BackOMCs gain on better demand, but refining margin rise is awaited
OMCs such as Indian Oil and Hindustan Petroleum have gained 30-41% from their Sept-Oct lows. Bharat Petroleum shares, on the other hand, are taking cues from progress in the divestment process
PremiumNews flow related to the Bharat Petroleum Corp. Ltd (BPCL) divestment has kept oil marketing company (OMC) stocks in the spotlight. The key concern of OMC investors, however, has been on weak demand since the coronavirus outbreak, leading to stock prices remaining subdued. This is getting addressed now with the positive news flow on vaccines.
OMCs such as Indian Oil Corporation Ltd (IOCL) and Hindustan Petroleum Corporation Ltd (HPCL) have gained 30-41% from their September-October lows. BPCL shares, on the other hand, are taking cues from progress in the divestment process.
Among the three, IOCL derives a significant portion of earnings from the refining business and petrochemicals too, in addition to fuel marketing. Comparatively, HPCL has a higher proportion of retail fuel sales in its portfolio. With better prospects for the marketing segment, HPCL shares have seen a sharper rebound.
IOCL is expected to benefit from sharp volume recovery as refinery utilization rate is close to 100% in November (versus 80% in Q2FY21), while volume recovery has been robust with overall petroleum consumption at close to pre-covid-19 levels, says Abhijeet Bora at Sharekhan Research.
The recovery in sales volumes may, however, have been helped by higher festival season demand. Hence, for a clearer picture, one may have to wait till the end of the December quarter.
Meanwhile, crude prices have been rising with Brent trading at around $50 a barrel, close to pre-covid levels. OMCs have continued to raise and hold retail fuel prices, which provides comfort that marketing margins may maintain the firm trajectory seen in recent times and help earnings in a weak refining margin environment.
Reported marketing margins ranged between ₹5.9 and ₹6.6 a litre during Q2 vs the typical ₹2-3 per litre. The margin boost is also because of inventory gains reported by OMCs (low price inventory being carried forward in a rising crude price environment).
The outlook for Q3 performance has clearly improved for OMCs. However, higher crude prices also mean higher working capital requirements. Further, the refining segment still remains a weak link. Benchmark Singapore GRMs had averaged just at $1 a barrel during Q2FY21, much lower than the $6 level in the year-ago quarter. Though some recovery in global demand can help refining margins, the fact that capacity expansions are outpacing demand growth till 2025 may keep upside limited.
Overall, with improvement in the operating environment, earnings are expected to rise. Macquarie India expects HPCL earnings to double by FY23, helped by capacity expansions too. Meanwhile, IOCL and HPCL are trading at 5-6 times one-year forward earnings estimates, and BPCL trades at 10 times thanks to privatization prospects.
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