 "Fuel price reforms not seen in OMC valuations")
While the introduction of EPP will reduce FY14 under-recoveries significantly, it will also trim the gross refining margins (GRMs) of the OMCs, eating away a large chunk of their earnings. “In the event of EPP being implemented, while BPCL and HPCL could become loss-making, with an EPS (earnings per share) impact of 120-130 per cent, IOC is relatively less impacted (61 per cent hit on EPS),” says Niraj Mansingka, oil and gas analyst at Edelweiss Securities. A committee under former Planning Commission member Kirit Parikh (formed to decide on implementing EPP) will give its report in three months. However, given the huge impact of EPP on OMCs’ financials and the gradual diesel price rises, analysts believe implementation of EPP is unlikely.
Petrol and diesel products are priced on TPP and LPG/kerosene at import parity pricing (IPP). EPP is lower than TPP by $5.1/barrel and by $3.1/barrel than IPP currently. Adoption of EPP would also discourage Indian refiners from exporting surplus products, say analysts. Thus, they believe, at worst the TPP ratio could get tweaked to 70/30 (import/export pricing) from the 80/20 prevailing ratio.
Meanwhile, all OMCs have reported robust numbers for the March quarter, led by full compensation of under-recoveries, lower interest burden and better GRMs (for HPCL and BPCL). GRMs were lower than the benchmark-Singapore GRMs of $8.6 a barrel, due to losses on crude inventory. Since crude prices have stabilised, such losses are unlikely in the current quarter. Going forward, lower crude oil prices and fuel price reforms will have a positive effect on OMCs’ profitability.
Most brokerages are positive on OMC stocks and expect price upsides of 17-22 per cent from Wednesday’s closing prices. “Lower under-recoveries would translate into lower interest cost (by 30-40 per cent) for OMCs in FY14-15, driving up their return on equity ratios to 10-14 per cent, versus four to seven per cent over the past few years,” says Dayanand Mittal, oil and gas analyst at Ambit Capital. The gains will be more visible when diesel prices are fully deregulated, which could take another six to nine months. On the flip side, any delay in diesel price deregulation due to political or other compulsions remains a key risk. Similarly, any significant fall in the rupee or jump in crude oil prices could hurt by way of delayed reduction in under-recoveries. Diesel price rises by Rs 2.5/litre till date and lower crude oil prices have reduced the diesel under-recoveries by about 67 per cent for the OMCs.
Q4 profitability
IOC’s results for the March quarter raced ahead of the Street’s expectations. Its net profit was Rs 14,513 crore and ahead of consensus Bloomberg estimates of Rs 13,335 crore. IOC gained from lower interest costs, down 7.8 per cent to Rs 1,377 crore. Interest costs should come down once IOC receives cash compensation of Rs 53,278 crore from the government for FY13 under-recoveries, accounted for in the March quarter. Its GRM of $2.39 a barrel was in line with expectations. The coming divestment of stake by the government is a key overhang on the stock.
BPCL, too, surprised with higher net profit of Rs 4,797 crore for the quarter, driven by receipt of cash compensation of Rs 8,670 crore towards under-recoveries. Consequently, interest costs fell 36 per cent. GRMs of $6 a barrel were largely in line with expectations. BPCL remains the top pick (among OMCs) of analysts due to its valuable exploration and production business, which could see a rise in valuations once its partner monetises stake in the Mozambique block.
HPCL’s net profit of Rs 7,679 crore was 15 per cent higher than the consensus estimates and fuelled by a steep 34 per cent fall in interest costs due to decline in under-recoveries and receipt of government contribution of Rs 12,620 crore. Analysts estimate HPCL’s Bhatinda refinery is making losses and believe its turnaround is important. “Profitable operations at the Bhatinda refinery would be crucial for HPCL’s valuation, as it contributes Rs 74 a share (or 23 per cent) to its fair value,” note analysts at ICICI Securities. HPCL is expected to gain the most from the ongoing fuel price reforms and could witness significant improvement in return ratios over the next couple of years.