As OMC shares bleed, analysts say correction may be overdone
India imports 80% of its crude oil needs and rising prices have hurt the fiscal balance of the country.
Shares of state-run oil marketing companies have been bleeding as they faced the dual blows of rising crude oil prices and a steep fall in rupee, but analysts argue their current valuations are attractive as the concerns may be overdone.
Year-to-date, Hindustan Petroleum Corp. Ltd. (HPCL), Indian Oil Corp. Ltd (IOC) and Bharat Petroleum Corp. Ltd (BPCL) have eroded 42.28%, 23.15% and 35.56% to trade at ₹240.30, ₹149.25 and ₹334.25, respectively.
“The OMCs are facing the double whammy of firm crude oil prices and a free-falling rupee, as they import most of the crude oil,” said Sudeep Anand, head of institutional research, at IDBI Capital Market & Securities Ltd.
While petrol and diesel prices have been deregulated, and dynamic pricing was introduced last year for these two products, with general elections set for 2019, there have been some concerns that there may be a pause in such hikes.
India imports 80% of its crude oil needs, and rising prices have hurt the fiscal balance of Asia’s third-largest economy. Brent crude has risen 23.79% to trade at $79.25 per barrel on Wednesday, the highest since 9 December 2014, while rupee has eroded 11.5% so far this year and hit a record low of 72.91 per dollar in intra-day trading on Wednesday. It closed at 72.19 per dollar on Wednesday.
“There is a concern that going ahead—will they be able to raise the prices of products. There is also an overhang that they may end up bearing some subsidy burden,” said Anand.
“However, it may be a good time to some bottom fishing in the pack because the concerns may be overdone as we have seen a steady rise in prices of auto fuels,” he added.
In a report on 10 September, HDFC Securities pointed that since peaking in August 2017, HPCL has fallen around 48%, while the benchmark index Nifty is up by around 16%.
“This was mainly due to the inadequate and untimely petrol and diesel retail price hikes, as oil prices surged, and expected subsidy burden,” said Nilesh Ghuge and Divya Singhal, analysts at HDFC.
“Although, the current gross margins are lower compared to normalised margins, we believe that OMCs will be allowed to make normative margins and recoup margins as they have in the past,” they said, while maintaining their buy rating on HPCL with a target price of ₹476 per share.
Others seem to agree.
“We agree that volatility in crude prices and the weakening rupee may pose a risk to OMCs’ earnings from a temporary pause in fuel price hike in an election-packed year,” SBICap Securities Ltd said in a 11 September note.
However, historical precedents suggest that OMCs may continue to be exempted from the subsidy burden, and temporary pauses don’t change the structural deregulation story, it said.
SBICap expects crude prices to be capped at $80/barrel as Saudi Arabia and Russia are rightly worried about long-term instability caused by surging oil prices, and reiterated a buy on OMCs because the risk-reward is highly favourable as the share price is factoring in negative Ebitda (earnings before interest, tax, depreciation and amortization) from marketing of diesel and petrol in perpetuity.
Surging retail oil prices in India have thrown a challenge for the government as it adds to inflation and fiscal woes ahead of elections, but New Delhi is unlikely to roll back oil policy reforms, keeping in mind the longer-term health of the economy, analysts and economists told S&P Global Platts.
Any move by the central government to artificially cut retail prices of gasoline and diesel may help to fix one problem by keeping vehicle owners happy. But it will it create another, as it could potentially let the fiscal deficit target to slip, S&P Global Platts said in a release on 13 September, citing the analysts and economists.