OMCs hit multi-year highs

Since Jan, scrips have rallied 25-43%, with encouragement from reforms in sector since mid-2013 and optimism on earnings prospects

Shares of state-owned oil marketing companies (OMCs) closed at respective multi-year highs on Thursday, on expectation of higher earnings growth. Bharat Petroleum Corporation moved up one per cent to Rs 900 on the BSE. Hindustan Petroleum Corporation and Indian Oil Corporation gained six per cent each, to Rs 414 and Rs 780, respectively. Thus far in 2015, these three have gained 25-43 per cent, compared to a two per cent rise in the benchmark S&P BSE Sensex. From the lows in August 2013, stocks of these OMCs have moved up 99-347 per cent, relative to the 50 per cent rise in the benchmark index.

The rally has been driven by several reforms, starting with the gradual rise in diesel prices by the previous government. It was fuelled by expectation of more progress under a strong and reform-oriented government that took charge in May 2014.

 

According to analysts at Nomura, this financial year will be a defining year for public sector undertakings in the oil sector. They expect an increase of 53-134 per cent in earnings, as the full impact of reforms in oil marketing (diesel deregulation, cooking gas direct benefits transfer, etc) and a sharp decline in oil prices will be visible.

“With a concomitant decline in subsidies, we expect the quality and predictability of earnings to improve. Importantly, we believe higher earnings are likely to be sustainable,” Nomura analysts said in a report dated Thursday. “For OMCs, as several key reforms are in place, earnings should now be driven more by fundamentals (refining margins, oil price, marketing margins, volume growth, etc) and their focus will now be on issues like efficiency and market share gains.”

 

 

Since decontrol, OMCs have been recording super-normal margins on diesel, averaging Rs 1.8/litre (it was around Rs 1/litre a year before). “We believe margins will eventually settle around Rs 1.8/litre, based on the economics of the marginal cost of setting up a new gas station and our global case studies,” said Jal Irani and Yusufi Kapadia, analysts at Edelweiss Securities, in a research report.

Tarun Lakhotia & Kumar Gaurav, analysts at Kotak Institutional Investors, however, maintain a cautious outlook on the sector. They say the sharp rally in OMC stocks after the robust March quarter results, aided by abnormally high marketing margins and recent strength in refining margins, leaves limited upside for the stocks. The marketing margins have moderated since then and refining margins are unlikely to sustain at such high levels, they said in a recent report.