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• Crude rise brings subsidies back into focus: Crude has rallied ~8%
since September due to a confluence of supportive economic indicators,
the Fed's QE2 announcement and the approaching winter. While the
overall subsidy level was ~Rs110bn for the September quarter, with
crude remaining persistently high, subsidies for 2HFY11 could be
significantly higher than anticipated.
• Lack of diesel reform to continue to hurt: While petrol deregulation
continues to work, with another price hike announced today, various
govt. functionaries have indicated that given the high prevailing inflation
rate, further price action on diesel is likely to be deferred. Current crude
levels indicate a 11% hike (Rs4.5/lt) being necessary for full deregulation.
We expect further action on diesel pricing to take place in
FY12/13, dictated by the federal elections calendar.
• Subsidy level could be higher than expected: We expect an overall
subsidy level of Rs547bn in FY11E (vs. a govt. estimate of Rs530bn).
However, at $85 crude, subsidy losses rise 28% to Rs699bn. A potential
balancer for this would be rupee appreciation; however the rupee would
need to appreciate 9% to negate a 10% increase in crude levels.
• Uncertainty on R&M earnings stay: We factor in a downstream
subsidy share of Rs40bn for FY11E (Rs60bn in FY10). Govt. has
approved a payout of Rs130bn for 1HFY11 – potentially indicating a full
year payout of Rs260bn, in-line with FY10. Higher crude and a lower
than expected govt. payout could impact R&M earnings for FY11.
• Remain cautious on the R&M sector: Given the risks to earnings
posed by higher crude levels (and consequently higher subsidies) we
remain cautious on the R&M space as we believe the stocks are currently
close to pricing in a zero subsidy scenario. We remain UW on HPCL due
to its higher linkage to policy initiatives. We stay Neutral on IOC
(relatively stable and diversified earnings stream) and BPCL (continuing
positive newsflow on its E&P assets provide upside).
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