OMCs: Correction offers a good opportunity

The companies will continue seeing cut in interest costs, improved marketing margins

Oil marketing companies - HPCL, BPCL, IOC - have seen significant correction in line with the fall in broader indices. The fall has been due to profit-booking and high valuations. But nevertheless, the outlook for these stocks remains strong and this correction offers a good opportunity, feel experts. 

OMCs stocks' rally was driven by lower crude prices, expected benefits of oil and gas reforms such as deregulation of diesel and petrol and direct transfer of LPG subsidy etc. These drivers still remain intact and will continue to drive earnings of OMC’s as more benefits flow.

In FY16, there are no risks of inventory losses that companies had to suffer in FY15. The working capital requirements have also reduced significantly leading to reduction in debt, which will in turn trim interest costs. 

For instance, HPCL has seen its total debt reduce from Rs 32,400 crore in FY13 to Rs 17,000 crore in FY15 and analysts at Emkay research see further reduction in overall debt in FY16. The interest expenses are seen reducing further to Rs 444 crore in FY17 from Rs 707 crore in FY15. With EPS estimated to grow from to Rs 109.2 in FY17 compared to Rs 80.6 in FY15, Emkay has a target price of Rs 1,059 on the stock. HPCL has corrected significantly from 52 week highs of Rs 990 to Rs 767 levels offering good entry point. 

Indian Oil Corporation (IOC) that has corrected from 52 week highs of Rs 465.40 to Rs 385 levels is also a beneficiary. Other triggers for the stock will be stabilisation of its Paradeep refinery, which after achieving break even after commissioning will lead to faster growth in earnings. 

Analysts at Motilal Oswal expect IOC’s profit to more than double, led by fall in interest costs and higher marketing margins (increasing from Rs 1.4 a litre to Rs 2.4 a litre by FY18). They expect Returns on Equity (RoE) to sustain at more than 15%. The agency says that refining margins would be governed by global demand supply, and likely higher marketing margins would provide predictability to its earnings, leading to re-rating. They have a fair value of Rs 570, implying a 48% upside.

BPCL too has moved down from highs of Rs 987 to Rs 871 now. The company will also benefit from lower debt and interest costs. Besides, exploration and production can further drive earnings. With regards to the oil marketing business, analysts see significant improvement in profitability. Analysts at SBI Caps have assigned a premium of 2.2x to the book value of refining and marketing assets (no discount earlier) due to improvement in GRMs and decline in interest costs due to lower debt. Their target price stands at Rs 1,073.