Refining margins may firm up in the remaining winter months but we are more alarmed by the sharp fall in auto fuel marketing margins in India since early November.
Refining margins may firm up in the remaining winter months but we are more alarmed by the sharp fall in auto fuel marketing margins in India since early November. We expect this to recover in 2H Dec but the weak 3QFY18 should still be a reminder of HPCL’s earnings vulnerability. With refining tailwinds also likely to ease in 2018-19E, we expect EPS to fall 21% in FY17-19E even as capex rises leaving return ratios lower and net gearing higher. Maintain Underperform.
Firm exports from China/US/India have weighed on regional diesel cracks despite hopes of firmer demand from higher global economic growth. Still, we expect cracks to firm up in December and re-grade premiums to sustain (as Chinese exports ease), but Q3FY18 benchmark refining margins may still be softer q-o-q (currently tracking $0.7 lower).
Our tracker for HPCL is also trending $0.6/bbl q-o-q lower, hurt also by lower base-oil, bitumen and FO cracks. Still, we model realised core margins rising q-o-q recognising one-offs cited by HPCL in 2Q (bitumen off-take issues) but firmer Middle East crude prices as Saudi reverses its OSP discounts to Dubai/Oman leave scope for downside surprises.
It is the 80% (`1.5-2.1/l) fall in diesel/petrol marketing margins, though, that has caught us more by surprise. Retail prices have lagged international prices significantly for these fuels since 7 Nov, leaving margins even lower than opex turning Ebitda here negative.
Still, even if oil prices stay firm post the 30-Nov OPEC meet, we expect margins to catch-up normal levels over 2H Dec post the Gujarat assembly elections but 3Q is still likely to be a soft quarter with core EPS likely to fall 31% q-o-q, in our estimates to near 3-year lows.
We factor the weak 3Q to cut FY18E EPS by 5%, but still bel FY18-20E cons EPS is 10-20% too high. Lower refining margins (mix, OSP, less benign global balances in 2018-19) and only a gradual increase in auto fuel margins (we est. 5.7% CAGR) are likely reality checks.
Indeed, we expect EPS to fall 21% in FY17-19E even as Hindustan Petroleum hikes capex, esp. in refining, where likely benefits are 3-4 years away. Meanwhile, negative FCF may leave net gearing higher and return ratios lower. The $6.6 bn Rajasthan refinery (74% owned, $1.6 bn equity outlay) may only accentuate these headwinds.
Maintain Underperform with a Rs 380 PT (SOTP). Higher margins are the key upside risk but favourable corporate action during its strategic sale may unhinge share prices from fundamentals.