Oil Companies At 'Trough Valuations' As Price-Hike Freeze Fuels Losses, Says Emkay

Valuations of India's oil marketing companies Bharat Petroleum Corp., Indian Oil Corp. and Hindustan Petroleum Corp. are at "trough levels" as they continue to face losses owing to a freeze in price hikes amid soaring Brent crude oil price, according to Emkay Research.

"With Brent at $110 a barrel and refining cracks at $40-60 a barrel, consolidated integrated auto-fuel margins are currently hovering at negative Rs 2-3 a litre versus the normative run rate of Rs 8-9 a litre," the research firm said.

The prices of petrol and diesel have not been increased since April 6. Before that, prices were hiked by 80 paise around 14 times, consecutively.

This continuing price freeze without any indication is worrying, Emkay said as it has led to a rise in under-recoveries for OMCs in the first quarter of FY23.

However, looking at past instances and the magnitude of current losses, the research firm expects the government to offer some solution in the form of a resumption of price hikes and/or subsidies.

"Windfall taxes have been reported by the media earlier, though the mechanism for the same and UK-type capex-based incentives would require careful deliberations," Emkay said. "Our checks with PSU refiners as well as experts indicate incremental Russian crude purchases, which, however, are not big enough currently to visibly offset under-recoveries."

Emaky said though G2G discussions may be underway, but any positive results are difficult to ascertain.

The government, to ease the pressure on the public, reduced excise duty on petrol and diesel on May 21 by Rs 8 and Rs 6 per litre, respectively.

The research firm estimates adjusted under-recoveries of Rs 14,100 crore in auto-fuel and Rs 12,500 crore in LPG, based on accounting margins. This has led to an overhang on OMCs and upstream stocks as funding clarity is yet to emerge. "The current under-recovery run rate indicates an annualised hit of Rs 2 lakh crore (including LPG) and hence price hikes are essential unless government rolls back the deregulation itself," it said.

Despite these losses, the research firm maintains 'buy' and remains optimistic on the three OMC stocks owing to "trough-level attractive" valuations. Any cool-off in oil prices to a reasonable level would also be beneficial to the entire sector and act as a "positive trigger" for a "sizeable" rerating, it said.

The research firm is also positive on upstream firms such as Oil India Ltd. and ONGC Ltd., despite concerns over outsized subsidy burden.

"Our calculation shows even a 50% upstream subsidy burdens in first quarter could still entail almost $70 per barrel net realisation for ONGC and Oil India," it said. "Consequently, annualised EPS of Rs 24 per share for ONGC implies near-trough valuation. Here also at under 5x adjusted PE. Similar is the case with Oil India too."

Shares of the oil companies were mixed, with only Oil India and Indian Oil trading in the green.