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India – Oil
Under-recoveries continue to drag on OMCs
Govt reimburses less than its promised share of underrecovery
of 50% to Oil Marketing Companies for 9MFY11
Despite financial burden, OMCs continue to deliver on
physical parameters
We retain our cautious stance on the sector with a Neutral
rating on IOCL and Underweight ratings on BPCL and HPCL
The Indian government has paid less than its promised share of 50% of underrecovery
during first nine months. OMCs incurred a gross under-recovery of INR470bn
during 9MFY11 on sale of fuel below costs. The government reimbursed only 45% of the
total under-recovery, while public sector upstream companies chipped in with 33%,
leaving a gap of 22% for the OMCs to bear. The lower contribution from the government
poses a significant risk to the earnings of the OMCs as we estimate each 1% lower
subsidy by the government reduces the EPS of the OMCs by 2-8%. Though we believe
the government is likely to offer more before the OMCs report their Q4FY11 earnings,
but such an ad hoc approach to fuel pricing and funding of losses is likely to continue in
the near future, which in turn would continue to be a drag on the OMC stocks.
Despite financial strain, OMCs show robust physical performance. HPCL and BPCL
have shown Gross Refining Margins (GRM) in line with Singapore Complex GRM while
IOC’s GRM was at a moderate premium. While petrochemical business of IOC is still
ramping up, BPCL’s Bina refinery and HPCL’s Bhatinda refinery are on schedule to
commission by 4QFY11 and 2QFY12, respectively.
We continue to maintain our estimate of OMCs bearing ability limited to c17% of
gross under-recoveries. Similar to the last several quarters, upstream companies are
likely to bear 33% of under-recovery. Hence, the government will have to bear the
balance of 50%. However, the government contribution would depend on the overall
fiscal position. The annual budget exercise during the last week of February 2011
therefore assumes importance as it would not only point to the existing fiscal position of
the government but also indicate the OMC FY12 outlook.
Valuation and Risk: We are cautious on the sector as we believe under-recoveries will
continue and OMCs will have to bear c17% in foreseeable future. Hence, we value the
core earnings of the companies at 9x FY13e EPS, which is at a 10% discount to peers and
the other investments at market value. We are Neutral on IOC and Underweight on BPCL
and HPCL with target prices of INR350, INR605, and INR316, respectively. Risks and
catalysts. Key risk to our target price is materially different refining and petrochemical
margins, different share of under-recovery or announcement of oil and gas discoveries.
Valuation and risks
Valuation
We value the oil marketing companies on PE multiple for core business earning and quoted investments
on market value. We have used a PE of 9x, which is at a 10% discount to the OMCs’ Indian peers, to
reflect earnings uncertainty.
Under our research model, the stocks without a volatility indicator, the Neutral band is 5ppt above and
below our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price. For BPCL, our
target price of INR605 implies a return of 5.5% (including dividend yield of 1.9%), we maintain our
Underweight rating. For HPCL, we have a target price of INR316, which implies a return of -5.8%
(including dividend yield of 1.2%), hence we maintain our Underweight rating. For IOC, our target price
of INR350 implies a return of 14% (including dividend yield of 3%), we maintain our Neutral rating.
Risks & sensitivity
Any increase in regulated retail products like diesel, LPG and kerosene prices would be an upside risk.
Downside risks include higher under-recovery or a freeze on gasoline prices. Key to the stocks’
performance could be more clarity on the under-recovery mechanism.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India – Oil
Under-recoveries continue to drag on OMCs
Govt reimburses less than its promised share of underrecovery
of 50% to Oil Marketing Companies for 9MFY11
Despite financial burden, OMCs continue to deliver on
physical parameters
We retain our cautious stance on the sector with a Neutral
rating on IOCL and Underweight ratings on BPCL and HPCL
The Indian government has paid less than its promised share of 50% of underrecovery
during first nine months. OMCs incurred a gross under-recovery of INR470bn
during 9MFY11 on sale of fuel below costs. The government reimbursed only 45% of the
total under-recovery, while public sector upstream companies chipped in with 33%,
leaving a gap of 22% for the OMCs to bear. The lower contribution from the government
poses a significant risk to the earnings of the OMCs as we estimate each 1% lower
subsidy by the government reduces the EPS of the OMCs by 2-8%. Though we believe
the government is likely to offer more before the OMCs report their Q4FY11 earnings,
but such an ad hoc approach to fuel pricing and funding of losses is likely to continue in
the near future, which in turn would continue to be a drag on the OMC stocks.
Despite financial strain, OMCs show robust physical performance. HPCL and BPCL
have shown Gross Refining Margins (GRM) in line with Singapore Complex GRM while
IOC’s GRM was at a moderate premium. While petrochemical business of IOC is still
ramping up, BPCL’s Bina refinery and HPCL’s Bhatinda refinery are on schedule to
commission by 4QFY11 and 2QFY12, respectively.
We continue to maintain our estimate of OMCs bearing ability limited to c17% of
gross under-recoveries. Similar to the last several quarters, upstream companies are
likely to bear 33% of under-recovery. Hence, the government will have to bear the
balance of 50%. However, the government contribution would depend on the overall
fiscal position. The annual budget exercise during the last week of February 2011
therefore assumes importance as it would not only point to the existing fiscal position of
the government but also indicate the OMC FY12 outlook.
Valuation and Risk: We are cautious on the sector as we believe under-recoveries will
continue and OMCs will have to bear c17% in foreseeable future. Hence, we value the
core earnings of the companies at 9x FY13e EPS, which is at a 10% discount to peers and
the other investments at market value. We are Neutral on IOC and Underweight on BPCL
and HPCL with target prices of INR350, INR605, and INR316, respectively. Risks and
catalysts. Key risk to our target price is materially different refining and petrochemical
margins, different share of under-recovery or announcement of oil and gas discoveries.
Valuation and risks
Valuation
We value the oil marketing companies on PE multiple for core business earning and quoted investments
on market value. We have used a PE of 9x, which is at a 10% discount to the OMCs’ Indian peers, to
reflect earnings uncertainty.
Under our research model, the stocks without a volatility indicator, the Neutral band is 5ppt above and
below our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price. For BPCL, our
target price of INR605 implies a return of 5.5% (including dividend yield of 1.9%), we maintain our
Underweight rating. For HPCL, we have a target price of INR316, which implies a return of -5.8%
(including dividend yield of 1.2%), hence we maintain our Underweight rating. For IOC, our target price
of INR350 implies a return of 14% (including dividend yield of 3%), we maintain our Neutral rating.
Risks & sensitivity
Any increase in regulated retail products like diesel, LPG and kerosene prices would be an upside risk.
Downside risks include higher under-recovery or a freeze on gasoline prices. Key to the stocks’
performance could be more clarity on the under-recovery mechanism.
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