OMCs: Demand recovery, inventory gains, marketing margins to drive earnings

This is on the back of a surge in oil prices with major oil producing countries following production discipline.
Shares of state-run oil-marketing companies  Hindustan Petroleum (HPCL), Bharat Petroleum (BPCL), and Indian Oil (IOC) are up 22-29 per cent from their May lows. 

Besides the resumption of economic activities, the fuel price hikes undertaken by these OMCs has been taken positively by investors. These have improved confidence in marketing margins on retail fuels like petrol and diesel, looking at the rise in crude oil prices. Analysts now believe the marketing margins of the state-owned companies will remain firm as they are awaiting further price hikes in coming days in line with the rise in global oil prices.

Over the last three-four days, the OMCs have increased per litre price of gasoline and diesel by a total of Rs 2.14 and Rs 2.23, respectively. This is on the back of a surge in global oil prices, with major oil-producing countries following production discipline. The price of Brent in the last three weeks has jumped 30 per cent to around $40 per barrel. On Wednesday, it was trading 0.85 per cent up at $41.53 (until 12.22 am IST).

For these OMCs, the marketing segment cost is based on the last 15-day average product (crude and crack) prices of gasoline and diesel in the international market. With the rise in crude oil prices, analysts expect the OMCs to undertake price hikes to the tune of Rs 4 per litre on auto fuel. This should not be difficult given that the OMCs have already raised prices by more than half the required figure, say analysts.

The price hikes should ensure that marketing margins are maintained at Rs 3 per litre levels. Based on calculations of crude oil prices and hikes taken so far, the margins may look lower, but the overall auto-fuel margin may still be higher. Because of an increasing oil-price environment, the OMCs will benefit from inventory gains (generally 10-15 days of stock) in the marketing business. In the previous year, especially the March quarter, they suffered inventory losses due to falling oil prices. This is also a reason analysts expect a sharp increase in earnings in FY21.

 

 
Before the excise hike in the first week of May, the OMCs were making Rs 17-19 per litre of gross marketing margin (against normal levels of Rs 3) on auto fuel. Though absolute gains may not be significant in the absence of volumes, it should help mitigate some of the earlier inventory losses which would bode well for the June quarter and the current year as a whole, believe analysts.
“The assumption for gross marketing margin of Rs 3.3 per litre remains unchanged with the net margin at Rs 1.5 per litre for FY21 and FY22,” say analysts at Motilal Oswal Financial Services. Probal Sen and Akshay Mane of Centrum Broking, too, expect marketing earnings to remain robust in both FY21 and FY22. With Brent crude prices settling in the $35-40 range (eliminating prospects of inventory losses) and marketing business earnings to benefit from higher margins, they see earnings of IOC, HPCL, and BPCL growing annually by 27.3 per cent, 14.6 per cent, and 24.2 per cent, respectively, between FY20 and FY22. Though refining margins may remain soft, this business should benefit from low-cost inventory. Further, aggressive discounts available for Indian crude buyers are a boon, say analysts. 

The resumption in demand is also positive and as activity levels pick up over the next six months, refining margins may gain by the second half FY21, feel analysts.

In fact, on Wednesday, IOC said improved demand for petroleum products in May resulted in higher capacity utilisation of its refineries to the extent of 75-80 per cent and the same is being ramped up further.

Among the OMCs, HPCL has a larger share of retail sales in its portfolio, and should benefit most from higher marketing margins. IOC, on the other hand, has a larger share of refining and will get respite from lower inventory losses, as well as marketing margins. For BPCL, the prospects now hinge more on the government's proposed divestment. Analysts at Nomura say though they are less sanguine on valuation and timelines, they believe privatisation remains a key catalyst.


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