OMC stocks seem attractive after earnings decline and correction

Results for the first half (H1) of 2024-25 (FY25) of the three oil marketing companies (OMCs) — Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) — were poor with accumulated LPG losses, weaker gross refining margins (GRMs) and inventory losses dragging earnings sharply even after allowing for H1FY24’s high base.

 

However, crude prices are looking bearish, while product margins may be sustained.

 

Hence, the second half (H2) of FY25 could be better. Relatively lower crude price volatility could mean a lower inventory impact even as raw material prices fall. The possibility of partial LPG compensation coming through by end-FY25 is also reasonable.

 

H1FY25 saw OMCs’ aggregate earnings before interest, taxes, depreciation and amortisation (Ebitda) fall sharply with profit after tax (PAT) plummeting 86 per cent year-on-year (Y-o-Y).

 

Benchmark Singapore GRMs (SGRMs) slumped to a multi-month low in Q2FY25 to $3.7 per barrel (bbl).

 

There were inventory losses of $1.8–$5 per bbl due to the sharp fall in crude and product prices.

 

Marketing earnings also shrank due to inventory losses and accumulated under-recovery on LPG sales where product prices have fallen below the realised prices.

 

In H2FY25, LPG under-recovery is likely to remain at similar levels though partial compensation could appear in the revised Budget estimates by year end. 

 

But there are some reasons for optimism about the H2FY25 prospects for the OMCs. This is despite potential aggregated Rs 30,000–33,000 crore of under-recovery losses related to LPG over FY25 (aggregate Rs 17,500 crore loss in H1FY25).

 

There has been a drawdown in crude and product inventories in the US over the past several weeks.

 

Due to a small uptick in demand and disruptions of some refining capacity, this has driven Singapore GRMs to a three-month high of $6 per bbl in November 2024. These GRMs may sustain in the near term.

 

Marketing margins remain well above historical averages in Q3 and this could drive EPS upgrades.

 

Share price of OMCs have been range-bound post-Q2FY25 results, although auto-fuel prices are frozen, and crude prices are stable at $70-75 per bbl. And, GRMs have inched up from $3-4 per bbl to the $5-6 per bbl range.

 

LPG under-recoveries have ballooned to over Rs 210 per cylinder in Q3FY25, led by winter seasonality, but better auto-fuel margins (Rs 7.5-11.5 per litre current gross margin for diesel-petrol) more than made up.

 

OPEC-plus has extended its production cut, leading to hopes of oil prices stabilising. Delhi is the only upcoming election in the recent future. Hence, the current trade off with higher auto-fuel margins versus LPG under-recoveries could continue without much policy interference.

 

Benchmark GRMs have averaged at over $5.0 per bbl in Q3FY25-to-date, implying $1.5 per bbl sequential improvement, while Middle-East crude premium has contracted by $1.6 per bbl quarter-on-quarter (Q-o-Q).

 

Media reports indicate range-bound discounts on Russian crude imports. Brent crude has been more or less flat in Q3FY25-to-date, implying negligible refining and inventory losses for BPCL and HPCL. IOC could see refining inventory loss of $2 per bbl due to an elongated inventory cycle.

 

Gross marketing margin in petrol and diesel is likely to average at Rs 12 per litre and Rs 8 per litre, respectively, in Q3FY25, indicating upticks of 33 per cent and 60 per cent respectively Q-o-Q.

 

Current LPG under-recoveries are edging up to Rs 230 per cylinder.

 

Petroleum products demand is steady at 5-10 per cent Y-o-Y for Q3FY25-to-date. OMCs have been hoping for LPG subsidy by end of FY25 while enjoying the auto-fuel marketing margins cushion.

 

Given the correction, and the Street assuming a 50 per cent Y-o-Y drop in earnings this financial year, the current prices may be attractive, if one factors in a likely 4 per cent dividend yield.

 

Resumption of more frequent revision in retail prices could be a driver. Policy risk appears low.

 

Adverse crude oil price moves based on geopolitical uncertainty and further downward pressure on the rupee could be adverse factors, along with possible policy risks.