Elevated Brent and busy political calendar in 2018-19 makes this uncertain, though, and could peg back a re-rating for India's downstream SOEs with softer refining likely to weigh on earnings too.
Petrol/diesel prices in India rose 0.6/0.9% over the weekend before the last one but much more is needed to normalise marketing margins as we forecast. Elevated Brent and busy political calendar in 2018-19 makes this uncertain, though, and could peg back a re-rating for India’s downstream SOEs with softer refining likely to weigh on earnings too. We like just the cheaper and more resilient IOCL to BPCL/HPCL, therefore, amidst this tougher macro, and also like ONGC.
Price hikes: India’s downstream SOEs had started to raise prices from mid Dec after the extended hiatus before the Gujarat elections but with global prices also rising, marketing margins rose much more slowly despite the appreciating Rs. Indeed, the pace of hikes was much more tentative in the new year.
Politics: With the stormy winter session of Parliament concluding on January 5, though, the SOEs found courage again, raising petrol prices by Rs 0.45/litre (0.6%) and diesel by a larger Rs 0.55 (0.9%). Diesel prices have now risen Rs 2.2/litre (3.7%) since 14 Dec (to well past prior highs) with petrol up Rs 1.4 (2.0%) adding, in aggregate, 15bps to overall inflation. More: Yet while petrol marketing margins have risen smartly to Rs 1.5/litre (net of freight), diesel margins have only been flattish at Rs 0.75 despite the price increases, weighed down by seasonally strengthening cracks. More is needed, therefore. If the current Brent/crack/INR macro holds, for example, getting to pre-Nov marketing margin levels of Rs 1.8/2.5 per litre will require another 2.9% rise in petrol and a stiff 4.4% in diesel, adding a further 18bps to inflation. Time may be short; the budget session opens on 29th Jan.
Uncertain: This could leave diesel-petrol margins lower than the Rs 1.7-2.3/litre we forecast for 4QFY18E and Rs 1.7-2.0 for FY18E. Indeed, we also build in 6.4% CAGR in blended auto fuel margins for FY18-21E too — higher than the 6.1% CAGR since prices were fully deregulated. Still, the scale of the margin compression ahead of Gujarat has left us less confident of the trajectory — especially as oil prices could also remain firm in 2018.
Re-rating: Even if these concerns prove exaggerated, though, it may still peg back a valuation re-rating for India’s downstream SOEs in 2018 when eight states elect assemblies. Indeed, politics has trumped economics before in India O&G even if we see no signals yet of price controls or upstream subsidies.
Upstream: We still like the upstream SOEs where we raised FY19E EPS recently by 15% to factor in $63 Brent. ONGC FY19E EPS may rise 32% y/y leaving the shares at an inexpensive 9x P/E and 4.3x adj. EV/EBITDA. We keep our BUY with a Rs 225 PT. We like Oil India too where adjusted E&P valuations are similar to ONGC.
Downstream: The downstream SOEs may have a tougher year though, weighed down by the uncertainty on marketing margins and a softening refining macro. Global demand/supply balances look less skewed than they did in 2017 with the reversal of the Saudi OSP discounts a headwind too. We keep our UNPF on BPCL and HPCL preferring only the more diversified IOCL (BUY) where expectations are more reasonable and valuations cheaper.
Reliance: We keep UNPF on Reliance where its $122 bn EV bakes in the Ebitda surge premised on flawless ramp-up in energy/telecom. Lifting ARPU and subs together may be tough, though, while refining/olefin margins may soften and FCF/ROCE lag Street estimates.
Petronet: We maintain HOLD on Petronet noting that its long-term contracts may help it weather the softening India LNG macro while rich valuations preclude significant upside.