With diesel price implementation on track, HPCL, IOC and BPCL are likely to witness improved earnings visibility going forward
Stocks of public sector oil marketing companies (OMCs) have witnessed re-rating over the past five year period. Stocks of Indian Oil Corporation (IOC) and Hindustan Petroleum Corporation (HPCL) have grown 1.3 times and 1.2 times respectively since March 2009 while Bharat Petroleum Corporation (BPCL) scrip has multiplied 2.6 times.
They key factor driving this re-rating is the deregulation of petrol prices followed by gradual and on-going diesel price de-regulation. This means the OMCs will be free to determine prices of petrol and diesel based on market forces such as crude oil price movement, rupee movement,amongst others.
Notably, the OMCs profitability was highly dependent on government and upstream companies' contribution to them to compensate for losses made on selling fuel at subsidized rates. This process resulted in volatile earnings performance of these OMCs making it difficult to estimate their profitability accurately. Once diesel price is de-regulated, the OMCs' interest cost will come down resulting in better profitability. Also, they will now be valued by the street based on their core business' strengths and weaknesses.
The street has been pricing these positives as visible in the run-up.
"We expect the re-rating of OMCs to continue given improving RoE predictability at the margin. Moreover, a potentially favourable electoral outcome can be a game-changing catalyst. Assuming full compensation for OMCs to continue in FY14/15, the potential improvement is unappreciated given still attractive valuation of estimated adjusted Price/Book Value of 0.5-0.7 times for FY14. We prefer HPCL and BPCL and downgrade IOC to In-line given recent out-performance to peers", says Rahul Singh of Standard Chartered Equity Research.
The OMCs have raised diesel prices by total Rs 7.8/litre since January 2013 and are expected to wipe out the under-recoveries of about Rs 7.4/ litre (via Rs 0.5/litre price hike per month) by March 2015. Analysts believe the OMCs are likely to save about Rs 800 and Rs 1,500 on incremental interest costs in FY14 and FY15 respectively as diesel price de-regulation progresses. Improved working capital cycle, zero subsidy burden and bottoming out of gross refining margins (GRMs) would rub off positively on OMCs' profitability as well as return ratios.
"Despite assuming Brent at $105/barrel and Rupee at 62 per US Dollar, gross under-recoveries are estimated to decline 45 per cent during FY14-16 to Rs 1,050/765 billion in FY15/16 from estimated Rs 1,387 billion in FY14. We estimate OMC earnings to bottom-out in FY14. OMC earnings are highly sensitive to gross refining margins, which are at cyclical lows", says Amit Rustagi, Oil and Gas analyst at Antique Stock Broking. According to him, a $ 1/barrel improvement in GRMs could provide a 23-35 per cent upside to earnings of OMCs.
While brokerages are optimistic on all OMCs, BPCL remains the top pick of most given strong prospects of its exploration and production business.
BPCL
BPCL scrip has undergone fastest re-rating over the past five years in the OMC pack. This is largely a function of growth in BPCL's exploration and production (E&P) activities. Its Mozambique block's reserve estimates have been upgraded from 3-4 trillion cubic feet (tcf) in 2010 to about 45-70 plus tcf (was raised by 15 per cent earlier this month). The company has stakes in 10 Brazilian blocks which are undergoing exploration and appraisal activities. Announcement of reserve estimates across these blocks will act as a trigger for the stock.
"We have revised BPCL's target price to Rs 486/share (versus Rs 464 earlier), following the reserve upgrade for Mozambique block. We maintain BPCL as the top pick among OMCs due to its relatively strong balance sheet, operational upsides through capacity additions and complexity improvement and E&P upside potential", says Harshad Borawake of Motilal Oswal Securities. Every Rs 0.5/litre hike in diesel price leads to 20 per cent increase in the company's earnings per share.
IOC
Post announcement of sale of 10 per cent stake in IOC to ONGC and Oil India, a key overhang on the stock is removed. Analysts believe, the company's GRMs are likely to improve post commercialization of its Paradip refinery which is also the most complex PSU refinery in India. This, along with diesel price de-regulation will be key earnings drivers for IOC. At 0.90 times FY15 estimated book, the IOC stock trades at a 25 per cent discount to its historical average one-year forward price/book value ratio of 1.2 times. Weak polyester intermediate margin is a key pressure point for the company.
HPCL
HPCL is expected to gain most from on-going fuel price reforms and could witness significant improvement in return ratios over the next couple of years, believe analysts. The company plans to raise its standalone refining capacity by 61 per cent to 23.8 million metric tonne per annum by setting up a 9 mmtpa refinery in Barmer. In addition to the lower subsidy, HPCL's debt is likely to reduce further as large part of its refinery upgradation capex is over. The stock currently trades at 0.71 times FY 15 estimated book value, which is 29 per cent lower than its historical average one-year forward price/book value ratio of about 1.0 times.
