OMCs to see inventory gains; GAIL derating likely: Antique

Anuj: A word on the subsidy bombshell that the government had in store for both ONGC and Oil India. Market had a bit of fear that something like that would happen but do you think market is a bit sanguine about this considering that in FY16 maybe there would be new formula or you think it is time to actually sell these stocks - both ONGC and Oil India?

A: If we look at the stocks and the bombshell which the government has put on these companies, a clear message is that despite reduction in the under recoveries, companies like ONGC and Oil India are not going to benefit. So, we have to see whether the government is going to provide clarity to investors. Minority shareholders particularly are at the receiving end for these companies as they have been getting shocks every quarter because this quarter we had seen the lowest under-recovery of Rs 160 billion. Despite that upstream companies had the highest sharing of 68 percent and net realisation of these companies were at the lowest of USD 35-38 which was quite shocking for the investors and investors want a sustainable sharing mechanism so that they can take a call on the earning of these companies which are not being provided by the government.

There is no clarity whether in FY16 the ad-hoc mechanism will be continued or government will provide a sharing clarity. So till that time investor should stay away from these stocks and probably Oil India is still relatively safer bet as compared to earnings and multiples. However, ONGC because of its oil exposure in the form of Cairn India and ONGC Videsh Ltd (OVL) is likely to take a earnings hit in the year to come as oil prices are averaging USD 60. So we see that it is trading at around 12x multiple to next year earnings and that is slightly expensive related to its historical multiples. So we will suggest that investor should move from, if they want to take a bet on PSU upstream they should move to Oil India rather than ONGC. However, till the time clarity comes it is beneficial to stay away from these stocks.

Ekta: How did you read the numbers of BPCL, HPCL and Indian Oil Corporation (IOC) and now that we are seeing Brent crude prices tick higher how would it change your numbers that we could see in Q4 versus Q3?

A: When we look at oil marketing companies (OMCs) they have been an interesting play on the market side of the business as well as on the refining side of the business. Last one year we have seen markets have been remaining focused on the marketing side. However, inventory at the refining side and the marketing side was quite a bit of concern. So this year last two quarter we have seen these companies together reporting a loss of almost Rs 150 -180 billion in terms of inventory losses as they corrected their inventory levels to the realigned to the crude level of around USD 40-50 per barrel.

Now oil prices going up or moved up to USD 60 per barrel the inventory losses are a thing of past so Q3 earnings we have seen is likely the bottom of these companies. From Q4 onwards the refining margins are likely to recover; there won’t be any inventory losses going forward or in fact there will be inventory gains. Marketing earnings are quite robust for these companies because they have been able to take the price hikes at the adequate time. So, this time also on the 15th they have also increased the prices of petrol and diesel to sustain their marketing margins on these two regulated commodities.

So when we look at these two factors together next year we are going to see a significant jump in the earnings for companies like HPCL, BPCL and IOC largely driven by improved refining margins, sustainable marketing margins at the regulated products and sustainable inventory gains and stable rupee. When we put all these factors into consideration we have a buy on BPCL with a target price of Rs 1,000, HPCL with a target price of Rs 880 and IOC with a target price of Rs 475. This leaves almost 30-50 percent upside from the current levels due to recovery in the earnings.

Anuj: You were among the first to downgrade GAIL and that call has played out well. After the kind of underperformance we have seen do you think GAIL is still overvalued or do you think if it is taken out of subsidy net may be that could lead to a bit of minor re-rating? How would you be positioned on this one now?

A: As I said initially that government has not given any clarity on sharing mechanism so this quarter can be just an aberration where GAIL has been taken out of the sharing mechanism and whenever the earnings recover for GAIL, GAIL might be put back to the sharing mechanism again. We are not going to take a big call on the stock as of now but looking at fundamentals we continue to see that petrochemical prices are still declining, LPG prices are still at the lower end so these two commodities or these two segments constitute roughly 65 percent of the profitability of the company which is still under pressure. So we are going to see further de-rating in the stock from current levels.

Whatever positive is there that is just because of for the third quarter GAIL has been taken out of the sharing mechanism. However, we are not seeing any sustainable recovery in the two segments which are determining 65 percent of the profit of the company. Going forward as we have highlighted for Petronet LNG as well GAIL is having long-term contracted LNG from Petronet which is coming at the highest price of USD 13.50 -14 versus spot LNG prices of USD 7-8.

So they are facing a lot of challenge on that front that how to accommodate the higher price gas with the consumers. So last quarter also we have seen around Rs 95 crore loss in the marketing segment which might continue in the fourth quarter as well. So when we estimate earnings are likely to remain much weaker for GAIL in the fourth quarter and the years to come. Unless we see oil prices recovering back to USD 80-90 per barrel.

Ekta: Can you tell us about your call on Cairn India in a rising Brent crude scenario or what are you envisaging in terms of Brent Crude prices as well and your call on Reliance?

A: We have Brent price assumption of USD 60 for FY16 and USD 70 for FY17. If we see oil prices are near to that levels around USD 60 but if we look at the sustainability of oil prices at these levels look difficult looking at the global supplies. US supplies are still rising and in the summers we are going to see more supplies coming from US Shale Gas and hence oil prices are likely to remain under pressure between USD 50-60.

So now when we priced in USD 60-70 for Cairn India we get a target price of Rs 195 based on the assumption that they are going to cut back on the capex going forward which is going to challenge the production recovery or production growth from the current levels. For exploration & production (E&P) company’s two factors as we have said earlier are the most important one is the volume growth and the pricing. So both of them are under pressure and are likely to remain under pressure for next one and a half year to two years and hence we have a sell rating on the stock with a target price of Rs 195.

Coming to Reliance, we have a buy rating as I said that refining margins are recovering for the sector. Reliance’s 60-65 percent of the earnings is still derived from the refining segment. So in the quarter to come we are going to see an improved earning outlook for the company. We are going to see fourth quarter GRMs improving to between USD 9-10 in the coming quarter and hence we have a buy on the stock with a target price of Rs 1,045.

Disclosure: Network 18, which publishes moneycontrol.com, is now part of the Reliance Group.