Indian Oil SOEs-- Falling crude may not lift all SOE boats; OW ONGC, stay cautious on downstream ::JPMorgan

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��


With a decline in crude prices increasingly likely in our view, we analyze
the impact on the Indian Oil SOEs – traditionally a good place to hide in
this scenario. We conclude the downstream SOEs [BPCL (N), HPCL
(UW), IOC (N)] provide a lower beta to crude as reform hopes have priced
in normalized earnings without factoring equity, margin risks. Upstream
ONGC (OW) provides the best play on declining crude/subsidies.
 ONGC has robust earnings resilience in declining crude scenario:
Significant government tax cuts and retail price hikes have reduced
overall oil subsidy levels – we estimate ONGC’s net realized crude price
for domestic crude will be US$63-US$68/bbl building in higher
upstream subsidy sharing in FY12/13E (45/60%). A cap of US$60/bbl on
net realization will impact our FY13E by 12% and our fair value by 11%
to Rs300.
 Downstream cos. are pricing-in reform hopes, normalized earnings...
Downstream cos. are trading at 7.6x-9.2x EV/EBITDA based on
earnings building in significant subsidy back-stops. Even based on
normalized marketing margins, stocks are trading at EV/EBITDA
multiples of 5.7x-9.0x, and at mean book value multiples.
 …but not risk aversion, margin uncertainty With the crude decline
likely led by an uncertain demand environment, there is risk to refining
margins. Also, in an uncertain earnings environment, equity risk aversion
could lead to a de-rating. We remain cautious on the downstream
companies.
 Pricing reforms, though unpredictable, will be a bigger driver: As
against crude level, we believe a bigger driver for Indian Oil SOE stock
performance will be retail fuel price reform measures. While we are
currently not very hopeful of any major reform initiatives in the current
political, inflationary environment, we are building in some success in
direct targeting of LPG subsidies (the most likely reform measure in the
short term) in our subsidy forecasts. Our order of preference for the
downstream cos. would be IOC (greater earnings resilience), HPCL (beta
on lower subsidy) and BPCL (risk aversion may impact E&P
optionality).


Downstream valuations are still optimistic
With the announcement of further reform measures in June 2011, the downstream
companies are now pricing in retail fuel reform measures, in our view. We note that
the stocks are trading around or above their mean book value multiples. Even pricing
in normalized earnings for FY10 (when refining margins were weak in the wake of
the GFC), BPCL, HPCL and IOC are trading at 5.7x-9.0x EBITDA.
With the crude decline likely led by uncertain demand environment, there is a risk to
refining margins. Also, in an uncertain earnings environment, equity risk aversion
could lead to a de-rating. We continue to remain cautious on the downstream
companies.
Our order of preference for the downstream companies in the current environment
would be IOC (beta on lower subsidies and higher earnings resilience), HPCL
(highest beta to crude decline) and BPCL (high valuations build in E&P optionality
which could be vulnerable due to uncertain timelines in a risk-averse environment).