Oil&Gas: Big step towards small hikes, follow-up crucial
Emkay Global Financial Services has come out with its report on Oil and Gas sector. According to the research firm, amongst OMCs HPCL is likely to outperform in wake of diesel price hikes given its marketing heavy portfolio relative to refining.
January 18, 2013 / 19:01 IST
Emkay Global Financial Services has come out with its report on Oil and Gas sector. According to the research firm, amongst OMCs HPCL is likely to outperform in wake of diesel price hikes given its marketing heavy portfolio relative to refining. Emkay believes BPCL is a safer bet given the cushion it has from its upstream valuations.
"Oil marketing companies (OMCs) allowed to increase diesel prices by 50 paise/litre per month. Govt increases LPG cylinder cap from 6 to 9. Net annual savings of Rs228bn from diesel price hikes, free pricing for bulk sales and rise in LPG cylinder cap. Although we like ONGC/Oil India, we believe amongst these ONGC is the best play on pricing reforms given its size and consolidated production growth by FY15. Within OMCs HPCL more leveraged to pricing reforms, though believe BPCL a safer bet given cushion from upstream valuations.On the diesel price hike, assuming price hikes by 50 paise/litre per month for next one year the under-recovery on diesel would decline by about Rs203bn in the first year. Govt has also decided to increase cap on LPG cylinders from 6 to 9 resulting in additional burden of Rs105bn, while deciding not to increase prices for LPG/Kerosene. There have also been reports of free market pricing to bulk consumers of diesel which form about 18% of the total diesel demand. We estimate under recoveries on diesel to decrease by Rs130bn on account of this. These three measures would result in net savings in underrecoveries of Rs228bn.Based on subsidy sharing of 40% for upstream companies, ONGC/Oil India would benefit to the extent of Rs75/Rs11bn. Any such move if followed up by regular changes in diesel prices would be positive for OMCs. By reducing the difference between domestic and international prices the mismatch in cash flow for OMCs would be reduced, helping them in saving interest cost on short term borrowings that they have to resort to take care of their working capital requirement.We believe upstream companies are best play on the pricing reforms given the potential in earnings growth from their core business. Amongst upstream companies we prefer ONGC given its size relative to Oil India and the likely increase in its consolidated production 61.1mtoe in FY12 to 71.3mtoe in FY15 a CAGR of 5.3% as against a flat production in last 3 years. Expect OVL production to grow at 12% CAGR over FY12-15 to 12.3mtoe (excluding Kashaghan). Based on potential re-rating, ONGC/Oil India has upside of 40%/32% (Refer Exhibit - 2 below).The last time markets were hopeful of pricing reforms were in mid-2010 when government decided to deregulate prices of petrol and diesel. Chart below show that BPCL/HPCL/IOCL saw their P/B increase to 1.7x/1.3x/1.7x. For the last 5 years, BPCL/HPCL/IOCL have traded at an average P/B of 1.2x/0.9x/1.1x. Based on potential rerating, we see an upside of 37%/75%/77% for BPCL/HPCL/IOCL (Refer Exhibit 1). While valuing OMCs on P/B basis we have looked at what P/B OMCs have quoted at the time of increased hope of pricing deregulation in 2010. Amongst OMCs HPCL is likely to outperform in wake of diesel price hikes given its marketing heavy portfolio relative to refining, however we believe BPCL is a safer bet given the cushion it has from its upstream valuations," says Emkay Global Financial Services research report.Bodies Corporate holding more than 50% in Indian cos Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.To read the full report click on the attachment 
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