Active Stocks
Fri Sep 29 2023 15:59:14
  1. Tata Steel share price
  2. 129 1.78%
  1. NTPC share price
  2. 245.65 3.3%
  1. Power Grid Corporation Of India share price
  2. 199.85 -0.45%
  1. State Bank Of India share price
  2. 598.7 1.48%
  1. Wipro share price
  2. 406.25 0.11%
Business News/ Market / Mark-to-market/  Fuel price reset: How should we value oil marketing companies now?

Fuel price reset: How should we value oil marketing companies now?

The big worry now is that OMCs will need to pay up their share of the subsidy bill, which is likely to burgeon if petrol and diesel prices aren't allowed to move with market rates

Graphic: MintPremium
Graphic: Mint

If Life Insurance Corporation of India (LIC) is willing to dish out more than 20,000 crore to bail out IDBI Bank Ltd, what is a few thousand crore rupees shared by three large oil marketing companies (OMCs) to help the government lower fuel prices? Apparently, it’s worth a lot. With unlisted LIC, there is no way of knowing what the Street thinks of the government’s penchant for looking to the insurance giant for help. Not so with Indian Oil Corp. Ltd, Bharat Petroleum Corp. Ltd and Hindustan Petroleum Corp. Ltd, all of which are listed.

The market capitalization of the three OMCs has fallen by 75,781 crore in the past two trading sessions. That was after the government looked to them to sacrifice part of their marketing margins in an effort to lower fuel prices. According to analysts, there may be more pain to follow, since there is no way to know how much the government expects the companies to contribute towards fuel price management.

The cut in marketing margins announced by the three OMCs last week is expected to hit their profits by about 5,000 crore in the second half of fiscal year 2019, according to a report by Kotak Institutional Equities. That is a drop of about 14% compared to the brokerage firm’s previous earnings estimate.

In that backdrop, the 28% drop in the market cap of the three companies may look overdone. It is not.

That’s simply because the government’s move last week is being seen as a throwback to the days when OMCs shared a portion of the subsidy on fuel prices. Analysts at Jefferies India Pvt. Ltd point out that after last week’s cuts, fuel prices are 3-5% lower than market-determined rates, based on the current spot price of crude oil and the dollar-rupee exchange rate.

Fuel prices are reset based on a 15-day moving average, and it seems unlikely now that the government will allow prices to revert to market-determined rates, since that will completely nullify the impact of the cut in prices last week. This, in turn, raises the spectre of a much higher-than- expected subsidy bill for FY19. As it is, the government has provided for only about 21,000 crore for fuel subsidy this year, which is less than half the 51,000 crore under-recovery Jefferies’ analysts expect for LPG and kerosene sales alone.

The big worry now is that OMCs will need to pay up their share of the subsidy bill, which is likely to burgeon if petrol and diesel prices aren’t allowed to move with market rates.

It’s not that investors were completely unmindful of this possibility. Even before last week’s sharp fall, the cumulative market value of the three companies had fallen by about a third since the time Brent crude prices rose more than $60/barrel. Investors had foreseen the possibility that OMCs would be asked to do their bit to rein in prices.

As the chart alongside shows, stocks of upstream companies such as Oil and Natural Gas Corp. Ltd and Oil India Ltd haven’t gone anywhere in the past one year, even though crude oil prices have risen by more than 50% during this period. Again, it’s the fear of a heavy subsidy burden.

In FY14 and FY15, when crude oil prices averaged around $100/barrel, upstream companies had shared over half of the total subsidy burden. The share of OMCs was minimal, and with fuel prices moving in tandem with market rates in the past few years, investors had rerated stocks of OMCs significantly.

Things have suddenly changed, and it’s now almost impossible to predict earnings of these companies. Analysts are resorting to the price-to-book multiple, a measure that was in vogue years ago when fuel prices were administered. For the Street, government risk looms large over the sector.

"Exciting news! Mint is now on WhatsApp Channels 🚀 Subscribe today by clicking the link and stay updated with the latest financial insights!" Click here!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Updated: 08 Oct 2018, 07:53 AM IST
Next Story
Recommended For You
Switch to the Mint app for fast and personalized news - Get App