Near-term upsides priced into stocks of oil marketing companies

The oil marketing companies, IOCL and BPCL posted better-than-expected earnings in Q3FY24 due to a big upside in refining margins and also marketing inventory gains as crude prices rose.

BPCL and IOCL gross refining margins or GRM came in at $13.4 and $13.5 per barrel (bbl) respectively at a premium of $8-plus to Singapore complex GRM of $5.4/bbl.

Overall, IOCL and BPCL reported a net profit of Rs 8,063 crore and Rs 3,397 crore respectively, well ahead of Q3FY23 PAT of Rs 448 crore and Rs 1,960 crore.

There was a quarter-on-quarter (Q-o-Q) decline in earnings due to a higher base of Q2FY24. 

HPCL disappointed the Street on the operational front due to a lower-than-expected marketing margin of Rs 2.7 per litre as against the estimates of Rs 3.4 per litre led by suppressed margins on diesel.

The fuel price freeze for petrol pumps continues with crude range-bound between $80-85/barrel, while refining spreads are steady. In FY25, there could be a deep cut to earnings Y-o-Y, assuming a cool-off in refining spreads and normalisation of marketing margins.

OMCs’ GRM may settle down due to normalisation of diesel crack rates and thinner Russian crude oil discounts.

The outlook for refiners remains upbeat for Q4FY24 with GRMs remaining ahead of Singapore at $8 per barrel in Q4FY24-till date.

Media reports have indicated lower Russian discounts, however, West Asian spreads have fallen by $1.5 per barrel Q-o-Q. IOCL reported surprise inventory gains during Q3FY24 and BPCL’s numbers probably include inventory gains also. Hence inventory gains in Q4FY24 will not be so significant.

The gross marketing margin in petrol and diesel averaged Rs 9.2/litre (petrol) and Rs 4.6/ litre (diesel) in Q4FY24 till mid-February.

If the trend holds, Q4FY24E could average better sequentially over Q3FY24. This means that sequentially, Q4FY24 reported numbers could be better and closer to the Q2FY24 rate.

Brent oil (February 2024 to date) is down 4.3 per cent M-o-M and 1.4 per cent Y-o-Y.

The retail margin is marginally positive. There is little apparent risk of a sharp rise in crude prices despite the Red Sea issues since Opec's surplus capacity is around 5 million barrels/ day. However, there could be an uptick if the Houthi situation escalates.

OMCs have partly recouped auto fuel losses of FY23, and a price cut in Q1FY25 is likely, given elections, if Q4FY24 is strong. OMC stocks will fall if there is such an action and it will also adversely affect CNG volume growth. This could be an entry point with a medium-term perspective.

The other possible overhang is the ongoing aggressive capex plans which may not create much long-term value for shareholders.

OMCs’ valuations are assessed to be trading at 25-50 per cent premium to historical valuations. Every USD 1/bbl change in GRM has an impact of 10 per cent (or roughly Rs 5,000 crore ) on IOCL FY25 consolidated operating profit and 9.7 per cent (or Rs 2,500 crore) on BPCL’s FY25 consolidated Ebitda.  

In IOCL, analysts have 15 Buy calls and 10 Sell calls with 9 Holds. In BPCL, there are 22 ‘buys’ and 8 ‘sell’ recommendations. 

For HPCL, 50 per cent of analysts have a buy rating while a third has a ‘sell’ rating. However, many of the target prices are below the current market price, which suggests that valuations are expensive.

The BSE’s OMC index is up 117 per cent in the last year whereas the Sensex has gained only 25 per cent.