Crude price, the most critical factor, determining the profitability of Oil Marketing Companies (OMCs), has been on a rebound. Therefore, we expect pressure on marketing margins of OMCs going forward.
Earnings comfort from the refining segment would be missing in FY10E, given significant refining capacity additions across geography.
Policy reforms also continue to remain an uncertainty. Consequently, we initiate coverage with a ’cautious’ outlook on the sector.
We expect oil prices to average $49/bbl in FY10E and model for a higher trading range of $55-$65/bbl in FY11E. More importantly diesel crack have improved from $6/bbl seen in March ’09 to $11/bbl in FY10E .
Higher diesel cracks mean lower diesel margins and, as a consequence, reduced blended auto margins (diesel and petrol) of Rs1.6/ltr for FY10E, from ~Rs4/ltr currently.
Diesel, with a marketing margin of ~Rs4.5/ltr, is the only profitable product out of the other three key petroleum products.
We note that our core EPS estimates for FY10E are highly sensitive to crude price, rupee-dollar exchange rate, marketing margins and refining margins.
Volatility in any one of the aforementioned factors, particularly the first three, would keep earnings very fluid. Given the uncertainty surrounding the core EPS for FY10E, we are cautious on the perceived improvement in downstream fundamentals.
We have valued the OMCs on P/BV multiple of 0.7x-0.9x one-year forward, arriving at a 12-month target price of Rs450, Rs380, and Rs255 for IOC, BPCL, and HPCL respectively.
This implies an upside of 12% for IOC and ~1% for BPCL and a downside of 2% for HPCL from the current market price and forms the basis of our recommendation.
We note that in a strong crude price environment, IOC’s EPS would be the least affected, given its diversified revenue base (refining, pipelines, petrochem). In contrast, HPCL’s earnings would be the most affected due to its higher dependence on marketing earnings.