The recent rebound in the Rupee versus the Dollar coupled with benign crude oil prices has put oil marketing companies (OMCs) namely Indian Oil Corporation (IOC), Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation (BPCL) in a sweet spot.
Also, the government's measures such as diesel price hike and cap on LPG cylinder will further improve profitability of these companies. Analysts thus have now trimmed their under-recovery expectations to around Rs 1,30,000-Rs 1,50,000 crore from about Rs 1,90,000 crore before the reforms were announced. Notably, Brent crude oil has fallen by 4 per cent and the rupee has gained 6 per cent post reforms for oil & gas sector (announced on 14th September), reducing the overall under-recovery burden. Analysts estimate that every 1 per cent fall in crude oil price lowers under recovery by Rs 3,000 crore while a 1 per cent gain in rupee reduces the under-recovery by Rs 4,000 crore.
"The sharp reduction in under-recovery could turn into a virtuous cycle as a result of lower fiscal burden leading to further Rupee appreciation and a further fall in underrecoveries to as low as Rs 81,400 crore (crude at $100/barrel and Rupee at 50). While this fall in under-recoveries benefits all OMCs via better cash flows and lower interest expenses, BPCL remains our top pick, given its ongoing drilling programme in Brazil/Mozambique, which should lend greater clarity to oil reserves", says Niraj Mansingka, analyst at Edelweiss Securities.While these favourable factors will improve the cashflows of OMCs and reduce their working capital needs, their profitability will continue to be a function of compensation of the under recoveries by government. "Since Government did not provide any cash subsidy in the June quarter, we expect Rs 30,000 crore coming in as cash subsidy towards June and September 2012 quarters. If provided in time, the cash subsidy along with inventory/forex gains would help OMCs report September quarter in black", believe Ballabh Modani and Nitin Tiwari of Religare Institutional Research.
Going forward, analysts rule out further fuel price hikes but they expect the stocks to gain from further rupee appreciation and weakening crude oil prices. Secondly, OMCs are also likely to witness improved gross refining margins (GRMs) - in line with Singapore GRMs.
While fundamentals are improving, the valuations of these OMCs are also reasonable, believe analysts. "OMC valuations, excluding investments (and E&P for BPCL), are at undemanding 0.5-0.6 times Price/Book and below book for all three OMCs. Hence, we upgrade all three OMCs to Buy" , wrote Anil Sharma and Ravi Adukia of Nomura in a recent report.
Most analysts remain positive on BPCL and expect newsflow to be positive as the company progresses with its drilling activities in Mozambique and Brazil. The ramp up at the Bina refinery (Madhya Pradesh) will also act as a catalyst for the stock.
Analysts expect HPCL, too, to gain from higher refining volumes, post commissioning of Bhatinda refinery. Its exploration portfolio could also surprise on the upside.
IOC’s Paradip refinery(likely to be commissioned in 2013) could boost its return ratios from FY14. But, any delay in this commissioning will be an overhang on the stock, believe analysts.
