Shares of OMCs or state-run oil marketing firms—Bharat Petroleum Corp. Ltd (BPCL), Hindustan Petroleum Corp. Ltd (HPCL) and Indian Oil Corp. Ltd (IOC)—took a beating on Monday.
Two factors are causing concern. One, the government announced last week that consumers making payments through the digital route for purchase of petrol or diesel will be offered 0.75% discount from OMCs. Two, higher crude oil prices.
On Tuesday, a Mint report said the burden of discounts will be borne by OMCs, citing two executives. Some things are not clear though. For instance, what is the timeframe for which the discounts will be offered? Will the government compensate the OMCs for damages they incur due to the discounts?
If retail price discounts last for the entire duration of financial year 2018, IOC/BPCL/HPCL earnings per share will be hurt by 11/10/18% respectively (if 100% of transactions are converted to digital payments), pointed out Credit Suisse Securities (India) Pvt Ltd in a report on 8 December. “If effective for the whole of FY18, this scheme can hurt OMC Ebitda by a combined Rs5,400 crore (profits by Rs3,700 crore),” said Credit Suisse.
Ebitda is earnings before interest, tax, depreciation and amortization.
It will be interesting to watch whether volumes will increase for OMCs considering private firms are expected to see some market share loss due to this move.
The second factor causing concern is strengthening crude prices. Investors worry higher crude prices will increase the “fuel and loss” component for OMCs, point out analysts. Fuel and loss refers to the cost that refineries incur due to the fuel consumed to run the refineries and the fuel lost in the system while processing crude oil into petroleum products. Additionally, working capital requirements tend to increase, which will mean higher interest burden.
The Organization of the Petroleum Exporting Countries (Opec) announced a production cut on 30 November. On 10 December, non-Opec countries too agreed to cut production. These moves are expected to bring forward the balancing of oil markets and this has led to a rally in crude price recently.
From a longer term perspective, investors have little to complain. The OMC stocks have outperformed the benchmark Sensex since the beginning of this financial year. The shares trade at about 9-11.6 times estimated earnings for FY17. Valuations aren’t threatening. Earnings will surprise positively even now, says an analyst. But given the sharp outperformance in stocks and the concerns mentioned above, meaningful upsides from these levels could well be limited in the near-future.