BPCL, HPCL, IOC shed up to 8% on petrol, diesel price cut, margin worries

Analysts expect OMCs to trade lower in the near-term given the retail price cut and elevated brent crude prices of $85/bbl

Investors shunned shares of oil marketing companies (OMCs) on Friday as they feared the government's decision to cut retail prices of petrol and diesel could hurt the companies' profit margins in the near-term. 
 

On Thursday, the government announced that OMCs will reduce pump prices of petrol and diesel after a record 22 months, making them cheaper by Rs 2 per litre in the national capital. The changes, were effective Friday onwards.
 

As there is no indication of any excise duty relief from the central government, analysts expect OMCs to bear the cost of this price cut. 
 

Reacting to the development, shares of state-owned oil marketing companies tumbled up to 19 per cent on the BSE in Friday's intraday trade.
 

Hindustan Petroleum Corporation (HPCL), and Indian Oil Corporation plunged 9.8  per cent each to Rs 451, and Rs 153.6 per share, respectively, while Bharat Petroleum Corporation (BPCL) declined 8 per cent to Rs 571.75 in the intraday trade.

These stocks ended up to 6 per cent lower as against 0.6 per cent fall in the benchmark Sensex index. The Oil & Gas index, meanwhile, fell 2.2 per cent.
 

With Friday's decline, the stock prices of OMCs have declined between 15 per cent and 21 per cent from their respective 52-week highs, touched in mid-February. 
 

"We expect a negative stock price reaction from OMCs in the near-term amid the retail price cut and recent elevated Brent crude prices of $85/bbl. Yet, we have a 'buy' rating on HPCL and IOCL and a 'Neutral' rating on BPCL as the waning impact of Red sea crisis on crude oil and refining gross refining margins (GRMs) will help marketing margins recover to above Rs3/litre in the medium-term," said a note by Motilal Oswal Financial Services.
 

Analysts believe a price cut, especially in diesel, was not warranted at present given a spurt in Brent crude prices, and marketing margins being around breakeven levels.
 

Every Rs 0.5/litre change in auto-fuel gross marketing margin (GMM), they said, may have an impact of 7.1 per cent (Rs 3,400 crore) on IOCL FY25 consolidated Ebitda; 8.3 per cent (Rs 2,130 crore) on BPCL FY25 consolidated Ebitda; and 10.5 per cent (Rs 1,860 crore) on HPCL FY25 consolidated Ebitda.
 

Early estimates suggest that, post the latest price cut, OMCs' GMMs will decline to Rs 2.2/litre on diesel and Rs 3.5/litre on petrol, resulting in blended auto-fuel GMM of Rs 2.6/litre (vs historical GMM of Rs 3.5/litre). 
 

Marketing Ebitda, meanwhile, may be Rs 1/litre (vs historical marketing Ebitda of Rs 2/litre) based on spot Brent price of $85.2/bbl and actual product cracks of around $18/bbl for diesel and $14/bbl for petrol.
 

"We believe the 2 per cent cut in retail fuel prices may be a big de-rating event for OMCs. The cut may also take down marketing margin for Diesel/Petrol to below long-term average of Rs 2 per litre. Margins on diesel are below fair levels at present, and this cut challenges optimistic narrative," said a report by CLSA. The brokerage maintained 'Sell' call on HPCL, BPCL, and IOCL.
 

Premium valuation
 

Shares prices of HPCL, IOCL, and BPCL have surged between 78 per cent to 113 per cent over their respective 52-week lows, hit in March/April, 2023.

With this. HPCL is trading at 1.4x FY25 price-to-book (P/B) (vs historical average of 1.0x); IOCL at 1.4x FY25 P/B (vs average of 1.0x); and BPCL at 1.6x FY25 P/B (vs average of 1.3x).
 

This 15-25 per cent premium valuation, also, makes their risk-reward unfavourable given the development, analysts said.
 

That said, they have refrained from tweaking earnings estimates for the current financial year of 2023-24 (FY24), and next fiscal (FY25) as they expect the cut to last only two-to-three months. 
 

"With most part of the March quarter (Q4FY24) largely over and margins being strong earlier, this price cut does not change our estimates for FY24. Further, with OMCs embarking on new capex plans and aiming for net zero by CY40, we expect the government to allow them enough freedom to earn healthy returns FY25 onwards (post elections). Thus, we do not see any case to lower FY25-26E integrated margins and earnings estimates," said Sabri Hazarika, senior research analyst at Emkay Global Financial Services.