However, we believe that continued retail price hikes alleviate the risks of a rollback of pricing reforms while equality of upstream crude production with subsidised product volume makes the maths easier for the govt to keep OMCs away.
The 3 key risks inferred for oil marketing companies (OMCs) in a rising oil price environment are (i) rollback of retail fuel price reforms; (ii) claw-back of LPG (liquid petroleum gas) and kerosene under-recovery (u/r) burden on OMCs; (iii) negative impact on refining margins with higher oil prices. However, we believe that continued retail price hikes alleviate the risks of a rollback of pricing reforms while equality of upstream crude production with subsidised product volume makes the maths easier for the govt to keep OMCs away. Though the clouds of u/r burden uncertainty are likely to remain until May’19, we believe that uncertainty is priced in. We still estimate nil u/r burdens on OMCs at UBSe Brent price of $63/65/70/bbl for CY18/19/20e.
Private sector share in retail fuels make risk of govt control look slim
Continued retail price hikes by OMCs on gasoline and diesel eases the risk of govt control as $75/bbl of Brent is nearly passed through along with 5% Rupee (INR) depreciation against US$. Also, private sector market share of above 8% in retail fuels and the govt’s commitment to promote investments in the sector further reduce these risks, in our view. During April, OMCs have earned healthy marketing margins (April’ 18 diesel gross margins at Rs 3.5/ltr (40% above normal) despite Brent of $70/bbl.
PSU upstream output = subsidised products sales, low case for OMCs
While the govt currently subsidises LPG under direct benefit transfer and kerosene through the fiscal budget, we highlight that burden sharing has become much easier as upstream crude output equals the sales volume of subsidies products. For FY18E, we estimate the govt is likely to bear Rs 12/ltr and Rs 213/cyl u/r on Kerosene and LPG, respectively. Hence, we believe that as a first indication OMCs may not bear any loss for FY18e. If this formula is followed in FY19e as well, then upstream would need to bear a smaller u/r burden, with no burden on OMCs, all else being equal. Even in an unforeseen scenario of subsidy burden, we estimate not more than a Rs 56 bn burden on OMCs under $63-80/bbl Brent crude prices, and the impact of this we believe is priced in post the recent correction in stock prices.
We value OMCs at 12x FY19E PE (a 33% discount to the Nifty’s current one-year forward PE of 18x).We value them on PE, as they derive a significant portion of their earnings from equity-accounted JVs, which are not properly captured in the EV/Ebitda methodology, in our view. We value IOCL at 12x FY19e consolidated EPS. We value BPCL at 12x FY19e consolidated EPS. We value HPCL at 12x FY19e consolidated EPS.