 "Street bullish on OMCs despite stellar gains")
The Street continues to remain bullish on the prospects of oil marketing companies (OMCs), particularly Hindustan Petroleum Corporation Limited (HPCL) and Bharat Petroleum Corporation Limited (BPCL), despite their stellar gains. Shares of these two state-owned OMCs have nearly doubled over the past two years even as Sensex has seen a relatively muted performance amid a sharp drop in global oil prices. Indian Oil Corporation (IOC)'s performance has been relatively subdued as its financial performance lagged behind that of its peers. This year, HPCL and BPCL gained 10 per cent each even as the Sensex stayed flat.
A strong showing in the March quarter by HPCL and BPCL has further supported the rally and buoyed the outlook on these stocks.
"OMCs reported impressive results led by 25-45 per cent increase in marketing margins and firm gross refining margins or GRMs (excluding those of IOC). Results were robust despite meaningful inventory losses. The current quarter could be equally good," says Axis Capital. GRMs are the difference between buying of crude oil and average selling price of refined products.
The brokerage expects OMCs to do well on the back of profits and firm GRMs. Valuations at only seven times expected 2017-18 earnings and return of equity (RoE) of 15-20 per cent provide more room for growth in stocks, say analysts. RoE is the amount of net income returned as a percentage of shareholders equity. RoE measures a firm's profitability by revealing how much profit a company generates with the money shareholders have invested.
Strong demand for petroleum products in the country is another positive for OMCs. India's petroleum consumption grew 11 per cent in FY16, and the growth in April was 10 per cent.
"The fuel demand is likely to go up. It is a constant growth story," says G Chokkalingam, chief executive and founder, Equinomics Research and Advisory. But he says the crude oil price in the international market is likely to improve 10-20 per cent as global economy is set to get better.
Analysts say OMCs are a play on lower crude oil prices. In June 2014, oil prices were around $100 per barrel. These dropped to $25 per barrel in January 2016, a drop of 75 per cent in 18 months. This drop was attributed to a record production in the United States and weak demand in emerging markets, which led to a supply surplus.
Low oil prices have also reduced the working capital requirement for OMCs, which is typically funded by debt. This has boosted OMC's RoE. Working capital requirement is the funds a company is required to keep on hand to be able to pay its short-term debt and other business-related expenses.
However, after the drop, oil prices started to crawl back and now stand at $50 per barrel. Analysts say a further rise is a threat for OMCs.
Low crude oil prices have supported the marketing and refining margins of these companies. Should the oil prices go up, these discounts would narrow, says Nomura.
