Daily revision of fuel prices structurally positive for OMCs

New Delhi: The shift to daily revision in prices of petrol and diesel from fortnightly revision starting 16 June is structurally positive for Indian oil marketing companies (OMCs)—Bharat Petroleum Corp. Ltd (BPCL), Hindustan Petroleum Corp. Ltd (HPCL) and Indian Oil Corp. Ltd (IOC). With this, India joins countries such as the US and Australia where fuel prices are revised on a daily basis.

This means OMCs will be able to pass on daily changes in product prices and exchange rate fluctuations without delays.

IOC said daily revision of petrol and diesel prices will set new standards of transparency, encourage the automation drive of petrol pumps and lead to better stock management practices.

However, it will probably be a while before OMCs see benefits in the form of higher marketing margins in their financials. Every Re0.1/litre increase in petrol/diesel price adds 1.9-3.5% to OMC earnings per share, according to Credit Suisse Securities (India) Pvt. Ltd.

It’s also worth remembering here that competition from private sector companies will pose a threat to expansion in marketing margins. Already, OMCs have lost market share in the fuel retailing business to private sector firms in fiscal year 2017 (FY17).

Nevertheless, all three stocks have outperformed the Nifty 50 index in the past year, supported by earnings growth. Even so, valuations aren’t expensive.

Kotak Institutional Equities highlights in a report on 19 June that OMCs may look optically inexpensive trading at 10-12 times price-to-earnings multiples or 6-6.7 times EV/Ebitda for FY19. EV is short for enterprise value and Ebitda stands for earnings before interest, tax, depreciation and amortization.

“However, it may be justified as a significant portion of the business is cyclical and it also requires meaningful amount of capex for upgradation and modernization, let alone to raise capacities,” added Kotak.

Share prices of these stocks did not alter dramatically on Tuesday. Note that Kotak’s earnings estimates are 12-15% below consensus for BPCL and HPCL, and around 2% for IOC.

Some analysts believe that OMC earnings peaked in FY17 and see risks for FY18 earnings. Lack of sizeable one-offs from inventory gains is one reason, says Spark Capital Advisors (India) Pvt. Ltd. Another reason would be rising competition in the auto fuels segment, it added.

The sharp appreciation in the last one year and the above mentioned concerns could well limit meaningful upsides for these OMC stocks. On the brighter side, a better refining margin environment and stronger demand for petroleum products will help boost sentiment for these stocks.

Disclaimer: This information has been collected through secondary research and IBEF is not responsible for any errors in the same.