State-run refining and marketing companies (OMCs)—Bharat Petroleum Corp. Ltd (BPCL), Indian Oil Corp. Ltd (IOC) and Hindustan Petroleum Corp. Ltd (HPCL)—have all delivered strong June quarter results.
A key reason why these companies were able to perform better is the fact that they reported a better gross refining margin (GRM).
For the quarter, the measure for IOC, HPCL and BPCL stood at $9.98 a barrel, $6.83 a barrel and $6.09 a barrel, respectively.
GRM is a measure of profitability for refining companies. In general, GRMs of refining companies were expected to get a boost from inventory gains, thanks to the rising oil price trend over the quarter. That has panned out. Spark Capital Advisors (India) Pvt. Ltd says, adjusted for refining inventory gains, the GRMs for these companies were in the range of $4-5 a barrel. That’s not very impressive.
Nevertheless, the results beat street expectations.
IOC’s operating profit increased by one-third, compared with the same period last year to Rs.13,683 crore. HPCL’s operating profit increased 17% year-on-year to Rs.3,627 crore, while BPCL’s operating profit increased at a much slower pace of 3% to Rs.3,919 crore.
Reported net profit of IOC, HPCL and BPCL increased 25%, 30% and 11%, respectively, to Rs.8,269 crore, Rs.2,098 crore and Rs.2,620 crore.
What next after a great quarter? Investors in these stocks have little to complain. Higher visibility on profits thanks to reforms in the sector, benefits from lower crude price and robust demand have helped sentiment. So far this year, shares of these companies have outperformed the Sensex meaningfully. Currently, BPCL, HPCL and IOC trade at 11 times, nine times and 10 times estimated earnings for this fiscal year.
Even as valuations do not appear demanding, the outlook isn’t the brightest. Spark Capital believes OMCs’ earnings have peaked out in fiscal 2016 and sees risks to 2HFY17/FY18E earnings. Some factors that pose risks, according to the brokerage, include weaker GRMs and narrowing of trade discounts offered by West Asian suppliers—hitting GRMs and normalization in marketing margins of auto fuels.
Further, while the June quarter was supported by strong inventory gains, a similar support in the current quarter is unlikely. In fact, it is possible that the June quarter ends up being the best quarter for this year. Given this and the sharp run-up in the stocks, upsides in the OMC stocks could be capped.