Stocks of public sector oil marketing companies (OMCs) have witnessed re-rating over the past five year period. Stocks of Indian Oil Corporation (IOC) and Hindustan Petroleum Corporation (HPCL) have grown 1.3 times and 1.2 times respectively since March 2009 while Bharat Petroleum Corporation (BPCL) scrip has multiplied 2.6 times.
They key factor driving this re-rating is the deregulation of petrol prices followed by gradual and on-going diesel price de-regulation. This means the OMCs will be free to determine prices of petrol and diesel based on market forces such as crude oil price movement, rupee movement,amongst others.
Notably, the OMCs profitability was highly dependent on government and upstream companies' contribution to them to compensate for losses made on selling fuel at subsidized rates. This process resulted in volatile earnings performance of these OMCs making it difficult to estimate their profitability accurately. Once diesel price is de-regulated, the OMCs' interest cost will come down resulting in better profitability. Also, they will now be valued by the street based on their core business' strengths and weaknesses.
The street has been pricing these positives as visible in the run-up.
"We expect the re-rating of OMCs to continue given improving RoE predictability at the margin. Moreover, a potentially favourable electoral outcome can be a game-changing catalyst. Assuming full compensation for OMCs to continue in FY14/15, the potential improvement is unappreciated given still attractive valuation of estimated adjusted Price/Book Value of 0.5-0.7 times for FY14. We prefer HPCL and BPCL and downgrade IOC to In-line given recent out-performance to peers", says Rahul Singh of Standard Chartered Equity Research.
The OMCs have raised diesel prices by total Rs 7.8/litre since January 2013 and are expected to wipe out the under-recoveries of about Rs 7.4/ litre (via Rs 0.5/litre price hike per month) by March 2015. Analysts believe the OMCs are likely to save about Rs 800 and Rs 1,500 on incremental interest costs in FY14 and FY15 respectively as diesel price de-regulation progresses. Improved working capital cycle, zero subsidy burden and bottoming out of gross refining margins (GRMs) would rub off positively on OMCs' profitability as well as return ratios.
"Despite assuming Brent at $105/barrel and Rupee at 62 per US Dollar, gross under-recoveries are estimated to decline 45 per cent during FY14-16 to Rs 1,050/765 billion in FY15/16 from estimated Rs 1,387 billion in FY14. We estimate OMC earnings to bottom-out in FY14. OMC earnings are highly sensitive to gross refining margins, which are at cyclical lows", says Amit Rustagi, Oil and Gas analyst at Antique Stock Broking. According to him, a $ 1/barrel improvement in GRMs could provide a 23-35 per cent upside to earnings of OMCs.
While brokerages are optimistic on all OMCs, BPCL remains the top pick of most given strong prospects of its exploration and production business.
BPCL
BPCL scrip has undergone fastest re-rating over the past five years in the OMC pack. This is largely a function of growth in BPCL's exploration and production (E&P) activities. Its Mozambique block's reserve estimates have been upgraded from 3-4 trillion cubic feet (tcf) in 2010 to about 45-70 plus tcf (was raised by 15 per cent earlier this month). The company has stakes in 10 Brazilian blocks which are undergoing exploration and appraisal activities. Announcement of reserve estimates across these blocks will act as a trigger for the stock.
"We have revised BPCL's target price to Rs 486/share (versus Rs 464 earlier), following the reserve upgrade for Mozambique block. We maintain BPCL as the top pick among OMCs due to its relatively strong balance sheet, operational upsides through capacity additions and complexity improvement and E&P upside potential", says Harshad Borawake of Motilal Oswal Securities. Every Rs 0.5/litre hike in diesel price leads to 20 per cent increase in the company's earnings per share.
IOC
Post announcement of sale of 10 per cent stake in IOC to ONGC and Oil India, a key overhang on the stock is removed. Analysts believe, the company's GRMs are likely to improve post commercialization of its Paradip refinery which is also the most complex PSU refinery in India. This, along with diesel price de-regulation will be key earnings drivers for IOC. At 0.90 times FY15 estimated book, the IOC stock trades at a 25 per cent discount to its historical average one-year forward price/book value ratio of 1.2 times. Weak polyester intermediate margin is a key pressure point for the company.
HPCL
HPCL is expected to gain most from on-going fuel price reforms and could witness significant improvement in return ratios over the next couple of years, believe analysts. The company plans to raise its standalone refining capacity by 61 per cent to 23.8 million metric tonne per annum by setting up a 9 mmtpa refinery in Barmer. In addition to the lower subsidy, HPCL's debt is likely to reduce further as large part of its refinery upgradation capex is over. The stock currently trades at 0.71 times FY 15 estimated book value, which is 29 per cent lower than its historical average one-year forward price/book value ratio of about 1.0 times.
