State-owned OMCs' fortunes take a turn

Every 25 paise a litre decline in automobile fuel margin could alter analysts' FY19 earnings estimates for IOC, BPCL and HPCL by 5-10%

In the September quarter, oil marketing companies (OMCs) had benefited from the spike in gross refining margins (GRMs), as well as marketing margins, and inventory gains. In the current quarter, however, they are finding more challenges.

The benchmark Singapore GRMs had surged to a 10-quarter high in the September quarter, the second one (Q2) of this financial year. This was on the back of supply disruptions caused by Cyclone Harvey in the US. At $8.3 a barrel, the GRMs were up 29 per cent sequentially and 61 per cent over a year.

However, by mid-November (the latest data available), these GRMs had declined 12 per cent sequentially to $7.3 a barrel, on increasing US supplies. Thus, the December quarter (Q3) might be different.

The bigger concern pertains to marketing margins, the profit the three government-owned OMCs make on retail sales of automobile fuels (petrol, diesel). In Q2, the OMCs had shown an improvement in these margins, which analysts said was a key positive. By mid-November, marketing margins are reported to have dipped significantly. Analysts at ICICI Securities, in fact, say the net marketing margins turned negative from November 16. And, that in Q3 till date, the margins are down 55 per cent sequentially and 23 per cent year-on-year, at 76p (a litre). This decline is on the back of inadequate retail price hikes, despite rising crude oil prices.

Assuming crude remains at $61.85 a barrel and diesel cracks (margin) stay during the rest of Q3 at the current level, ICICI Securities estimates the diesel net margin might fall 68-77 per cent sequentially and 44-60 per cent year-on-year. The net margin for petrol might fall by 57-65 per cent sequentially and 28-42 per cent year-on-year.

As a result, the shares price of Indian Oil Corporation (IOC) and Hindustan Petroleum Corporation (HPC) are down 16-17 per cent from their high in Q2. Bharat Petroleum Corporation (BPC) is down about 10 per cent from its high in October; its lower decline could be explained as owing to its exploration and production hydrocarbon assets. These get higher valuations with every rise in crude oil prices. BPC would also benefit from the expansion of its Kochi refinery.

IOC, too, will continue benefiting from its new Paradip refinery. However, concerns also remain elevated due to the potential risk in Oil & Natural Gas Corporation (ONGC) selling its equity stake in IOC to fund the acquisition of HPC. Analysts at Emkay Global, in their mid-November note, had said their earlier preferred pick was IOC but due to the offer-for-sale announcement and concern about ONGC selling its IOC stake for the HPC acquisition, the stock will remain range bound at Rs 370-420, till further clarity emerges.

Within the three OMCs, their preferred pick remains BPC. For, commissioning of the Kochi expansion will add to its volumes and incremental GRM from the second half of this financial year, a catalyst for growth.

Having said that, with the present headwinds in the form of lower refining and marketing margins, most analysts are cautious on the OMC stocks despite the recent fall. Those at Kotak Institutional Equities say, “It might be a bit difficult for OMCs to earn steady margins as earlier, leave aside any possibility of increase in these, under an environment of elevated crude prices of $55- 65 a barrel, a coming prolonged election cycle over the next 12-18 months and sustained competitive pressure from private players.”

Notably, the private players have garnered 7.9 per cent market share in diesel and 5.5 per cent in petrol during the first half of FY18, from 5.9 per cent and 4.9 per cent, respectively in FY17. The prolonged period of elections could prevent the three state-owned entities from raising their fuel prices, affecting the marketing margins. Analysts say every 25p a litre reduction in automobile fuel margins would impact their FY19 earnings estimates for HPC, BPC and IOC by 10 per cent, 7.5 per cent and 5.6 per cent, respectively.

The marketing margins on diesel and petrol have already declined sharply to about Rs 1 a litre, from Rs 3.1 a litre in Q2, due to lack of a commensurate increase in domestic retail prices since the first week of November despite rising crude prices, say analysts at Kotak Institutional Equities.