PL Sector Report: Oil & Gas - Sector Update – OMCs - richly valued

Oil & Gas - Swarnendu Bhushan - Co-Head of Research, Prabhudas Lilladher Pvt Ltd.

Sector Update – OMCs - richly valued

Quick Pointers:

• Gross marketing margins have risen in Q3TD, however any spike in benchmark prices may impact these margins.
• Singapore GRM at US$4.5/bbl in Q3TD.

Oil marketing companies like Indian Oil Corporation (IOCL), Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) are likely to witness a strong Q3 performance on back of improvement in gross marketing margins on petrol and diesel. Singapore GRM for Q3TD stands at US$4.5/bbl, while gross marketing margins (GMMs) on petrol and diesel are at Rs8.2/(-0.6)/ltr. IOCL/BPCL/HPCL have historically traded at long term P/BV of 1/1.3/0.8x respectively (we exclude the period between 2014-18, during which the OMCs enjoyed higher valuations due to twin benefits of deregulation and benign oil prices) and are currently trading at 0.9/1.3/1.1x FY24 P/BV. We downgrade our rating from ‘HOLD’ to ‘REDUCE’ on IOCL with a TP of Rs94 based on 0.7x FY26 P/BV. We downgrade our rating on BPCL from ‘HOLD’ to ‘REDUCE’ with TP of Rs365 based on 1xFY26 P/BV. Similarly, on HPCL we downgrade our rating from ‘HOLD’ to ‘SELL’ with a TP of Rs272 based on 0.7x FY26 P/BV.

GRMs soften in Q3-TD: Average petrol cracks which were at US$13.5/bbl in Q2 softened to US$4/bbl in October but have risen to US$8.2/bbl in November. On the other hand, diesel cracks which were at an average of US$26.6/bbl in Q2 fell to US$22.8/bbl in October and US$19.8/bbl in November. This led to softening of Singapore GRM from US$9.6/bbl in Q2 to US$3.8/bbl in October and US$5.3/bbl in November. Over a longer period, we expect Singapore GRM to stabilize at US$6/bbl and OMCs also to broadly report in line with the same.

Gross marketing margins moderate: Average gross GMMs on petrol and diesel in Q2 were Rs7.6/1/ltr. Gross margins on diesel which were negative in Aug-Oct turned positive in November. GMM on petrol stands at Rs8.2/ltr in Q3-TD while there is a gross marketing loss of Rs 0.6/ltr on diesel. In the week ended 28th November, GMMs on petrol diesel stood at Rs9.7/4.7/ltr. However, sustainability of higher-than-normalized GMMs is questionable in light of the upcoming elections.

Valuations stretched: IOCL has historically traded at an average P/BV of 1x and is currently trading at 0.9x. The company has been generating free cash flows and is hence trading at a higher valuation. BPCL has historically traded at a higher P/BV due to investments across its upstream segment. We assign ~25% discount to its long term P/BV of 1.3x on account of no significant development in its E&P assets. HPCL’s long term average P/BV stands at 0.8x and is currently trading at 1.1x. HPCL has been reporting lower GRMs than the other two companies since FY22 due to ongoing expansion/upgradation at Vizag. We expect this to continue for another 1-1.5years till Vizag refinery stabilizes. We expect its net debt to rise from Rs664bn in FY23 to Rs694bn in FY26E due to ongoing projects.