Higher cess and fading reform hopes to hit earnings
The cess on crude oil has been raised from R2,575/tonne ($7.0/bbl) to 4,635/tonne ($12.5/bbl) in the FY13 budget. This would mean a cut in OIL?s FY13-14e EPS (earnings per share) by 14%, but the cut is just 4-5% as we had under-estimated other income, which we have raised. We have cut OIL?s PO (price objective) by 18% to R1,331/share from R1,618/share earlier. OIL?s revised PO implies 10% potential upside. We downgrade OIL to Neutral given the hit from rise in cess and also as hope of reforms is fading after the recent state election results.
EPS cut due to rise in cess by 80% ($5.6/bbl): The increase in cess on crude oil by 80% ($5.6/bbl) to R4,635/ton ($12.5/bbl) has meant a cut in OIL?s FY13e (estimates) EPS by 5%. If there is no diesel price hike, or only a modest hike, OIL?s FY13 EPS is likely to be lower year-on-year. Its share in subsidy is another crucial factor which will influence the earnings outlook.
PO at 10% discount to fair value: OIL?s theoretical fair value is down by 9% to R1,479/share due to the rise in cess on crude. OIL trades at discount to its fair value when there is no progress on reforms, there is uncertainty on subsidy sharing, and earnings outlook is poor. We are skeptical about reforms in the remaining two-year term of this government. When there is no progress on reforms, the risk of adverse subsidy sharing also rises. We have therefore fixed OIL?s PO at 10% discount to its fair value at R1,331/share.
What would make us bullish on OIL? Hefty hike in subsidised products or steep fall in oil price and favourable subsidy sharing which improves earnings outlook, would make us more bullish. Sharply higher oil price and adverse subsidy sharing would make us more bearish on OIL.
Investment thesis: Large subsidy on petroleum products has ensured that OIL does not benefit from rising oil prices and has hurt its earnings growth. Subsidised gas prices have also hit OIL. Reforms that substantially reduce or eliminate subsidy would improve earnings outlook and potentially lead to re-rating. Gas price hike or deregulation would also help. OIL is aggressively acquiring highly prospective acreage in India and overseas but large reserve accretion is likely to take some time.
FY12 EPS raised by 7% assuming subsidy sharing same as 9-month: Upstream share in subsidy was 37.9% in 9M(nine- month)FY12. However, our FY12 EPS estimate was based on the assumption of upstream share in subsidy at 40% as we were worried that their share is subsidy would be raised. The subsidy provision made for Q4FY12 in the FY13 Budget suggests that subsidy sharing formula for upstream companies for FY12 may be the same as in 9MFY12. We are now assuming upstream subsidy in FY12 being on the same basis as in 9M. This has meant an upgrade in FY12e EPS by 7%.