Windfall tax cut to normalise equity multiples of RIL, ONGC: Morgan Stanley

Centre, on Wednesday, eliminated a levy on gasoline exports and cut windfall taxes on other fuels less than three weeks after they were imposed

The government's quicker-than-expected cut in windfall tax on fuel exports should "normalize equity multiples" of Reliance Industries and state-owned ONGC (Oil and Natural Gas Corporation), analysts at Morgan Stanley said on Wednesday. Besides, they see ONGC earning profit per barrel worth $25, which is 20 per cent higher over last year's profit.

"RIL's gross refining margins (GRM), is currently near $13 per barrel, i.e. near upcycle margins, as reduction in fuel margins is cushioned by lower crude official selling price (OSPs). ONGC, meanwhile, is seeing profit/bbl at$25, i.e. 20 per cent above last year's levels. More importantly, the move lowers investor concerns on a potential downgrade cycle for the stocks in a recessionary demand environment," Morgan Stanley said.

In a surprise notification on Wednesday morning, Centre eliminated a levy on gasoline exports and cut windfall taxes on other fuels less than three weeks after they were imposed. The government reduced the windfall tax on diesel and aviation fuel shipments by Rs 2 a liter, and scrapped completely a Rs 6-per-liter levy on gasoline exports. It also cut the tax on domestically produced crude by about 27 per cent to Rs 17,000 a tonne. SEZ refineries are also exempt from export taxes as well.

"While, in absolute terms, the windfall taxes are still high, we believe steady normalisation in local fuel availability (a key energy security concern for government), stability in oil prices, more normalised global fuel margins, and currency stability will help further reduction in windfall taxes under fortnightly review," the brokerage said.

Following the development, shares of Mukesh Ambani-controlled RIL (Reliance Industries Ltd) spurted 4.2 per cent in the intra-day trade to Rs 2,545 apiece on the BSE. The stock was the top gainer on the S&P BSE Sensex, and contributed nearly a third of the index's 690-point gain at 9:50 AM.

ONGC, meanwhile, surged 7 per cent, MRPL 5 per cent, Chennai Petroleum Corporation 11.4 per cent, and Hindustan Oil Exploration 4.6 per cent. 
 

International crude prices have slumped since mid-June on concerns about a potential global recession, at one point erasing all the gains that followed Russia's invasion of Ukraine. Brent crude was quoting at $107 per barrel on Wednesday, down 0.4 per cent. The price has dropped over 12 per cent from a high of $122.3 per barrel, hit on June 13, 2022. On a year-to-date (YTD) basis, though, the price is still up 31 per cent.

Returns from processing gasoline and diesel in Asia have plunged in recent weeks, with industry consultant FGE expecting a further decline in margins this quarter due to increased supplies.

Impact on Valuations

According to Morgan Stanley, Reliance, Oil India Ltd (OIL), and ONGC will see reduction in overhang and equity valuations should start pricing in high sustainable energy margins as government intent gets clear. 

"We believe RIL should get priced at $13-15/bbl sustainable refinery margins while ONGC gets priced at $75-80/bbl oil and $6/mmbtu commodity deck. The two should imply 25-40 per cent upside to equities as energy markets are expected to remain tight despite the current volatility in oil and reduction in global fuel margins from peak levels," it said.

Emkay Global, too, remains optimistic about ONGC, Oil India and RIL, and expect the review of the windfall tax should protect their downside risks. "Normalizing margins augur well for OMCs too. We maintain Buy on RIL, OIL, and ONGC with target prices of Rs 2,800, Rs 270, and Rs 185, respectively, on attractive valuations," it said.

"In April-June quarter (Q1FY23), ONGC/OIL are likely to register 200 per cent/328 per cent YoY growth in earnings, while unchanged retail prices will lead to losses for oil marketing companies (OMCs; ex-IOCL: benefit from strong GRMs); RIL will also log a strong Q1, but fluid macro and overhang of government policies make near-term earnings less relevant," said those at IIFL Securities.

PSU valuations are cheap on price-to-book value (P/BV), but lack trigger. On this backdrop, RIL and city gas distribution (CGDs) firms stand out well, they added.