Nishi Vasudeva will finally call it quits next March, when she steps down as the chairman and managing director of HPCL. Vasudeva, who worked with HPCL for about 37 years, is the only lady to have ever headed the country’s fourth-largest company by revenue (FY15).
Till date, the top three oil PSUs in India — Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL), and HPCL — have never had a woman chief, not even in the role of director. MK Surana, currently the CEO of Prize Petroleum Co, the upstream oil exploration arm of HPCL, will take over from Vasudeva next year.
Incidentally, Surana will be steering HPCL through an interesting era of falling global crude oil prices and, closer home, the benefit of fuel price deregulation and falling under-recoveries playing out simultaneously. In fact, FY15 was a great year for oil marketing companies (OMCs).
As Brent crude prices crashed from $100 levels to as low as $40, OMC stocks caught investor fancy, gaining an average 72% during the fiscal, even as the benchmark Sensex fell around 5%. Since October 2014, when diesel price was decontrolled, OMCs have gained an average of 35% against a flattish Sensex. The buoyancy in the stocks has continued in the current fiscal, with the troika gaining by an average 12% as on October 26.
What’s interesting is that at 19.75%, FIIs’ stake in HPCL is the highest in 36 quarters, followed all-time highs of 19.67% in BPCL and 3.27% in IOC. Even domestic fund managers are raising their bets on OMCs. Mutual funds’ stake in HPCL is at a seven-quarter high of 9.86%, while their stake in IOC is at a 15-quarter high of 1.3%.
With Brent crude currently hovering around $48 per barrel, OMCs are enjoying refining margins of $8 per barrel — last seen in FY13. And with the Chinese economy showing clear signs of a slowdown, OMCs don’t see crude prices rising anytime soon.
BK Namdeo, director, refineries, HPCL, told Outlook Business on the sidelines of the company’s post-AGM press conference, that he sees supply exceeding demand as Opec countries are maintaining their production schedule. “Combined with the slow growth in China and Europe, crude is likely to hover in the $40-$60 range,” adds Namdeo.
With a monthly hike in diesel prices since 2012, the contours of the sector have witnessed a sea change. Throw in goodies such as the excise duty cut on petrol and the limit on subsidised LPG cylinders, and all these measures have together boosted the sector’s profitability and brought down under-recoveries.
More importantly, after a two-year dip, diesel demand (42% of overall petroleum consumption) in the country jumped 20% y-o-y in September 2015 and 8% y-o-y in Q2FY16, with gasoline demand remaining in double digits (25% y-o-y in September and 16% y-o-y in Q2FY16). As a result, overall petroleum demand jumped 9% y-o-y in Q2FY16.
“Domestic demand recovery bodes well for PSU refiners, as it will lead to higher marketing volumes,” states analyst Jal Irani of Edelweiss in his report on the sector. Analysts believe that soft crude prices and deregulation could lead to better earnings visibility and valuation support for OMC stocks. The consensus, then, is for OMCs’ earnings to grow at 38% CAGR over FY15-FY17.
Brokerages see improvement in gross-refining margins
Analysts believe that improved marketing and refining margins combined with the absence of any inventory loss would be key drivers for this growth. Amar Ambani, head of research at IIFL, says, “Going ahead, there is further upside in store for OMCs. They are clearly the biggest beneficiaries of low crude prices. The losses that they were facing are not there anymore. Their refining margins have gone up and, in fact, have doubled (See: Margin call).” Not surprising that, amid the commodity conundrum, OMC stocks are being viewed as safe bets.
Take, for instance, chief investment officer and fund manager at Kotak AMC, Harsha Upadhyaya’s take on OMCs — he says that most of his portfolios are overweight on the sector. “We continue to remain positive on OMCs. Although a one-time re-rating of the sector has happened post diesel deregulation, given that the global crude oil market remains soft and pricing in the domestic market has been linked to markets, we believe that the sector will be in good shape. It may outperform the overall market, going forward.”
The fund house’s assets under management (AUM) stand at over ₹56,000 crore. The chief investment officer of another fund house, which accounts for ₹1.3 lakh crore worth of AUM, feels that the fall in receivables and debt levels have improved the balance sheet of OMCs. The correction in crude prices has reduced the under-recovery burden and the delay in government’s subsidy payments has also reduced.
