See further cut in LPG subsidy; bullish on IOC, BPCL: Quant

A: This is mostly factored in the valuations of BPCL, HPCL and IOC but definitely there is a visibility on the earnings that will further help the re-rating of these stocks.

We observed in the past four or five years that diesel constitutes around 50 percent of the overall gross under-recoveries of the oil marketing companies (OMCs). So, when we are talking about Rs 1,00,000-1,40,000 crore that level should get halved. So, just LPG and kerosene remain in the system and that is the key benefit that we see.

We expect the reforms in terms of LPG subsidies and direct tax subsidy or these type of things, which if they come, we expect reduction in the LPG subsidy as well. Growth in the CGD sector, which appears to be the first priority, will also help cap the LPG growth. So, that also is a factor that we have to look when we try to see growth upside from the OMCs.

Q: With 18 percent rise in BPCL and HPCL with all the gains factored in, we had someone from Moody’s tell us that these oil companies if they don’t have to have diesel under-recoveries will borrow Rs 15,000 crore less and that means at an interest rate of 10 percent they get Rs 1500 crore going to the bottomline of which half would go to IOC. So, is that much gains in the P&L factored in, what is your EPS of these three companies and your price targets – IOC, BPCL, HPCL?

A: When you see their results in the first quarter, clear observations are that their interest expense has declined sharply on year-on-year (YoY) basis from 38 percent to 73 percent of the three oil marketing companies. So, the decline in under-recoveries and there are subsequently less borrowings and due to delay in the government payment already reflected in their earnings and that is the benefit they have.

In terms of price target I expect around Rs 540-550 in the medium-term for HPCL. For IOC, I expect around Rs 430-435 somewhere and for BPCL I expect around Rs 700. However, there also, if we get more clarity on LPG side then there will be further earnings upside of around 10-20 percent for these OMCs.

ONGC and Oil India have not run up just like OMCs, primary reason is that when we see first quarter numbers they do not have relief in terms of upstream subsidy. They are paying at rate similar to the previous year and that is the key reason.

However, now if we see that overall gross under-recoveries in FY16 at around Rs 70,000-80,000 crore versus pervious FY14 level at around Rs 1,40,000 crore, they will also get the benefit in terms of decline in losses by next year. So, their realisation is also expected to improve by around USD 55-60 versus previous years USD 45-50.

Q: You told us about the interest cost for OMCs but have you done any calculation on how much the marketing margins could improve for some of these companies?

A: There is no change in the marketing margins as such because they are passing on actually. So, when we calculate the under-recoveries they already have charged around Rs 1-2 per litre marketing margins and then that shortfall should be paid by the government and upstream at the end of the year.