Despite a weak June quarter for IOC, analysts are turning positive on oil marketing companies due to subdued outlook for crude oil prices and attractive valuations.
The worst for Indian Oil Corporation (IOC), Hindustan Petroleum (HPCL) and Bharat Petroleum (BPCL) might be behind if recent developments are any indication. Events in the last one week and consequently, fears of a global slowdown, suggest that crude oil prices are likely to remain subdued for some time at least. In expectation of this and despite higher underrecoveries consequent to sale of fuel at below costs (as mandated by the government), stocks of oil marketing companies (OMCs) — IOC, HPCL and BPCL — had seen a spurt. If oil prices remain subdued, these companies should get some relief. It would also enable the government to expedite the reform process, say experts. In this light, analysts are cautiously turning positive on these stocks while suggesting that investors should monitor oil prices.
Niraj Mansingka, analyst at Edelweiss Securities says, “We remain positive on OMCs due to our bearish stance on crude oil prices (FY12 Brent estimate at $100 per barrel).”
JUNE QUARTER
Meanwhile, Wednesday’s June quarter results of IOC were broadly in line. IOC reported a net loss of Rs 3,720 crore versus a loss of Rs 3,388 crore in the year-ago quarter. This loss was below analysts’ expectations, as the government provided compensation worth Rs 8,200 crore to IOC for selling cooking and auto fuel at discounted prices, as against the nil compensation factored by analysts. The higher losses were also due to doubling of interest expenses (due to higher borrowings) and halving of other income.
| UNDERRECOVERY WOES | |||
| (in Rs crore) | IOC actuals | HPCL estimates | BPCL estimates |
| Sales | 101,285 | 42,713 | 48,820 |
| % Chg y-o-y | 40.8 | 46.1 | 42.6 |
| Net profit/(loss) | -3,719 | 346 | 389 |
| % Chg y-o-y | 9.7 | LTP | LTP |
| Net underrecoveries | 7,670 | 5,640 | 6,420 |
| All figures are for the June 2011 quarter, LTP is loss to profit Source: IOC, Analysts reports | |||
Good volume growth of 5.6 per cent year-on-year and higher crude oil prices drove revenues growth. IOC posted lower loss at the operating level (Ebitda loss of Rs 1,862 crore versus a loss of Rs 2,667 crore in the June 2010 quarter) driven by better gross refining margins (GRMs) on a year-on-year basis.
Sequentially, though, GRMs fell, reflecting valuation losses in inventory of $2.35 a barrel. Post the fund infusion by the government and discount of Rs 7,930 crore by upstream companies, the net underrecoveries stood at Rs 7,670 crore.
IOCs closest peers, HPCL and BPCL, are also expected to witness similar contraction in their GRMs for the June quarter, driven by inventory valuation losses. However, compensation from the government would limit their net underrecoveries. Going ahead, GRMs for the three companies should inch up from current levels, in line with the trend in Singapore-benchmark margins.
GAINS FROM LOWER CRUDE OIL PRICES, REFORMS
Analysts at Kotak Securities are also bearish on crude oil prices and expect these to hover around the $100-a-barrel mark in this financial year. Lower prices could benefit the sector in two ways, one, curtail underrecoveries and two, a push to the reforms. At a crude oil price of $100, the gross underrecoveries for FY12 are estimated at Rs 92,000 crore. While this is still higher than Rs 77,922 crore in FY11, it is lower than the underrecoveries estimated earlier for FY12—Kotak analysts had estimated it at Rs 1,04,000 crore assuming crude oil price of $110.
Lower crude oil prices will also make it easier for the government to push reforms like deregulation of diesel prices. The Empowered Group of Ministers is already looking at a proposal of direct transfer of subsidies on kerosene, LPG and fertilisers. Analysts believe this is a step in the right direction and will solve the problem of subsidies. If the recent proposal of capping the number of LPG cylinders per household to 4-6 per annum is implemented, it would reduce the LPG subsidies by $600 million to $2.40 billion, believe analysts.
THE ROAD AHEAD
Most analysts are positive on stocks of OMCs and see upside potential of 15-25 per cent (the most for IOC, 15 per cent for BPCL and 22 per cent for HPCL) from current levels. However, the uncertainty of subsidy sharing mechanism may act as an overhang on these stocks.
Alok Deshpande, analyst at Elara Securities says, "The OMC pack has the potential to double its valuations over a three-year period, driven by robust business growth and valuation kickers in the form of reduced underrecoveries. Within OMCs, we recommend HPCL over the medium term and BPCL as a long term pick over 18-24 months.” Amongst these three players, HPCL stands to gain the most from lower underrecoveries. Also, its new refinery will lead to higher GRMs. BPCL is likely to derive significant value from its exploration activities in Brazil over the next two years. IOC is expected to witness good traction in its petrochemical business, which is expected to grow by 20 per cent in FY12. Analysts believe IOC should benefit from improvement in earnings quality, better cash cycle and lower debt levels. If the reforms process takes off, then it should clear the hurdles for its proposed FPO (provide cash) and act as a trigger for the stock.
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