Goldman Sachs: India: Energy Uncertainties on government subsidies weigh on OMC earnings

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India: Energy
Uncertainties on government subsidies weigh on OMC earnings



OMCs to have more than Rs100bn net under-recovery for 1HFY11
According to Reuters, the Indian government is likely to pay Rs100bn to the
state-owned oil marketing companies (OMCs) as subsidy for 1HFY11. The
state-owned upstream companies have been asked to pay Rs103bn out of
the total under-recovery of Rs 310bn during this period. This implies that
the OMCs would end up with net under-recovery of around Rs107bn for
1HFY11. We are currently assuming a much lower Rs30bn as the net
under-recovery of OMCs for full year FY11E against Rs56.7bn for FY10.

OMC stock prices are largely pricing in diesel deregulation already
Our risk-reward analysis shows the key catalyst of auto fuel deregulation
has been largely priced in by the OMC stocks. Despite a base case
assumption of diesel deregulation in 2HFY11E, we do not find much upside
in the stocks and in fact, find downside for HPCL on a FY12E basis.
Therefore, delay in policy action, either due to sticky inflation or rise in oil
prices/ distillate cracks, would put pressure on the stocks, in our view.

Better to stay with state-owned upstream – GAIL is our top pick
In this scenario of uncertainty on the earnings and cash flows of the OMCs,
we would prefer to take exposure to any further regulatory tailwinds in the
sector through the upstream names, particularly GAIL. We find that not only
is GAIL not pricing in full benefits of lower subsidy payout, but it is also not
getting any value for GAIL Gas (100% subsidiary), which is likely to emerge
as the largest player, in our view, and could be worth an extra US$7bn by
2015E. The Indian city gas industry is now undergoing an early “land-grab”
phase that happened in China 7-9 years back, in our view. Reiterate Buy
(Conviction List) on GAIL with 12-m DCF-based TP of Rs570 (15% upside).

HPCL least liked among OMCs as no catalyst beyond policy action
We like HPCL the least as we believe it is already more than pricing in
gasoline and diesel de-regulation and has no catalyst apart from policy
action. Reiterate Sell (Conviction List) on HPCL with EV/EBITDA-based 12-m
TP of Rs450 (rounded from Rs 449.84 - implies 8% downside). We prefer
BPCL/IOC over HPCL among the OMCs since we believe BPCL has the
potential to surprise on its E&P portfolio, while IOC has more stable
earnings mix owing to its pipeline business and rising exposure to the
petrochemical cycle. We have also rounded off the target prices of BPCL,
IOC, Cairn India, GSPL and Petronet LNG.