SENSEX NIFTY
Aug 22, 2013, 01.43 PM IST | Source: CNBC-TV18

Diesel price hike of Rs 3/L likely; buy OMCs: Macquarie

Speaking to CNBC-TV18, Jal Irani, managing director-oil & gas research, Macquarie adds that the steep correction seen in the Indian currency has made a fuel hike a desperate need of the hour.

Jal Irani

Senior vice-president - wholesale capital markets

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Adding to the chorus of a possible diesel price hike, Jal Irani, managing director-oil & gas research, Macquarie says the government is likely to hike prices by Rs 2-3 per litre.

Speaking to CNBC-TV18, Irani adds that the steep correction seen in the Indian currency has made a fuel hike a desperate need of the hour.

Also read: Is rupee 'out of control'?

"With the rupee depreciating so sharply within such a short period of time, there is certainly a significant need for the same. I would be surprised if there is Rs 5-7 hike. This is the first time I have heard of it and it’s falsely going to build-up expectations. I think the more likely scenario is Rs 2-3 per litre, which will be adequate to sentimentally swing around these stocks," Irani says.

Irani further adds that investors should now be looking at oil marketing companies (OMCs). He believes the volatile stocks that are down right now, pose very good buying opportunity.

Below is the edited transcript of Irani’s interview to CNBC-TV18.

Q: What are you expecting in terms of the diesel price hike? How much could it be? Do you think it could be Rs 5-7 per litre or less than that?

A: The diesel price hike seems to be a fairly high possibility. It has already been proposed by the petroleum minister. However, last year, same time in September there was a 5 percent hike. So, in terms of any inflationary base effect, it has effectively been taken care of.

With the rupee depreciating so sharply within such a short period of time, there is certainly a significant need for the same. I would be surprised if there is Rs 5-7 hike. This is the first time I have heard of it and it’s falsely going to build-up expectations.

No such number has ever been heard of. I think the more likely scenario is Rs 2-3 per litre, which will be adequate to sentimentally swing around these stocks given that in addition to this, the 50 paise per litre hike every month has now been firmly put in place.

Hence, effectively, for the whole year maybe about Rs 9 per litre hike in diesel price could happen. We had, so far 25 percent hike year-on-year, which is unprecedented in the past and I would think realistically a Rs 2-3 per litre price hike looks fairly likely.

Q: How do you then approach some of these oil marketing companies if there is one time diesel price hike that may be in store or do you think this is a good time to be putting in money?

A: It is an extremely good time to be putting money into these stocks. We are highly recommending the same. These stocks have fallen roughly about 40 percent within three months which is a significant drop. These stocks tend to be very volatile and these are the opportunities when one can make a lot of money on these stocks when they fall like this.

If we take a step back, year-to-date, the government has been reforming the sector significantly which has partially gone unnoticed by the market. However, in my opinion the government doesn’t need to do a lot more. It just has to reverse the current negative sentiment. They need this price hike and that will be adequate to revive the stock prices.

If one looks at these stocks from value perspective, they are ridiculously cheap and if you strip out the value of the investments of these companies, for example Bharat Petroleum Corporation ( BPCL ) USD 2.5 billion overseas upstream investments, it is completely free. BPCL which is our top pick as the overseas upstream investments, the oil and gas investments, are dollar based business. So, the rupee depreciation benefits BPCL in a very significant way and on the contrary, the stock should have been going up. So, undoubtedly we are pushing these stocks harder and BPCL is our top pick.

Q: I was more worried about Oil and Natural Gas Corporation (ONGC) - from July to now in seven weeks or less, in 5 weeks it is a fall of 30 percent in that stock?

A: Similar to the oil marketing companies (OMCs). The market is actually assuming the worst for ONGC as well. Let’s not forget that in ONGC’s case, rupee depreciation actually benefits it, its realisation actually increases in rupee terms and then that gets taken away perhaps fully by the subsidy burden increase. So actually, it shouldn’t be net-net hurt materially and the first quarter results of any of these companies don’t really matter as the fourth quarter in which balancing act happens. More importantly, the government has instituted a doubling in gas prices which will benefit ONGC.

If one looks at the last gas price increase, about three years back, subsequently the company’s profits were allowed to be increased by 20 percent. While the government may take away part of the upside from the gas price increase as well, net-net it will benefit in any case.

If the government didn’t intent allowing ONGC to benefit on a net basis, why would it increase gas price. The main reason why the government has allowed a gas price increase is to enhance India’s oil and gas production basically. The very purpose would be beaten and therefore I think not just from a near-term but into the next year as well ONGC is looking quite good.

Q: Your point is taken that gas prices were raised for certain intent but the governments intent with respect to oil marketing companies and ONGC is not that above board. They have made it plainly clear that the benefits of raising diesel prices will go to the government and the subsidy burden will not change if anything after depreciation there is a real and persistent fear that the subsidy burden in fact could increase for the oil marketing companies. I would assume that the 30 percent fall in ONGC was reflecting that fear. When you recommend a buy on ONGC have you discounted that even the gas price advantageous could be absorbed by this hungry fisc?

A: The market is assuming the worst so if one looks at OMC valuation, the market is actually pricing it in. A price earning ratio (PER) of 4 times or less is actually pricing in a 20 percent per annum fall in earnings effectively bankruptcy very fast.

Can any one of these companies be bankrupt? These companies control 99 percent of the gas stations in the country, petrol pumps in the country. If one drags them to bankruptcy one is going to have economic chaos. So, that is not an option. Market is assuming actually the worst, the market is assuming effectively bankruptcy but that is an impossible situation, so the worst in my opinion is that the earnings of these companies are going to be largely flat which still suggest that they should be on a PER of about 7 times and one is still going to have a 50-60 percent growth in stock prices, is what I would think.

Q: I also want your view on Cairn that one also like ONGC has got an advantage in terms of the rupee depreciation and higher crude prices as well any price targets there. Is that in your buy list?

A: We got a price target of closer to Rs 324 a share. Cairn is relatively a very pure oil play perhaps Asia’s purest oil play and most leverage to both oil prices and the currency depreciating. That is quite straight forward.

More importantly, it has been allowed to explore in the extremely prolific Rajasthan- Barmer region and it is adding two rigs every quarter, so that is actually far more important and far more significant especially in the longer term. Indeed Cairn India is a good company.

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