Crude at 31-month high, oil marketing companies likely to be under pressure
Mumbai: Increase in Brent crude price is likely to hurt profitability of Indian oil marketing companies (OMCs), according to analysts. Prices of Brent crude touched a 31-month high on Tuesday, hitting over $67.29 per barrel.
Crude oil prices have increased by 40% to $67 per barrel in December 2017 from $48 per barrel in November 2016-end, when the Organisation of the Petroleum Exporting Countries (Opec) decided to cut back on crude oil production.
Geopolitical tensions, extension of timeline for production cut-back by Opec and few non-Opec countries, higher-than-anticipated global demand growth of petroleum products and some supply disruptions are a few factors behind the sharp increase in oil prices.
In the past three months, most OMC stocks have under-performed BSE Oil & Gas index. BSE Oil & Gas index gained 9.71% and benchmark Sensex index jumped 8.86%, while Indian Oil Corp. (IOC) lost 2.91% and Hindustan Petroleum Corp. Ltd (HPCL) slipped 2.39%, but Bharat Petroleum Corp. Ltd (BPCL) was up 9.87% in the last three months ending December.
K. Ravichandran, senior vice-president and group head - corporate sector ratings, ICRA, said, “Spike in crude oil prices would lead to increase in the working capital requirements and short-term debt levels of OMCs, thereby negatively impacting their profitability. Further, if public sector undertaking OMCs are directed to share a part of higher gross under-recoveries (GURs), it could be a key negative for their profitability. Higher crude oil prices would also test the government’s resolve to keep prices of auto-fuels at market-determined levels, which would have material implications for private marketers.”
He said in a report on 29 December that GURs of OMCs are already expected to be higher by Rs3,000-5,000 crore as compared to the earlier anticipated levels following spike in crude oil prices, despite the regular increase in retail prices of sensitive products and the anticipated fall in sales volumes of subsidised kerosene.
According to Kotak Institutional Equities, recent correction in OMCs led by weakness in marketing margins has not made valuations compelling enough and continues to see downside risks to consensus estimates for these companies. It said, in a note on 7 December, “We remain cautious on intermittent curtailment of marketing margins, sustained loss of market share and significant capex plans, which may limit free cash flow generation.”
Marketing margins on diesel and gasoline have declined sharply to about Rs1 litre currently from Rs3.1 per litre in Q2FY18, led by lack of commensurate increase in domestic retail prices since the first week of November despite a sharp uptick in global crude and product prices during the same period.
The research house said that OMCs may look optically inexpensive trading at 9-11 times price-to-earnings (PE) multiples, but it is difficult to justify growth multiples for OMCs, as a significant portion of the business is cyclical and requires meaningful amount of capex for upgradation and modernization, let alone to raise capacities.