OMCs bounce back to sweet spot as crude oil prices slip, GRMs improve

Declining crude oil prices, improving GRMs, and firm marketing margins make them attractive after sharp correction

The share prices of public sector oil-marketing companies (OMCs) such as Hindustan Petroleum Corporation (HPCL), Bharat Petroleum Corporation (BPCL), and Indian Oil Corporation (IOC), which had declined more than 30 per cent since their early-June highs, are now seen bouncing back.
 
The declining crude oil prices, improving gross refining margins (GRMs), and a decent outlook for marketing margins (earned by retailing fuel such as petrol, diesel, etc) bode well for the OMCs and their earnings.
 
Weak GRMs had continued to impact the profitability of OMCs during the April-June quarter (first quarter or Q1). In Q1, the Singapore benchmark GRMs at $3.5 a barrel were at half the levels seen in the year-ago quarter. This had impacted the core GRM of OMCs, with IOC, BPCL, and HPCL reporting per barrel refining margin of $4.7, $2.8, and $0.75 versus $10.2, $7.5, and $7.1, respectively — reported by these companies in the June ‘18 quarter.
 
However, the positive now is that Singapore GRMs are seen rebounding. In fact, on a sequential basis, from an average $3.2 a barrel in the March ‘19 quarter, GRMs were slightly better at $3.5 a barrel in Q1 in 2019-20 (FY20) and have improved further in the current quarter to around $4.2 levels.
 
Analysts at Edelweiss say a dual bonanza from change in competitiveness — greater complexity at refineries — and a structural uptick in global GRMs is set to light up Indian OMCs.
 
The Indian refiners also have the world’s most competitive refineries and analysts say that with stricter International Maritime Organization norms (emission standards) kicking in early next year, they are in a sweet spot to gain from even higher diesel cracks (price difference between refined diesel products and crude oil).
 
Notably, the OMCs have been reporting firm trend in marketing margins and Q1 had seen IOC, BPCL, and HPCL’s blended margins improving 8.8 per cent, 9.3 per cent, and 4.5 per cent year-on-year, respectively.

With the general elections behind, the overhang of any regulatory interference in retail fuel pricing for the time being is also behind. Subdued global oil prices add further to the benefits, while their working capital requirement will also reduce.
 
Moreover, the correction in the share price of OMCs has made their valuations attractive too. “While we don’t feel OMCs are completely out of the woods, the correction makes the value proposition somewhat attractive,” say analysts at Antique Stock Broking.
 
Given the recent correction in crude oil prices, marketing margins have improved and can help them tide over weaker refining environment in general, add analysts.
 
Among the three OMCs, HPCL is more sensitive to marketing margins and is well placed to see further improvement in the same, with planned cost reduction and recovery of certain unrecoverable items, say analysts.
 
HPCL, however, has planned a 45-day shutdown at the Vizag and Mumbai refineries in the third and fourth quarters of FY20, to align petrol/diesel quality to Bharat Stage VI and this might adversely impact the refinery throughput in FY20, say analysts at Motilal Oswal.
 
However, refining margins will be in a sweet spot thereafter and also HPCL’s expanded refining capacities will start coming onstream from mid-2020-21.
 
IOC has least exposure to marketing (23 per cent), but offers the greatest upside potential among OMCs due to its superior middle distillate yield, the cushion from petrochemical earnings, highest dividend yield (7.4 per cent), strongest return on capital employed (12.9 per cent), and steady cash flow, say analysts at Edelweiss. However, the Street will be keep an eye out on the uptick from IOC’s Paradip refinery and any delay in stabilisation can impact investor sentiment, feel analysts.
 
Meanwhile, BPCL, with exposure to upstream operations (exploration assets) and downstream operations (refining and marketing), remains well-cushioned in case of volatility in crude oil prices. Probal Sen at Centrum Broking prefers BPCL as a defensive play.
 
On the whole, while the tide is turning favourable for OMCs, investors need to be watchful of any moves by the government in terms of stake sale or regulatory interference in marketing margin/pricing.