Why OMC shares lack fuel these days
Crude oil prices were the highest in 30 months on Tuesday. Shares of oil marketing companies (OMCs)—Indian Oil Corp. Ltd (IOC), Bharat Petroleum Corp. Ltd (BPCL) and Hindustan Petroleum Corp. Ltd (HPCL)—reacted by declining 2.2-4%, on a day when the benchmark Sensex shed 0.7%.
Since the Indian government reduced excise duty on petrol and diesel effective 4 October, Brent crude prices have climbed 17% so far. In contrast, retail prices of diesel and petrol at Delhi increased at a much slower pace of 2.5% and 1%, respectively, during the same time frame, according to IOC. The rupee-dollar exchange rate hasn’t moved dramatically over this period.
Therein lies the problem for OMCs. Marketing margins on diesel and petrol have declined sharply to about Rs1/litre currently from Rs3.10/litre in the second quarter of fiscal year 2018 (FY18), said analysts from Kotak Institutional Equities in a note on 6 December. This is led by lack of commensurate increase in domestic retail prices since the first week of November despite a sharp increase in global crude oil and product prices during the same period, said the brokerage firm.
According to Ritesh Gupta, an analyst with Ambit Capital Pvt. Ltd, this creates an impression that OMCs are still governed by the government. At such times, investors start losing confidence and they feel that these companies don’t enjoy much pricing power, he added.
Sure, the latest data on petroleum product consumption for the month of November showing a 6.2% year-on-year increase is encouraging. This comes after the yardstick had risen 10.4% year-on-year in November last year, so the base isn’t particularly favourable.
While higher volumes are always welcome, “margins remain much more important for earnings and the share price outlook”, wrote analysts from Jefferies India Pvt. Ltd in a report on Monday. Every Rs0.10/litre change in auto fuel marketing margin impacts earnings per share by 1.6-3.8%, according to Jefferies.
These concerns are reflected in the share prices of all OMCs, which have underperformed the Sensex in the last three months. The bright spot is that current valuations are not demanding. Based on Bloomberg data, these shares are trading in the range of 9.1-9.7 times estimated earnings for FY19. But the outlook isn’t exciting enough. Kotak remains cautious on intermittent curtailment of marketing margins, sustained loss of market share to private sector companies and significant capex plans, which may limit free cash flow generation.
Jefferies India continues to prefer IOC (BUY) to BPCL and HPCL (both Underperform), noting more modest expectations, cheaper valuations (10-35% discount) and a more balanced earnings mix (~40% from petchem and pipelines) that lends greater stability to earnings.
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