While partial deregulation and rise in prices could cut underrecoveries for oil marketing companies, the extent of gains is not substantial.
Reforms in the fuel sector, long considered politically contentious, have finally taken off. The move to deregulate petrol, the willingness to deregulate diesel in the future and the increase in prices of all the key petroleum products are in line with a partial implementation of the Kirit Parikh committee report. As this was seen as a positive development for the sector, stocks of oil and gas companies ran up 15-25 per cent since the announcement.
However, from an investment perspective, this run-up has been in line with potential earnings upgrades. And, while the outlook for the sector is positive, there is still a long way to go before the earnings see a quantum jump. Consensus estimates indicate the three oil marketing companies (OMCs) could see earnings upgrades in the 20-25 per cent range for the financial years 2011 and 2012. On the other hand, upstream companies could see a potential earnings upgrade of 8-12 per cent in the same period. Therefore, the current positive movement in share prices is along expected lines.
| REVENUE LOSSES FOR 2010-11 | ||
| In Rs cr | After | Before |
| Auto fuels | -16,720 | -33,610 |
| MS | 1,680 | -3,920 |
| HSD | -18,410 | -29,690 |
| Cooking fuels | -39,820 | -46,500 |
| LPG | -23,540 | -26,930 |
| SKO | -16,280 | -19,570 |
| Total | -56,540 | -80,110 |
| Source: Crisil, considering crude at $80/barrel | ||
However, according to Edelweiss Securities’ Analyst Niraj Mansingka: “After the price run-ups, the valuations of state-owned OMCs look stretched. Further, we are cautious about the political pressure on the government on the issue.”
Essentially, the view now emerging after the initial euphoria is that the impact on earnings is not expected to be as dramatic as the reaction from the market would suggest. There would be a reduction in underrecoveries. But for financial year 2011, they are still estimated to hover around Rs 53,000 crore. Underrecoveries from diesel alone are expected to be in the Rs 25,000-30,000 crore range, and would continue to be a drag on earnings. More clarity on the subsidy-sharing mechanism is now seen as the next event for the sector. That could cause a realignment of share prices. So, being company-focused and watchful on the sector is advisable.
| EARNINGS GROWTH FACTORED IN | ||||||||
| In Rs crore | IOC | BPCL | HPCL | ONGC | ||||
| FY10 | FY11E | FY10 | FY11E | FY10 | FY11E | FY10 | FY11E | |
| Net sales* | 2.54 | 2.80 | 1.24 | 1.35 | 1.10 | 1.30 | 1.00 | 1.10 |
| Interest costs | 1,700 | 2,700 | 2,400 | 1,100 | 900 | 1,500 | 560 | 660 |
| Adjusted PAT | 8,750 | 8,990 | 1,620 | 1,900 | 1,190 | 1,300 | 19,740 | 23,940 |
| EPS (Rs) | 36 | 37 | 45 | 52.8 | 35 | 38 | 94 | 114 |
| Total debt* | 0.50 | 0.40 | 0.23 | 0.26 | 0.21 | 0.19 | 0.06 | 0.12 |
| Book-value (Rs) | 214 | 241 | 406 | 441 | 347 | 379 | 480 | 552 |
| P/E (x) | 11.00 | 10.70 | 14.30 | 12.20 | 12.40 | 11.40 | 13.90 | 11.40 |
| P/BV (x) | 1.90 | 1.60 | 1.60 | 1.50 | 1.20 | 1.10 | 2.70 | 2.40 |
| E: Estimates * Rs lakh crore | ||||||||
BPCL
BPCL managed to deliver profits, with the cash compensation coming from both upstream companies (Rs 1,500 crore) as well as the government (Rs 2,900 crore). This helped save the day in the fourth quarter of 2009-10. Higher gross refining margins this quarter, at 3.1 per cent, (compared to 1 per cent in the third quarter) also helped. Auto fuel sales for BPCL are higher. The recent cool-off in crude oil prices, as well as the recent petrol and diesel price rise, should help it the most. Commercial production from the Bina refinery is expected from September. Prospects of declared reserves in the Wahoo block in Brazil (which will get bigger with the second well being tested) also bodes well. The company can be considered for a further upside.
HPCL
Thanks to subsidies, private players haven’t been able to compete with the likes of HPCL. But competition could heat up now, with news coming in that some companies like Essar Oil are embarking on aggressive plans for the fuel retailing space. HPCL controls about 20 per cent of the retail fuel market. Although it has a lower share in auto-fuel sales compared to its peers, the company has a larger share in the LPG segment and kerosene, especially when compared to BPCL. However, if HPCL’s proposal to shift the Mumbai refinery is accepted by the government, it could be a positive trigger. The stock can be accumulated at lower levels.
IOC
IOC holds the maximum crude inventories among all three OMCs. Inventory gains contributed significantly to profitability in 2009-10 (net profits more than doubled to around Rs 10,000 crore during the year). Its interest costs also came off substantially in 2009-10 to more than half of the 2008-09 level. Hence, IOC was able to deliver a significant jump in net profits. It’s also looking at the 15-million tonne Paradip refinery project, scheduled to become operational by March 2012, which would aid in higher volumes. However, no major upside is expected.
ONGC
Considering the 2009-10 sharing formula, ONGC could save as much as Rs 4,000 crore in 2010-11. This is a relief for the company, which had been contributing around Rs 20,000 crore on an average on subsidies in the last four years. Favourable news on the administered price mechanism front — that would add another Rs 5,500 crore to the coffers from the recent rise in gas prices — should further boost profitability. A lower burden on the subsidy front should help companies like ONGC plan for their major capital expenditure, both in India and abroad. The company’s shares can be considered for the long term.
