Low oil prices to boost OMC gains

HPCL may benefit more from improvement in marketing margins

Shares of state-owned oil marketing companies (OMCS), such as Hindustan Petroleum Corporation (HPCL), Bharat Petroleum Corporation (BPCL), and Indian Oil Corporation (IOC), are off 30-40 per cent from their 2020 highs, led by a sell-off in the broader markets. However, there is a silver lining, and that is the fall in oil prices and its muted outlook.

Crude oil prices may have jumped 20 per cent (by $4.3 per barrel) on Thursday, but this is of little consolation, given it has fallen from $70 levels in January 2020 and is still around $29 (after touching 18-year lows).

It is this sharp fall in oil prices that has many long-term triggers for these companies. Shares of OMCS, after hitting 52-week lows recently, have rebounded up to 15 per cent in the last two trading sessions, and could gain more. First, the bad news. The fall in oil prices and demand collapse due to lockdown will lead to inventory loss (on crude oil and products) as well as profitability, and will hit OMCS’ near-term earnings. Analysts at Centrum Broking foresee 66-86 per cent fall in OMCS’ operating and net profit in the March 2020 quarter, led by weak refining margins, inventory losses, decline in demand, etc.

The good news is that much of this bad news is priced in the share prices now. Despite the earnings cut, Centrum Broking has upgraded the three OMCS to ‘Buy’ due to cheap valuations.

Importantly, any sustained softness in crude oil prices bode well for these companies, as it will lead to a rise in their marketing mar

gins, decline in working capital requirements, and zero risks of subsidy burden. Even the government will get an opportunity to roll out more reforms on kerosene and cooking gas pricing, which will be a positive for OMCS.

Beyond near-term concerns, analysts say OMCS remain well placed for growth as they see demand rebounding fast once the lockdown is over. The outlook on marketing margins (on retailing fuels such as petrol and diesel), too, remains strong.

Yogesh Patil at Reliance Securities says that for every $1 per barrel fall in crude prices, net marketing margin of OMCS rises by ~0.45 per litre (45 paise). However, some of these gains may get offset if the government raises

duties on retail fuels.

Analysts at Kotak Securities say their estimate of gross retail marketing margins (on per litre basis) on diesel and gasoline increased week-on-week to ~11.8 and ~13.3, as on March 27, from ~8.1 and ~7.1, respectively, a week ago. On the positive side, margins for key polymers also increased in the recent week, led by decline in naphtha and gas prices. The concerns had remained high on petrochemical margins as well.

Edelweiss says globally, there has been a sharp fall in gross refining margins (GRMS) and the trend in India is similar, with modest refinery cutbacks ranging between 10 per cent and 30 per cent. OMCS, however, have sharply increased retail fuel margins, partially offsetting lower volumes and weak GRMS.

They say: “We believe our recent 12-21 per cent cut in 2020-21 (FY21) estimated earnings per share of OMCS is currently adequate. In fact, we believe Indian refineries will structurally gain in the long term, as they enhance competitiveness.” Despite the cut, their FY21 estimates indicate 20-75 per cent earnings growth for OMCS.

Experts such as Yan Chong Yaw, director of oil research & forecast, Refinitiv (formerly Thomson Reuters Financial & Risk), say the global oil demand for 2020 is set to contract for the first time in over a decade at 99.9 million barrels per day. This implies global crude oil prices are likely to remain soft or range-bound, and the expected benefits for OMCS are likely to sustain. Even if oil prices rise, to say $4050 levels led by increased demand, it should lead to higher GRMS. In that case, in the fuel retailing business too, the higher prices/costs will be passed on to customers.

Analysts say, among the three, HPCL — having highest share of retail sales in overall revenue — remains best placed to gain from the better outlook for marketing margins. The stock is up more than 10 per cent in the last two trading sessions, compared to 3.4 per cent gains recorded by IOC. For IOC, concerns are more, compared to HPCL. According to the Emkay Global data, IOC is likely to see 20-30 per cent hit in its refining throughput, compared to 10-20 per cent hit expected for HPCL and slightly more than 10 per cent for BPCL, given the lockdown.

Among the three, BPCL has gained the most, up almost 11 per cent since Tuesday. Though there has been some delay, with respect to the government’s plan to sell its stake in BPCL, the stock is likely to see further upside. The three OMCS also offer strong dividend yield of more than 6 per cent, which makes them attractive investment bets as well.