We expect OMCs to benefit from (i) the recent improvement in auto fuel marketing margins amid range-bound crude oil prices; (ii) gradual recovery in benchmark refining margins driven by anticipated recovery in global demand; and (iii) a rebound in domestic petroleum consumption post the second Covid wave. We find the valuations inexpensive for HPCL and IOCL at around 5X EV/Ebitda and BPCL’s at 6.2X EV/Ebitda reflecting a modest premium for privatisation.
Auto fuel margins up in recent months
Our calculations suggest that auto fuel marketing margins improved in the recent months amid a moderation in crude prices with OMCs reducing retail prices at a modest pace. Our estimate of diesel marketing margins increased to Rs 5.5/litre in August 2021 and further to Rs 6.6/litre currently from Rs 2.5/litre in April 2021. Current marketing margins reflect Dated Brent crude price of ~$70/bbl; if crude prices do rise back to their recent peak of ~$78/bbl, OMCs may still be able to maintain diesel marketing margins at above normative levels of Rs 3.1/litre without raising retail prices. Petrol marketing margins also increased to Rs 4.7/litre currently from Rs 2.3-2.5/litre in the recent months.
Refining margins improve in the recent months
Regional refining margins have improved in Q2FYTD22, moving gradually towards historical cyclical trough levels of $3-4/bbl from distressed levels earlier amid pandemic-impacted demand. Kotak Indian margin increased to $2.4/bbl in the current quarter to date, versus an average of $1.8/bbl in the previous quarter, underpinned by anticipated robust recovery in global demand. We expect margins to improve further due to large-scale permanent shutdowns announced by several refiners, which may ease the supply situation in the next 12 months.
Encouraging recovery in domestic petroleum demand in July 2021
Domestic petroleum demand exhibited encouraging signs of recovery in July 2021. Petroleum consumption for July 2021 was up 8% y-o-y and a modest 5% lower in comparison to July 2019 levels, with diesel demand remaining 10% lower, while gasoline demand was up 4% from pre-Covid level. We expect the demand environment to improve further in the coming months.
Valuations remain reasonable
We find valuations for HPCL and IOCL inexpensive around 5X EV/Ebitda based on reasonable assumptions on recurring refining and marketing margins; BPCL’s valuation also remains reasonable, ex-dividends, at 6.2X Ebitda reflecting a slight premium for privatisation. Any weakness in these stocks may be seen as a buying opportunity, as sustained increase in margins and volumes may drive an improvement in the underlying earnings trajectory in the near term.