Energy - OMCs (BPCL | HPCL | IOCL): Some relief, but not enough - Kotak

The reduction in excise duty on diesel and gasoline by Rs2/liter, although passed on to end-consumers, will allay recent apprehensions on marketing margins for OMCs. However, any structural expansion in margins is certainly ruled out under the current environment; diesel margins have contracted by ~Rs1/liter over the past fortnight, which needs to reverse in the near term for restoration of normalcy. Reiterate our negative stance on OMCs with relative preference for IOCL.

Rs2/liter reduction in excise duties on diesel and gasoline, passed on to end-consumers

In an unanticipated development, the government decided to reduce excise duties on diesel and gasoline by Rs2/liter effective from October 4, first change since February 2016 when global diesel/crude prices were half of current levels. The reduction in excise duty will reduce fiscal receipts by about Rs130 bn for 2HFY18 or Rs260 bn on an annualized basis. OMCs have reduced retail prices accordingly, passing on the entire benefit to end-consumers.

Rs1/liter reduction in implied marketing margins on diesel over the past fortnight

Our calculation suggests that the implied marketing margins on diesel have contracted by Rs1/liter for OMCs since mid-September when there were media/political concerns around elevated retail prices of auto fuels in India. In our view, this may take some time to reverse, until global fuel price or exchange rate turns favorable, as OMCs may find it difficult to increase margins in the given scenario when the retail prices remain somewhat elevated and the government is being forced to cut excise duties partly forfeiting its fiscal receipts from the petroleum sector.

Structural expansion in marketing margins (and higher multiples) unlikely, in our view

In our view, the Street's expectation of a structural expansion in marketing margins on auto fuels for OMCs in the medium term is unlikely to play out in the context of (1) expected steadiness in global crude/fuel prices, (2) possibility of depreciation in Rupee against the US Dollar, (3) gradual loss in market share of OMCs with rising competition in fuel retailing from private players and (4) tacit oversight by the government. Hence, we rule out attributing higher valuation multiples to the marketing profits of OMCs, given (1) our subdued outlook on marketing segment profitability over the next few years until private players gain their fair share of volumes and (2) earlier-highlighted concerns on fungibility of cash flows across segments—robust cash generation from marketing segment gets deployed in relatively lower-return businesses of refining, petchem or even upstream.

Reiterate negative view on OMCs with relative preference for IOCL

We reiterate our negative stance on BPCL, HPCL and IOCL with relative preference for the latter, as IOCL stock trades at reasonable 6.2X EV/EBITDA on FY2019E basis as compared BPCL at 7.1X and HPCL at 6.7X. We highlight that BPCL and HPCL are relatively more leveraged to volatility in marketing margins as compared to IOCL—Rs25p/liter change in auto fuels margins impacts EPS of BPCL by ~8%, HPCL by ~10.5% and IOCL by ~5.5%.

Source : Equity Bulls

Keywords