JM Financial downgrades HPCL, BPCL, IOCL citing unfavourable risk-reward; here's what the brokerage firm says

The sharp jump in shares of oil marketing companies (OMCs) in the last two months, led by moderating crude oil prices and bullish sentiment across all PSU stocks, has shot up their valuation, raising the risk of a correction.

Considering this, brokerage firm JM Financial Institutional Securities has downgraded several OMC stocks citing the risk-reward has turned unfavourable for OMCs due to the absence of any valuation comfort after the recent rally. The brokerage firm observed that OMCs are trading at 10-30 per cent premium to historical P/B valuations.

Also Read: Bajaj Auto stock jumps nearly 6%, hits fresh record high as board approves ₹4,000-crore share buyback

JM Financial has downgraded the stocks of HPCL to a sell from a buy with a revised target price of ₹370, Indian Oil Corporation (IOCL) to a sell from hold with a revised target price of ₹110, and BPCL to a hold from a buy with a revised target price of ₹450.

Also Read: Zee share price drops 10% on news report Sony deal may be called off

"Stock prices of OMCs (HPCL, BPCL and IOCL) have rallied by 30-70 per cent in the last two months driven by (a) sharp jump in auto-fuel gross marketing margin (GMM) on account of moderation in crude price/product cracks, (b) near-term delay in auto-fuel price cuts, (c) end of rights issue-related overhang, and (d) bullishness across all PSU stocks," JM Financial observed.

Also Read: IRB Infrastructure share price surges 7% to hit 52-week high as December toll collection jumps 26% YoY

JM Financial has raised OMCs’ FY24 EBITDA estimate by 26-38 per cent to account for strong GRMs in the nine months of the current financial year (9MFY24) and the recent sharp jump in marketing margin, aided by a fall in crude price and delay in fuel price cuts. However, it underscored that its FY25-26 EBITDA estimate sees only a limited 2-3 per cent upgrade.

Also Read: Adani Ports share price rallies over 3% to hit 52-week high; Motilal Oswal raises target

The brokerage firm said it has rolled forward its valuations to March 2025 and raised the EV/EBITDA multiple for the marketing business to 5.5 times from 5 times earlier due to improved visibility on marketing segment earnings on account of a fall in crude price from nearly $90 per barrel to $75-80 per barrel.

Hence, JM Financial has revised the target price to ₹110 for IOCL (from ₹85), ₹370 for HPCL (from ₹280), and ₹450 for BPCL (from ₹400).

(Exciting news! Mint is now on WhatsApp Channels. Subscribe today and stay updated with the latest financial insights! Click here!)

JM Financial believes the recent sharp jump in auto-fuel GMM to ₹7-8 per litre versus normalised ₹3.5 per litre is not sustainable as (a) the government is highly likely to cut auto-fuel prices ahead of General Elections in Apr-May 2024 and/or hike auto-fuel excise duty, and (b) OPEC+ strong pricing power will support Brent crude price near $80 per barrel.

The brokerage firm believes OMCs’ refining margin will normalise to $7-8 per barrel from FY25 versus $10-20 per barrel in FY23/FY24) driven by (a) the normalisation of diesel cracks due to easing supply-side concerns and a rise in Chinese diesel exports, (b) end of windfall tax benefits following the normalisation of diesel cracks, and (c) narrowing of Russian crude discount.

Besides, the brokerage firm believes several of the projects of OMCs fail to create long-term value for shareholders.

"OMCs have historically seen significant cost- and time-overrun in the execution of large projects (case in point being HPCL’s Rajasthan refinery project cost jumping to nearly ₹73,000 crore versus original ₹43,000 crore). OMCs’ aggressive capex plans accentuate our key structural concern as many of the projects fail to create long-term value for shareholders, with several of them being undertaken from the country’s strategic energy security perspective," JM Financial said.

Read all market-related news here

Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decisions.