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Analysts at Macquarie in their 20th August report say OMCs standalone profits are a reasonably-fixed number which the government plans based on their operational profits, capital expenditure needs and the fiscal situation. They believe stock prices are mispriced at sub-four times PE ratios, suggesting investors expect a 10-20 per cent profit decline to perpetuity. As OMCs control 99 per cent of petro-retail and 64 per cent of refining in India, this doomsday expectation is absurd; even if the fiscal is badly stretched. The analysts have an outperform rating on OMCs.
OMCs to report profits
At the start of FY14, while analysts pegged under-recoveries for oil companies at Rs 80,000 crore, with the rupee depreciation, these estimates have risen to Rs 130,000-140,000 crore. However, these are still lower than the Rs 161,000 crore in FY13. An underrecovery is the cumulative difference between the actual and subsidised price of the fuel such as diesel, liquefied petroleum gas, kerosene and petrol the OMCs sell.
The FY14 estimates are lower than the last year's because while the rupee has depreciated more than 12 per cent, crude oil prices are still lower than a year ago. During the June quarter, Brent crude oil price averaged at a two-year low of $103 a barrel (down nine per cent sequentially and five per cent year-on-year).
More, diesel prices have been raised by 25 per cent, while petrol remains decontrolled. Also, of the overall under-recoveries after accounting for government's compensation, it is the upstream companies such as Oil and Natural Gas Corporation and Oil India that bear the majority of the subsidy (in the form of discounts). OMCs are left to bear minimal.
Macquarie analysts say OMCs will not (and cannot, given their profit-and-loss size) bear more than five per cent of the total yearly subsidies. Historically also OMCs have never been allowed to end the year in losses. Vivek Gujrati at Anand Rathi, too, says that looking at the limited profitability, the OMCs cannot be made to bear a heavy subsidy burden.
Even analysts at Nomura say that while the earnings predictability remains low, OMCs operate in too important a segment, and the government will likely continue to ensure their full-year profitability. They add the subsidy problem is less menacing now as they expect under-recoveries to decline a sharp 56 per cent by FY16 even at rupee-dollar exchange rate of 60.
BPCL remains the top pick
Though all the OMCs remain attractively priced, Bharat Petroleum Corporation Limited (BPCL) remains the top pick of analysts. Its prospects look bright, given its strong exploration and production base. Also, unlike Indian Oil Corporation (IOC), it does not have any hangover from the government's plan to sell the latter's stake in the company.
During the June quarter, BPCL had reported a net profit of Rs 150 crore despite limited cash compensation from the government that led HPCL and IOC to report losses. This is because BPCL saw superior gross refining margins of $4.1 a barrel compared to HPCL's $2.6 and IOC's $1.67 and lower forex losses of Rs 940 crore (versus IOC's Rs 4,020 crore; HPCL does not disclose this).
More, analysts at IDFC Securities say the value of BPCL's 10 per cent stake in the Mozambique block (on the basis of Videocon's deal to sell its own 10 per cent stake in the block) at two times its NAV of Rs 87 a share gives comfort on valuations for this segment. "The recent news flow around discoveries/appraisal on the Brazil blocks is an added positive and underpins our value of these assets (Rs 12 a share, $171 million)," say IDFC Securities analysts.
According to Bloomberg, in August, all 18 analysts polled had buy ratings, with a target price of Rs 420 for the BPCL stock trading at Rs 284. For IOC (Rs 211), of the 23 analysts, 13 have buy, seven have hold and three have sell on the stock (target Rs 262). While for HPCL (Rs 177), of the 25 analysts, 18 are buy, four have hold and three have sell, with target of Rs 267.
