Near-term upsides priced into OMC stocks

Oil marketing companies, IOCL and BPCL posted better-thanexpected earnings in the third quarter of financial year 2023-24 (Q3FY24) due to a big upside in refining margins and also gains in marketing inventory as crude prices surged. Gross refining margins (GRM) of BPCL and IOCL came in at $13.4 and $13.5 per barrel (bbl) respectively at a premium of $8-plus to Singapore complex GRM of $5.4/bbl.

Overall, IOCL and BPCL reported net profit of ~8,063 crore and ~3,397 crore respectively, well ahead of Q3FY23 profit after tax (PAT) of ~448 crore and ~1,960 crore respectively. There was a quarter-on-quarter (Q-O-Q) decline in earnings due to a higher base in Q2FY24. HPCL disappointed the Street on the operational front due to lower-thanexpected marketing margin of ~2.7 per litre as against estimates of ~3.4 a litre led by suppressed margins on diesel.

The fuel-price freeze for petrol pumps continues with crude range-bound between $8085/barrel, while refining spreads are steady. In FY25, there could be a deep cut to earnings year-onyear (Y-O-Y), assuming a cool-off in refining spreads and normalisation of marketing margins. OMCS’ GRM may settle down due to normalisation of diesel crack rates and thinner Russian crude oil discounts. The outlook for refiners remains upbeat for Q4FY24 with GRMS remaining ahead of Singapore at $8 per barrel in Q4FY24 till date.

Media reports have indicated lower Russian discounts, however Middle East spreads have fallen by $1.5 per barrel Q-O-Q. IOCL reported surprise inventory gains during Q3FY24 and BPCL’S numbers probably include inventory gains as well. Hence, inventory gains in Q4FY24 will not be very significant. The gross marketing margin in petrol and diesel averaged at ~9.2/litre (for petrol) and ~4.6/ litre (for diesel) in Q4FY24 till mid-feb. If this trend holds, Q4FY24E could average better sequentially over Q3FY24. This means that sequentially, Q4FY24 reported numbers could be better and closer to the Q2FY24 rate.

Brent oil (Feb 2024 to date) is down 4.3 per cent month-onmonth (M-O-M) and 1.4 per cent Y-O-Y. The retail margin is marginally positive. There is little apparent risk of a sharp rise in crude prices despite Red Sea issues, since Opec+ surplus capacity is around 5 million barrels/day. However, there could be an uptick if the Houthi situation escalates. Oil marketing companies (OMCS) have partly recouped auto fuel losses of FY23, and a price cut in Q1FY25 is likely, given elections, if Q4FY24 is strong. OMC stocks will fall if there is such an action and it will also adversely affect CNG volume growth. This could be an entry point with a medium-term perspective.

The other possible overhang is the ongoing aggressive capex plans which may not really create much long-term value for shareholders. OMCS’ valuations are assessed to be trading at 25-50 per cent premium to historical valuations. Every $1/bbl change in GRM has an impact of 10 per cent (or roughly ~5,000 crore) on IOCL FY25 consolidated operating profit and 9.7 per cent (or ~2,500 crore) on BPCL’S FY25 consolidated Ebitda. In IOCL, analysts have 15 ‘buy’ calls and 10 ‘sell’ calls with 9 ‘holds’.

In BPCL, there are 22 ‘buys’ and 8 ‘sell’ recommendations. For HPCL, 50 per cent of analysts have a ‘buy’ rating while a third of them have a ‘sell’ rating. However, many of the target prices are below the current market price, which suggests that valuations are expensive.