Oil marketing companies fall, and look more attractive
Decline in refining margins in September quarter a blip; these are likely to rebound and support profit
The stocks of oil marketing companies (OMCs) have seen a correction from their highs in October. This has been led by weakness in broader indices after demonetisation and some softness in the September quarter performance of these companies. However, except for Indian Oil Company (IOC), which is down about 10 per cent, the share fall of Bharat Petroleum Company Limited (BPCL) and Hindustan Petroleum Company Limited (HPCL) is lower than that of broader indices.
BPCL, IOC, and HPCL have fallen from 52-week highs of ~694.75, ~333.60 and ~471, to ~639.05, ~292.65 and ~452.20, respectively. The fall has made valuations attractive given that growth drivers remain intact. Analysts say that demonetisation will also not have any major impact on OMCs, and, hence, this offers a buying opportunity for investors.
Meanwhile, the performance of OMCs during the September quarter saw the impact of softer gross refining margins (GRMs). GRM is the difference between the selling price of refined oil and the cost of raw or crude oil.
The benchmark Singapore GRM during the quarter had also declined only to rebound towards the end of the quarter. With softer margins, while BPCL reported per barrel GRM of $3.08 compared to analyst’s estimates of up to $5 and above, HPCL reported GRM of $3.35 per barrel (analyst estimate of around $4.5 a barrel). BPCL’s GRM was also impacted by expansions and upgradations being undertaken at its Kochi refinery. Nevertheless, IOCL reported better performance amongst the peers, with GRM of $4.3 a barrel mainly on account of higher operational efficiency and no inventory losses for the quarter. This brings spotlight back to IOC, which is also being seen as a strong bet in the OMC space.
IOC, which had commissioned its Paradip refinery sometime back, is now getting benefits. After the initial time taken by the new refinery to stabilise, the progress thereafter is satisfactory and the refinery is to drive IOC’s earnings, say analysts.
Analysts at Ambit Capital have upgraded their earnings estimates once again, factoring full contribution from Paradip to FY18 profits, with refinery ramp-up progressing well and assuming the refinery achieving a 90 per cent utilisation by February 2017. The upgrade is also attributed to a good control over operating and interest expenses and inventory gains in first half of FY17.
Meanwhile, GRM for HPCL and BPCL are to rebound moving forward. For HPCL, analysts at JM Financial estimate GRM of $5 a barrel in FY17, and for BPCL, the same is pegged at $5-6 for FY17/18.
Going ahead, marketing margins are also expected to be robust while GRMs are likely to recover from the recent lows as winter season kicks in, leading to demand-supply balance tilting in favour of supplies, say analysts at IIFL, who have a target price of ~740 for BPCL.
Helped by strong demand, good refining margins, improving marketing profitability, and government’s efforts on fuel reforms and subsidy, the earnings growth drivers for OMCs remain intact. Against this backdrop, analysts say the correction offers a good buying opportunity.