the OMCs.
 

PROFIT GROWTH UNDER PRESSURE

In Rs crore

IOC BPCL HPCL ONGC OIL Sales3,71,4591,82,8401,56,3911,30,73010,556 Y-o-Y change (%)20.619.012.911.227.1 Ebitda (%)3.12.01.744.155.0 Y-o-Y change (bps)-100-80-90290654 Net profit5,26399754426,0103,969 Y-o-Y change (%)-32.3-36.3-68.414.937.6 P/E (x)15.522.324.49.17.8 Note: All figures are consolidated FY12 estimates                                 Source:Edelweiss, HSBC reports

However, the uncertainty over subsidy sharing for the year remains an overhang for oil and gas companies. The government will decide this formula only towards the end of 2011-12. For the June quarter, the government will share 52.5 per cent of the total subsidy burden. This ratio could fall to 45 per cent (upstream raised to 39 per cent from 33 per cent) for 2011-12, to compensate for the exchequer’s loss of Rs 49,000 crore due to the forgone duties.

While the fuel price rises were largely on expected lines, the duty cuts were icing on the cake, triggering an uptick in most stocks in this space. The OMCs (HPCL, BPCL, IOC) will be the biggest beneficiaries of reduced under-recoveries, as well as the possibility of lower crude oil prices, believe analysts. Though these moves will benefit the upstream (ONGC, OIL, GAIL) players as well, the uncertainty on subsidy sharing formula will continue to be a drag on the scrips.

Most brokerage houses have upgraded OMCs to a buy and also revised earnings estimates for the next two financial years, to factor in lower under-recoveries. Among upstream companies, Oil and Natural Gas Corporation remains the key pick of most brokerages, with estimated returns of 40 per cent from current levels. Its earnings per share is expected to grow by 16-20 per cent for FY12. Oil India is another company preferred by analysts, due to its sustainable earnings growth momentum.