OMC earnings now largely normalized; valuations yet to catch up
- OMC’s financial performance has been largely normalized (RoE’s now at 18- 24%) post the diesel deregulation, led by pricing freedom and strengthening of balance sheet. However, valuation multiples have not seen a commensurate improvement, in our view.
- Confidence on deregulation was a valid skepticism of investors a year back, given the lack of evidence of deregulation. Some delays in the fortnightly price changes and marginal subsidy burden in 3QFY16 further created concern.
- However, now with the full pass through (despite large excise hike) of international prices / exchange rate over the last 18 months, we believe investor concerns stand addressed. Further, LPG DBTL and also likely in kerosene (already rolled out in 33 districts), will make subsidy issue irrelevant soon. Consumption growth strong; OMCs unparalleled network well placed
- India clocked eight year high petroleum consumption growth of 11% in FY16.
- This was led by gasoline (+15% YoY), naphtha (+23% YoY) and well supported by 8% growth in diesel (41% share in total petroleum product consumption). We expect, higher GDP growth to drive auto fuel volumes and in turn benefit OMCs. Multiple levers at play; capacity expansion, marketing margins to drive earnings
- OMC’s earnings have multiple levers in our view and would play out in the nearmedium term: (a) Brownfield capacity additions – economics and execution better than greenfield; (b) Complexity improvement – GRM boost; (c) Crude sourcing freedom – USD1/bbl GRM boost increases EPS by 8-12%; (d) Petroleum product pricing freedom – auto fuel marketing margins to improve and (d) Nonfuel retail opportunity.
- There remains value unlocking potential from (a) IPO for JV refineries in HPCL (9mmt Bhatinda) and BPCL (6mmt Bina) and (b) oil price revival could add significant value to BPCL’s E&P portfolio.
- We estimate earnings CAGR of 16%/20%/54% in FY15-FY18E with average RoE’s of 19%/25%/14% for HPCL/BPCL/IOCL respectively.
Valuation and view
- We believe that current valuations do not reflect multiple levers of sustained earnings growth and higher return ratios for OMCs.
- Dividend yield is attractive at 3.5-4.5% for OMCs. Reiterate Buy.
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