Strategy: Earnings, economy and oil :: Kotak Sec,report

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Earnings, economy and oil. The Indian economy will benefit significantly from lower
crude oil prices but we see downside risks to our earnings estimates for the market
paradoxically from lower crude oil prices. The division of savings arising from lower
crude oil prices between households and governments will depend on the governments’
policies on taxes. Earnings downgrades in the energy sector will not be offset by
benefits elsewhere.

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Significant savings for the Indian economy from lower oil prices
The positive impact of lower oil prices on the Indian economy is well known with a US$1/bbl
decline in crude oil prices resulting in US$1 bn savings for the Indian economy. However, the split
of savings between companies, households and governments (central and states) will depend
on the governments’ policies on taxes. We do the calculations under two scenarios (see Exhibits
1-2) for FY2016 at US$55/bbl (a reduction of US$30/bbl versus FY2015E levels)—(1) government
cuts diesel and gasoline price to the equivalent of US$55/bbl crude price and (2) government
increases taxes on diesel and gasoline to remove the ‘over-recovery’. We estimate `400 bn of
savings for the central government in Scenario 1 and `650 bn in Scenario 2.
Central government to benefit, state governments to lose
We note that central government revenues will be boosted by higher excise duties on gasoline
and diesel and it will also benefit from lower subsidies. However, some of the gains will be
offset by lower excise collections on products other than diesel and gasoline, royalty on crude
oil (offshore), petroleum profit, income tax and dividends and dividend distribution tax. States
will lose meaningfully from lower products prices given the ad valorem nature of state VAT on
petroleum products. Some states will also receive lower royalty on onshore crude oil. We
estimate about `300 bn loss for state governments.
Plenty of other benefits from lower crude oil prices
We see significant direct and indirect benefits to the economy from lower crude oil prices.
Inflation is likely to remain subdued given low commodity prices and soft agricultural product
prices. This will allow the RBI to cut policy rates meaningfully. We see scope for 100-150 bps
reduction in 2015 although uncertain external factors may restrain the RBI to about 100 bps
cut. Lower fuel prices will reduce the cost of ownership of automobiles (see Exhibits 3-4) while
lower interest rates will also provide a meaningful boost to consumption of automobiles and
real estate and improve the financial position of leveraged companies.
Negative impact on earnings paradoxically from lower crude oil prices
We see further downside risks to our earnings estimates for FY2016 and FY2017 from lowerthan-expected
crude oil prices. We assume US$70/bbl and US$75/bbl for FY2016 and FY2017
and thus, see meaningful risks to net profits of the upstream energy companies. Exhibit 5 gives
sensitivity of the net profits of the oil companies under our coverage at various crude oil prices.
The energy sector contributes about 18-20% of the net profits of the BSE-30 or Nifty-50 Index
(see Exhibits 6-7). On the other hand, the consumer products sector accounts for about 5% of
the net profits of the Nifty-50 Index out of which ITC’s share is 3.5%. More important, a portion
of lower RM costs may be (1) passed on to consumers through lower product prices or
(2) invested in the business through higher A&SP spending.

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily16012015kl.pdf