Shares of three Indian OMCs Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd (BPCL), and Hindustan Petroleum Corp Ltd (HPCL) faced selling pressure today amid a broader stock market crash driven by small- and mid-cap indexes that logged their worst session in over two years.
Apart from domestic markets, the rise of two per cent in international crude oil prices today after Ukraine attacked a Russian refinery also dragged OMCs stock lower. High crude oil prices is a negative for OMCs for purchasing oil.
Also Read: OPEC+ to support Brent at $80/bbl; ONGC/Oil India placed well on dividend pay, valuations
Time to sell OMC stocks?
Domestic brokerage firm JM Financials has maintained a ‘sell’ rating on IOC and HPCL and a ‘hold’ on BPCL amid the current discounting of prices. The sell rating means the stock price is expected to move downwards by more than 10 per cent from the current market price (CMP) over the next 12 months.
OMCs’ valuations (HPCL 1.5x FY25 P/B; IOC 1.4x FY25 P/B; and BPCL 1.6x FY25 P/B) are trading at 25-50 per cent premium to historical valuations, according to the brokerage. ‘’Hence, we believe OMCs’ risk-reward is unfavourable and we maintain SELL rating on IOC, HPCL and HOLD rating on BPCL.”
Instead, the brokerage prefers upstream state-owned oil explorers including ONGC, Oil India as they are a play on high crude price, with CMP discounting ~$65/bbl net crude realisation, and have 4-6 per cent dividend yield.
Why are OMC stock prices discounting?
The reverse valuation exercise by JM Financials suggests that at CMP, IOC is discounting sustainable GRM of $9.5/bbl, BPCL is discounting sustainable GRM of $10/bbl and HPCL is discounting sustainable GRM of $9.2/bbl.
The brokerage expects gross refining margins (GRM) to normalise to $7.5-9 per barrel driven by the following:
-Normalisation of diesel cracks due to easing supply side concerns and normalisation of Chinese diesel exports
-End of windfall tax benefits following normalisation of diesel cracks
-Narrowing of Russian crude discount.
OMCs had reported very strong GRM of $10-20/bbl in FY23 and FY24 (vs. $ 5-7/bbl historically) driven by: a) record high diesel cracks of ($20-35/bbl vs. normalised $15/bbl); b) windfall tax benefits that accrued to them because they sourced diesel from standalone refiners; and c) Russian crude discount adding $2-4/bbl to their GRM.
The brokerage believes that the Organisation of Petroleum Exporting Countries and its allies (OPEC+) will continue to use its strong pricing power to support Brent crude price ~$80/bbl, which is the fiscal break-even crude price needed by Saudi Arabia
‘’We expect OMCs’ sustainable auto-fuel (diesel/petrol) gross marketing margin (GMM) at the historical run-rate of ₹3.5/litre as the government is highly likely to either cut auto-fuel prices ahead of general elections in May 2024 and/or hike auto-fuel excise duty post elections given that strong profits in FY24TD have enabled OMCs to recoup FY23 losses and repair their balance sheets,” said the brokerage.
Also Read: Oil prices rise 2% after supply disruption as Ukraine attacks Russian refineries; Brent at $83/bbl
Moreover, OMCs have historically kept GMM only at a normative level to mitigate competition from private fuel marketing companies (private players need higher GMM to break-even as they do not have advantage of OMCs’ legacy depreciated retail outlet asset base). This is evident from the private players’ market share in the fuel marketing business, which has stagnated at ~10 per cent in the last few years due to OMCs’ aggressive pricing strategy.
Valuation: The brokerage has raised OMCs’ FY25-26 EBITDA estimate by 10-14 per cent building it higher GRM of $8.0/bbl for IOC (from $7.0/bbl assumed earlier), $9.0/bbl for BPCL (from $8/bbl) and $7.5/bbl for HPCL (from $7/bbl).
‘’After the strong rally in the last 4-5 months, OMCs’ valuations are trading at 25-50 per cent premium to historical P/B valuations. Hence, we believe OMCs risk-reward is unfavourable,” said JM Financials.
Also Read: OPEC, IEA emerge most divided on oil demand projections since 2008
OMC Stocks Today
Shares of IOC, BPCL, and HPCL settled lower on Wednesday, after losing around four-six per cent each during the session. Shares of HPCL opened at ₹514.95 and cracked 7.02 per cent to hit an intra day low of ₹478.45, before…
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