OMCs likely to regain pricing flexibility

ET Intelligence Group: State-owned oil marketing companies (OMCs) are currently trading on the bourses at 34-53 per cent discount to their price-book (P/B) multiples of November 2017 following limitation on aligning fuel retail prices to international prices amid the election season. Now that the elections are over, these companies are expected to regain flexibility to change fuel prices in tandem with the international price trend. This should increase their earnings visibility by improving marketing margins.

Marketing margin is the profit earned from the retailing of motor fuels. It constitutes nearly 40-60 per cent of the total operating profit of OMCs. Their ability to raise retail fuel prices in line with international prices was affected in the past 12 months due to several crucial state elections and the general election in April-May 2019. In the two months before May 19, which was the last day of polling, the prices of diesel and petrol declined by Rs 0.84 and Rs 1.75 per litre, while the prices in the international market rose 6-7 per cent.

In the March quarter, the OMCs recouped some of the loss in their marketing margins by keeping some benefit of the fall in crude oil prices. The gross marketing margins in January 2019 increased for diesel and petrol to Rs 8.3 and Rs 7.9 per litre. Consequently, the marketing segment operating profit of the HPCL for the March quarter was higher than the first three quarters of FY19. However, due to the limited room available to tweak retail prices during the elections, gross marketing margins dropped to Rs 3 for diesel and Rs 0.1for petrol in May 2019.

Every 50 paisa change in marketing margin may impact projected earnings by 11-21 per cent. HPCL was the most affected since the share of marketing volume to the refinery throughput is higher than other OMCs, which means it sells significantly higher volumes than produced by its refineries. HPCL, BPCL and IOC have marketing volumeto-refinery throughput ratio of 2.1, 1.5 and 1.2, respectively.

A better earnings visibility for the OMCs after the elections may boost market capitalisation of these companies, which will help the government to monetise its stake to bridge the fiscal deficit. The P/B of OMCs had increased five-six times after the NDA government was formed in 2014 when it introduced diesel regulation and daily pricing framework of petrol and diesel.

The current valuations of OMCs may get support of improving return on equity (RoE). Average RoE of the three OMCs reached 17 in FY19 compared with 10.7 in FY14, according to Bloomberg data. With improving RoE, dividend yield of 5-6 per cent and the government’s reduced influence in determining retail prices, the earnings multiple may expand from the current level.