Despite profitability overhang, OMC stocks remain attractive bets

Analysts expect marketing margin concerns, most of which are already priced in, to recede after elections, and say valuations are now attractive

Stocks of oil marketing companies (OMCs) continue to remain volatile, thanks to the volatility in the underlying crude oil prices after US sanctions on Iran. The Brent crude now trades near $69.5 a barrel, up significantly from the $52 a barrel mark seen at the start of 2019. 

Accordingly, the Indian crude basket has also risen. The Indian crude basket is the weighted average of Dubai, Oman, and Brent crude oil prices. It is used as an indicator of the price of crude imports into India and the index is tracked for examining domestic fuel prices.

While the retail prices of fuel (petrol and diesel) had continued to move in tandem with the rising crude basket till mid-March, they have lagged the rise thereafter. The per litre diesel prices in Delhi, after ranging between Rs 66.91 and Rs 67.12 levels during the first fortnight of March, are marginally down at Rs 66.66 now, while petrol prices have marginally gained from Rs 72.55 a litre levels to Rs 73.00 now. In comparison, Brent crude oil price is up about 5 per cent since mid-March.

This may have added to concerns on OMCs such as Bharat Petroleum Corporation, Hindustan Petroleum Corporation, and Indian Oil Corporation (IOC). If the movement of retail prices lags the rise in crude basket significantly, marketing margins of OMCs may come under pressure. 

Notably, OMCs after having had to absorb Rs 1 per litre marketing margin in the December quarter when crude oil had risen to $85 a barrel levels, had seen some respite in March quarter as marketing margins were seen up 19-35 per cent sequentially, according to Emkay Research estimates.

Analysts at Motilal Oswal Securities had said that OMCs have also stopped sharing their gross margins periodically and although auto fuel prices have declined, there is always a risk of populist measures hitting the companies during the election period.

On the retail fuel price movement, while analysts say prices are decided on the basis of 15-day average of crude prices and rupee to dollar movement, some lag in retail prices is not ruled out during the election period. Nevertheless, analysts also feel the valuation of OMC stocks is also factoring the risks, including those on gross refining margins (GRMs).

The benchmark Singapore GRM stood at $3.2 per barrel, down 55 per cent year-on-year and 26 per cent sequentially during March quarter. Analysts expect a weak near-term outlook with rebound only expected by end of 2019 to factor implementation of 2020 IMO Fuel Sulphur regulations.

Yet, looking at attractive stock valuations (5-6x FY21 earnings), analysts at Edelweiss Securities say OMCs have bottomed out, even as they expect near-term earnings overhang to recede only after elections.

IOC figures amongst the top pick of most analysts, given the company’s strong cash flows and high dividend yield.