Earnings pressure may intensify for OMCs; HPCL, BPCL, IOCL stocks fall

Despite sharp profit revisions, a weak rupee, higher crude oil prices and the government's stance could lead to further downsides

Investor confidence in public sector oil and gas companies took a battering for the second session in a row as brokerages downgraded the stocks and the rupee plunged further following the Reserve Bank of India’s (RBI's) stance on the rupee. After losing 10-12 per cent on the bourses on Thursday post government’s announcement, HPCL, BPCL, IOCL lost another 16-25 per cent on Friday. ONGC and GAIL also shed 10-16 per cent on worries of the higher proportion of subsidy sharing.

The Street is worried as Thursday’s decision asking the refiners to absorb the cost of higher crude oil prices was a reversal in the government’s stand on the free pricing mechanism for petrol and diesel. The Street, thus, believes that the government may intervene again given that the calendar over the next one year is filled with state as well as national elections. With a falling rupee and rising crude oil prices, the government’s move creates uncertainty about the profitability of oil marketing companies (OMCs).

The worries on shrinking marketing margins are not new. Late last year, OMCs allowed smaller hikes ahead of state elections despite a sharp increase in crude oil prices. Analysts such as Abhijit Bora at Sharekhan believe that the government may continue to partially regulate the auto fuel prices given several state elections scheduled in 2018-2019 and the national election due in May 2019.

Analysts at Motilal Oswal Securities have revised their FY20 earnings estimates sharply by 24-48 per cent for OMCs. They believe that this marks a U-turn from deregulation and raises the possibility of a return to subsidy regime. HPCL, which gets the highest proportion of its sales from fuel retailing, remains the most-impacted, while IOC that has a more diversified revenue stream (refining, petchem, pipelines) remains the least-impacted.  

Given the rising crude oil prices and the continued rupee depreciation, OMCs would need more price hikes and extent of the same will be a key monitorable. 
 

After the current move, analysts at Ambit believe OMC’s will make losses in petrol and very thin profits on diesel, assuming the operating cost of Rs1.3 a litre. Therefore, if there is a further government intervention and OMCs are unable to pass on prices, there could be more stress on marketing margins and profitability. Kotak Institutional Equities estimates that that OMCs will need to hike fuel price by Rs 3-4 per litre, considering the current price of crude oil and value of the rupee. Earnings uncertainty for oil PSUs could rise as the government prioritises the need for keeping fuel prices down over fiscal discipline.

However, OMCs have indicated that the government’s move is temporary. M K Surana, chairman and MD of HPCL, during an investor conference call said that there is no permanent shift in the government policy and the current move is only a short-term intervention to cool off consumer prices. Daily pricing mechanism will continue, he added.

HPCL will be taking other measures to mitigate the impact of Rs1 per litre in marketing margins that it has been asked to absorb. 

However, it was not only downstream companies that felt the heat on Friday but also upstream players, such as ONGC, OIL India and GAIL. The subsidy sharing overhang is now a major worry after the government curtailed the marketing margins of OMCs. ONGC earns better net realisations on higher crude prices and every $1/barrel (bbl) rise in crude oil brings an incremental Rs10 billion gains for ONGC. The company’s net realisations at $74.2 a barrel rose 46 per cent year-on-year in the June quarter. However, the same would reduce in the proportion of the subsidy burden that it has to bear. Further with HPCL, where ONGC holds a majority stake, witnessing lower earnings means ONGC’s consolidated earnings will already be impacted and also will receive lower dividend payout from HPCL. Analysts at Antique Stock Broking say that even if the government does not ask upstream companies to bear subsidy burden, it could consider a higher dividend from upstream to compensate the revenue lost due to excise duty cuts.

Analysts say that though the loss of revenue would be very marginal for a private retailer like Reliance Industries, the creation of under-recovery does create an uncertain environment not conducive for expanding operations.