Improved show by oil market companies like Indian Oil and HPCL in Q3 likely to attract investors

ET INTELLIGENCE GROUP: After seeing lacklustre returns in the past six months, investors are likely to get back to state-owned oil market companies ( OMCs), thanks to the strong refining margins and lower-than-expected inventory losses in the December quarter.

OMCs have beaten consensus operating profit estimate by 10-35 per cent in the third quarter of this fiscal, and have emerged among the few companies where earnings per share have been upgraded by 5-10 per cent after the results.

Continuance of robust refining margins and sensitivity to EPS show that Hindustan Petroleum is poised to gain the most, followed by Indian Oil and Bharat Petroleum. Every one dollar added to the gross refining margin may lift HPCL’s projected EPS for the next year by 17 per cent. For IOC and BPCL, this will be 12 per cent and 13 per cent, respectively.

However, stocks’ performance may remain subdued ahead of the Budget because of the possibility of imposing customs duty on crude oil. Shares of these companies are trading at 6-8 times next year’s projected EPS with a dividend yield of 4-5 per cent. This suggests that the near-term risks of customs duty is adequately priced in.




Despite a recent softening in the benchmark Singapore refining margins, the cracks — difference between product price and crude oil — of petrol and diesel remain in double digits. This indicates gross refining margins (GRMs) are likely to remain healthy. GRMs are expected to remain robust with the net refining capacity in the next two years projected to be lower than the oil demand growth forecast by the International Energy Agency.



Also, the consensus is gradually building that there is a limited downside for crude oil from the current level ($30-32 a barrel). This means the probability of inventory losses in refining is thin. Hence, this will be positive for the operating profits.

Analysts are factoring in GRMs for the next year for BPCL and HPCL at $7 and $5 a barrel, respectively — nearly similar to the current fiscal year. IOC’s margin is expected to come down as commissioning of the new Paradip refinery is yet to prove beneficial.

There are two risks for the OMCs in the near term. One, the possibility of removing tariff protection for the domestic refinery by increasing customs duty on crude oil. This may bring down GRMs by $0.30-0.60 a barrel.

Secondly, they may be punished for delivering high return on equity. The core RoE of OMCs has been 18-29 per cent in the first nine months of FY16, despite absorbing inventory losses. The government has not so far paid the subsidy contribution of `310 crore for the April-December period. Given that companies have posted robust RoEs, the government has an option of not paying an unfunded subsidy.