Oil marketing companies (OMCs) namely Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) reported better than expected results for the March 2015 quarter. Timely compensation by the government towards under-recoveries (loss on selling fuel at below cost), lower interest costs as well as higher other income (largely driven by forex gains) aided net profit in the quarter.
Consequently, although the profits were down year-on-year, BPCL's net profit at Rs 2,853 crore in the quarter was about 48 per cent higher than Bloomberg consensus estimate of Rs 1,932 crore. HPCL's net profit at Rs 2,162 crore was also 39 per cent higher than estimate of Rs 1,552 crore. Given that the timing of government compensation varies, there could be sharp fluctuations on a quarterly basis. For the March quarter though some of the profit decline can also be attributed to the fall in crude oil prices that impacted revenues.
While BPCL and HPCL had to bear about 3 per cent and 3.8 per cent of total FY15 gross under-recoveries, BPCL management believes there will be minimal subsidy burden in FY16. Full de-regulation of diesel prices along with lower crude oil prices are key reasons behind this. P Balasubramanian, Director- Finance, BPCL, says, "We hope there will not be any subsidy sharing in FY16 as diesel is fully de-regulated and kerosene will be the only product to remain under subsidy mechanism (LPG will fall under direct benefit transfer scheme). We believe under-recoveries will be far less in FY16 and will be pretty much manageable if crude oil prices remain between $60-80 a barrel."
For HPCL, at Rs 44,550 crore its net sales too came in 2.2 per cent higher than estimate of Rs 43,598 crore even as it was down 30.5 per cent over the year ago quarter. Lower crude oil prices impacted topline but HPCL's throughput increased 2.5 per cent to 4.5 mmt.
While the fall in interest costs aided profit growth throughout FY15, large part of interest cost savings are behind BPCL. Working capital needs of BPCL have come down due to lower crude oil prices and lower interest rates in domestic market have also been a positive in FY15. The management though believes interest costs could see marginal increase in FY16 on account of slight firming up of crude oil prices.
India’s largest oil market company, namely Indian Oil Corporation (IOC) is also likely to post good set of numbers as well given the timely government compensation. Analysts remain positive on the three oil marketing companies (OMCs) given that post full de-regulation of diesel prices, earnings visibility has improved.
"We switch our valuation approach for all three OMCs from a book value-based methodology to one based on earnings, as earnings visibility has materially improved for the companies following diesel de-regulation and also as earnings gains could start benefitting operating profits too as diesel starts making money for the OMCs", writes Saurabh Handa of Citigroup in a recent report.
Thus, higher marketing margin will act as catalyst for the OMC scrips. And, even though competition from private players like Reliance and Essar is seen picking up, the OMCs’ marketing business is unlikely to see any significant impact on the profitability. In fact, sometime ago, analysts were expecting their margins to increase as the costs for private players are higher than the margins the public sector companies enjoy currently.
BPCL stock though could also move up in tandem with positive announcements from exploratory activities in Brazil and Mozambique.