Between FY13 and FY15, the government’s subsidy payment cycle improved from six months to a month. This has had a significant positive impact on debt, as delay in cash payments from the government accounts for 60% of the working capital loan out of total debt for the companies.
For BPCL, trade receivables fell from ₹4,543 crore to ₹2,948 crore in FY15, while its gearing fell from 1.04X to 0.58X. For IOC, receivables were down to ₹6,758 crore from ₹11,022 crore. The total debt-to-equity ratio was at 0.8X from 1.3X in FY14. For HPCL, trade receivables were down to ₹3,603 crore from ₹5,465 crore and the net debt-equity eased to 1.1X from 2.1X.
With deregulation of diesel prices and linking of LPG sales to market prices by the implementation of the direct benefit transfer, under-recovery concerns have effectively been eliminated as far as these two petroleum products are concerned. This is against the earlier policy of relying on the government for under-recovery payments, which resulted in extended working capital cycles.
According to analysts at Goldman Sachs, under-recoveries will decline to just ₹38,500 crore — a decline of 50% y-o-y from ₹75,700 crore in FY15. To add a little perspective here: this would be 1/4th of the peak of ₹1.6 lakh crore seen in FY13.
Under the new government, OMCs have witnessed another spate of reforms. Diesel prices were deregulated in October 2014. In a clear sign that the government is showing a certain willingness to pursue deregulation despite state elections, diesel prices were hiked by ₹0.95 per litre recently. As a result, marketing margins on diesel stood at ₹0.7 per litre, up 3X, according to Edelweiss.
On the back of a sharp correction in crude prices, the under-recovery burden for all stake-holders is easing and is expected to boost profitability of oil marketing companies
Besides, the government has also called upon households to voluntarily surrender LPG subsidy benefits if they don’t need them. Nearly 6 crore LPG consumers have reportedly surrendered the benefits so far. Boosted by these initiatives, oil sector losses are expected to come down to decade-low levels of ₹36,800 crore and ₹37,900 crore for FY16 and FY17, respectively, and, in turn, improve profits for the OMCs (See: Better prospects).
Full steam ahead
Despite the sharp rally seen thus far, analysts believe that there is further steam left in the sector. For both IOC and HPCL, analysts expect an upside of 36% from current levels; they feel that the BPCL stock should at least add another 25% to its current valuation.
An analyst with a leading domestic broking firm believes that the full scale of re-rating is yet to play out. “There is still some ambiguity on whether marketing margins have been fully de-controlled or not. As a result, the stocks have seen some correction as well. Once there is clarity on that front, there might be further upside.”
There are some experts who favour IOC over its peers. “While BPCL, HPCL and IOC all look good, we prefer IOC as it has under-performed in the current fiscal as there was an overhang due to the company’s ₹9,302 crore follow-on issue. However, with that out of the way, the stock is not facing any major uncertainty,” says R Sreesankar, head of institutional equities at Prabhudas Lilladher.
IOC is trading at 1.2X estimated FY16 price to book, which is a 28% and 47% discount to those of HPCL and BPCL, respectively. Ambani at IIFL adds that in addition to the sectoral tailwinds, some of the OMCs are also likely to benefit from their specific business strategies.
“IOC’s Paradip refinery is expected to break even at PAT level. In case of HPCL, its lubricant business is capturing market from companies like Castrol, which is solely a lubricant player. BPCL’s E&P projects in Brazil and Mozambique are value-accretive.”
Besides, OMCs are looking to enter tier 2 and tier 3 cities due to the saturation of the market in metro areas. “There is no more growth in cities such as Mumbai, Delhi or Kolkata. But B and C cities such as Raipur and Bhubaneswar are going to drive growth. So, we are focusing on these cities as well as rural markets,” mentions S Jeyakrishnan, executive director, retail, HPCL.
With the going good for OMCs, the government might not want to divest further stake in these OMCs, from the current just-above-absolute-majority levels; government holding in all the three OMCs is 54.93% (BPCL), 51.1% (HPCL) and 58.57% (IOC). With earnings expected to see significant improvement in the coming days, the government would be banking on generous dividend payouts to keep its fiscal deficit in check. In other words, oversupply of paper is not a concern for the Street right now. All the better for OMCs, then.