Tide turns in favour of oil marketing companies

Bharat Petroleum remains analysts' top pick, given its ongoing drilling programme in Brazil

The recent rebound of the rupee versus the dollar, coupled with benign crude oil prices, has put oil marketing companies (OMCs) — Indian Oil Corporation (IOC), Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL) — in a sweet spot. Also, the government’s measures, such as diesel price hike and cap on LPG cylinder, will further improve profitability of these companies.

Analysts, thus, have now trimmed their under-recovery expectations to around Rs 1,30,000-1,50,000 crore from about Rs 1,90,000 crore before reforms were announced. Notably, brent crude oil has fallen four per cent and the rupee has gained six per cent post-reforms for the oil & gas sector (announced on September 14), reducing the overall under-recovery burden. Analysts estimate that every one per cent fall in crude oil price lowers under-recovery by Rs 3,000 crore, while a one per cent gain in the rupee reduces the under-recovery by Rs 4,000 crore.

“The sharp reduction in under-recovery could turn into a virtuous cycle as a result of lower fiscal burden leading to further rupee appreciation and a fall in under-recoveries to as low as Rs 81,400 crore (crude at $100/barrel and rupee at 50). While this fall in under-recoveries benefits all OMCs via better cash flows and lower interest expenses, BPCL remains our top pick, given its ongoing drilling programme in Brazil/Mozambique, which should lend greater clarity to oil reserves,” says Niraj Mansingka, analyst at Edelweiss Securities.

While these favourable factors will improve the cashflows of OMCs and reduce their working capital needs, their profitability will continue to be a function of compensation of the under-recoveries by the government. “Since the government did not provide any cash subsidy in the June quarter, we expect Rs 30,000 crore coming in as cash subsidy towards June and September quarters. If provided in time, the cash subsidy along with inventory/forex gains would help OMCs report September quarter in black,” said Ballabh Modani and Nitin Tiwari of Religare Institutional Research.

Going forward, analysts rule out further fuel price hikes but they expect the stocks to gain from further rupee appreciation and weakening crude oil prices. Secondly, OMCs are also likely to witness improved gross refining margins (GRMs), in line with Singapore GRMs.

While fundamentals are improving, the valuations of these OMCs are also reasonable, believe analysts. “OMC valuations, excluding investments (and E&P for BPCL), are at undemanding 0.5-0.6 times price/ book and below book for all three OMCs. Hence, we upgrade all three OMCs to ‘Buy’,” wrote Anil Sharma and Ravi Adukia of Nomura in a recent report.

Most analysts remain positive on BPCL and expect newsflow to be positive as the company progresses with its drilling activities in Mozambique and Brazil. The ramp up at the Bina refinery will also act as a catalyst for the stock. Analysts expect HPCL, too, to gain from higher refining volumes, post-commissioning of the Bhatinda refinery. Its exploration portfolio could also surprise on upside. IOC’s Paradip refinery could boost its return ratios from FY14.