Coronavirus outbreak: Subdued crude oil prices to help HPCL, other OMCs

IOC and BPCL to also gain from lower working capital requirement and firm marketing margins, but weak GRMs may limit the upside

Crude oil prices are on a slippery slope as global demand is likely to be impacted by the outbreak of the novel coronavirus in China. Against this backdrop, the International Energy Agency has lowered its oil demand forecast. The Organization of the Petroleum Exporting Countries (Opec) had cut its outlook for 2020 global oil demand growth by 0.99 million barrels per day a few days ago.

Even as demand growth expectations have been lowered — given the fear of losing market share to the US — the Opec may not consider a production cut, keeping oil prices subdued. Such a scenario is a positive for domestic oil-marketing companies (OMCs) such as Hindustan Petroleum Corporation (HPCL), Indian Oil Corporation (IOC), and Bharat Petroleum Corporation (BPCL).

Lower oil prices will help India’s major fuel retailing companies better manage working capital requirement and improve their marketing margins. Brent crude oil, which was hovering around $69 a barrel at the start of 2020, is now at $59-60 a barrel, and likely to remain subdued in future.

The volatility in crude oil prices over the past one month has hurt Street sentiment as the gross refining margin (GRM) outlook, too, has remained subdued.

Stocks of IOC and HPCL are also down up to 11-18 per cent since the start of 2020. BPCL though has been relatively firm (down only 4 per cent) on the hopes of value unlocking due to the government’s plan to privatise the company. However, analysts see a silver lining in this.

Though international oil demand and prices may remain subdued, analysts say they see steady demand from India, no major market share losses, and stable marketing margins for OMCs. The country is expected to continue reporting oil demand growth of 4-5 per cent over the medium term, which, along with an oligopolistic structure of the retail market (OMCs control about 90 per cent), should translate into steady marketing margins of Rs 2.5-3.5 per litre of retail fuels (petrol and diesel) for OMCs, estimate analysts.

Further, in the current benign oil price environment, structural changes in the pricing of liquefied petroleum gas and kerosene may further assist and the government may bid farewell to underrecoveries in the petroleum sector.

Among OMCs, HPCL, whose earnings are more dependent on fuel retail and marketing, remains the top pick of analysts such as Nilesh Ghuge at HDFC Securities. IOC and BPCL, too, will see gains in their marketing business and on working capital front, but their earnings are more dependent on an uptick in refining margins.

 

HPCL drives more than 50 per cent of its operating profit from the fuel marketing business, which should supplement its earnings in the current subdued GRM environment.

At Rs 222.50, the stock, too, is trading 35 per cent discount to its historical five-year average. Valuing it at 1.3x (20 per cent discount to FY15-18 post-reform period; factoring in heavy capital expenditure and project execution risk) its 2021-22 estimated price-to-book value multiple, analysts at Motilal Oswal Financial Services arrive at a target price of Rs 340. Target prices of Edelweiss and HDFC Securities at Rs 322 and Rs 315, respectively, also indicate a healthy upside for HPCL.

For IOC, the core refining margins, shutdowns at its Haldia and Mathura refineries for Bharat Stage-VI (BS-VI) upgrade and weak petrochemical pricing outlook remain near-term concerns. During the December quarter, IOC’s refining throughput had declined by 7.8 per cent year-on-year due to BS-VI shutdowns at Haldia and Mathura. Refining margins though got some boost with inventory gains as crude oil prices continued rising. But, in the March quarter, the company may see inventory losses, say analysts. The weak petrochemical price scenario, too, does not inspire. The stock though may also see some rebound, supported by gains in IOC’s marketing segment, as analysts feel valuations are inexpensive.

The news flow on stake sale will, however, be more important for any upside in BPCL, and analysts say that a successful sale to a strategic investor/buyer can lead to further increase in their target prices (up to Rs 609) for stock now trading at Rs 471.50.