Equity research firm Jefferies has initiated coverage on India’s oil marketing companies (OMCs), with a ‘buy’ recommendation on two state-run firms’ shares, and a ‘hold’ rating on the third stock.
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Equity research firm Jefferies has initiated coverage on India’s oil marketing companies (OMCs), with a ‘buy’ recommendation on two state-run firms’ shares, and a ‘hold’ rating on the third stock. Refining business is going through one of the worst phases in over a decade; however, Jefferies expects the marketing segment to compensate for drop in profitability. Jefferies has initiated its coverage of Bharat Petroleum Corp Ltd (BPCL) and Hindustan Petroleum Corp Ltd (HPCL) with a ‘Buy’ rating, while it has given a ‘Hold’ rating on Indian Oil Corp Ltd. Both BPCL and HPCL have outperformed the Nifty over 5 and 10-yr periods, with profits jumping close to 3 times.
In a recent report, analysts at Jefferies said that despite the increase in competition from private firms, core marketing EBITDA for HPCL and BPCL has grown at a ~15% CAGR over financial year 2017-2020. Similar to fiscal year 2019, the marketing margins for these OMCs have compensated for a sharp drop in refining profitability. “We note that marketing margin/Kl on auto fuels is up 60% YTD as the refining business is losing money,” the report said.
Jefferies is optimistic that BPCL will bring with it privatization gains. “A global major with a well-recognized brand as a potential new owner could usher in faster growth, operating leverage gains, cost savings, and a gradual increase in premium auto fuel acceptance, driving significant improvement in profitability and return ratios over the medium term,” the report noted. Auto fuel marketing margin/kl have grown 14.7% CAGR for BPCL since 2017. Auto fuels contribute 57% to volume and 54% to gross marketing margin.
BPCL has also increased its retail outlets and continues to maintain the outlet addition pace for the next five years. However, the major push for the stock is expected to come from the privatization of drive. “The right acquirer can shift BPCL to a sustainably higher growth trajectory with improving profitability and return ratios,” Analysts say privatization could help BPCL in faster growth, corset rationalization, premiumization, and operating leverage benefits. However, government intervention in price hike is something that remains a risk to privatization.
Analysts at Jefferies have picked HPCL as one of their top picks in the OMC space with potential upside of 105%. The firm also is the largest and fastest-growing value-added lubes business in the country and has seen the least market share loss in auto fuels among peers in the face of rising private competition. Further, it has been predicted that as the pandemic subsides there will be strong pent-up demand in calendar year 2021.
The primary reason behind Jefferies picking HPCL as their top pick is the deep discounted valuation of the stock. “The stock trades at a 45% discount to the last five-year average one-year forward P/B and 16% discount to the last five-year average one-year forward EV/EBITDA,” the report said. With valuations at such lows, the risk-reward ratio becomes favourable.