)
Oil marketing companies namely, Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) have already started reaping the benefits of diesel price deregulation, which led to lower interest burden in the December 2014 quarter.
Interest costs reduced between 26% (IOC) to 61% (BPCL) year-on-year in the quarter, supporting bottom-line of the oil marketing companies (OMCs). Lower under-recoveries and full compensation by both government as well as upstream companies towards subsidy (the loss on selling diesel below cost price) also helped. However, high inventory losses (due to sharp fall in crude oil price) along-with forex losses impacted profits of all the OMCs in the quarter.
BPCL was the only one of the three companies to report net profit in the quarter. While HPCL witnessed a significant 81.2% year-on-year fall in net loss to Rs 325 crore, IOC's net loss stood at Rs 3,069 crore up 123% over the year ago period.
The bad news though is likely to end here as these companies’ profits will be driven by higher marketing margins. “Weak crude will give OMCs an opportunity to expand their marketing margins. With low competition risk, OMCs’ profits could expand substantially, going ahead”, believe analysts at Axis Capital. The full benefits of diesel price deregulation are likely to kick in over FY16 and FY17. Analysts at Deutsche Bank expect gross under-recoveries of OMCs to fall by 72-75% by FY17 as compared to FY14. In this backdrop, most analysts remain bullish on all the OMCs.
While overall profitability will improve for IOC as interest costs and under-recoveries come down, divestment will remain a key overhang on the stock. Analysts believe, the company’s GRMs are likely to improve post commercialisation of its Paradip refinery which is also the most complex PSU refinery in India. At 1.1 times FY16 estimated book, the IOC stock trades at a 12% discount to its historical average one-year forward price/book value ratio of 1.2 times.
HPCL is highly levered to expanding marketing margins. Notably, every 50 paise/litre expansion in petrol/diesel margins could add 50% to HPCL’s earnings per share as against 20-25% in case of IOC and BPCL, estimate analysts. In addition to the lower subsidy burden, HPCL's debt is likely to reduce further as large part of its refinery upgradation capex is over. The stock currently trades at 1.1 times FY16 estimated book value, which is slightly higher than its historical average one-year forward price/book value ratio of about one times.
Even though BPCL’s downstream business will benefit from oil reforms, the exploration and production (E&P) business could witness near-term softness on the back of lower crude oil prices. However, announcement around positive developments in the E&P business could act as a key catalyst for the stock. Analysts expect BPCL’s return on equity (RoE) ratio to rise from 16.8% in FY13 to 20% in FY17 on the back of fuel price reforms. The stock though seems to price in most positives and is trading at 2.2 times FY16 estimated book.
