Q4FY16 results showcased the earnings power of oil marketing companies (OMCs) as they beat FY16 Bloomberg consensus expectations by 10% on average while upstream and gas distributors reported in-line to lower-than-expected earnings. This is consistent with our Buy rating on all the three OMCs and Neutral ratings on upstream E&P and gas stocks.
We see compelling risk-reward with 25% average upside potential for three Buy rated OMCs; BPCL remains on our CL. Post strong 4QFY16 results, we raise OMCs FY17E-18E EPS by 5-30% and 12m TPs by 3-13%. We believe OMC earnings will continue to improve, driven by- volume growth (India has overtaken China in oil product demand growth), higher marketing margins (lack of inventory losses) and capacity expansions/upgrades (e.g. Kochi refinery expansion/upgrade for BPCL). As investors give more credit to their sustainable earnings growth potential, we expect valuation multiple expansion (12-month fwd EV/EBITDA is at 20% discount to 5-year avg.) combined with positive estimate revisions (our new FY17E EPS is on avg. 15% above consensus) driving further stock price re-rating. In our scenario analysis, we see average bull case upside potential of 51% vs. bear case downside risk average of —20%, all else being equal. We expect India gas demand to grow at 10% CAGR between FY15/18E driven by lower prices from oversupply, and policy-driven growth in the fertilizer and power sectors.