Falling Brent or reform hope? Buyers take fancy to oil PSUs

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Moneycontrol Bureau

Fall in global Brent prices has come in much earlier than much-anticipated big-bang oil reforms by team Modi and this may be enough a reason for market participants to bet their chips on this sector.

Brent crude oil prices fell below the psychological USD 100-a-barrel mark, a 17 month low, for the first time since June 2013 on ample supply pressure and a strong US dollar. Consequently, the Indian crude basket, which is used as an indicator of the price of crude imports in India, has also sunk below USD 100/barrel. With this, there is a likelihood of reduction in petrol prices by Re one a litre and first cut in diesel rates in seven years. Also, it may aid OMCs to report consecutive quarterly profits in the second half of FY15 and a reduced subsidy burden. 

While shares of oil marketing companies (OMCs) have been celebrating the decline in global oil price by soaring to new highs, brokerages are also growing bullish on the sector as a whole.

Macquarie has maintained its outperform rating on HPCL with an increased target of Rs 506 per share courtesy decline in crude price and expected gains from oil reforms. The stock has already seen a 20 percent rally from August till date. The brokerage is positive on HPCL’s ability to ramp up refining capacity and face private sector retail competition.

Refining margins at risk?

Allaying fears that further fall in Brent crude prices will steeply hurt global refining margins of OMCs, Dipen Sheth, Head-Institutional Research, HDFC Securities says that he continues to be upbeat on oil stocks as many of companies are slated to gain disproportionally from falling oil subsidies because it will improve their working capital cycle.

"Yes, some easing of refining margins is apparent. But these companies represent a play on represent a play on regulatory dynamic in the industry than fall in refining margins. I don't think refining margins will crack to a point where their refining business deliver zero or negative growth returns," he tells CNBC-TV18 in an interview.

Nitin Tiwari, Vice President-Institutional Research at Religare Capital Markets also explains that refining margins are more linked to how demand for the refined products pan out, so if crude oil prices decline, then the refined product prices also follow the trend. But margins are more of a function of how demand and supply is panning out. "I don’t see much of a downside in the refining margins because we still have a demand growth this year although sometime back IEA had cut down the demand forecast for 2014," he adds.

Oil and Natural Gas Corporation (ONGC) and GAIL are Religare's top bets. Among OMCs, while it likes both BPCL and HPCL, it prefers the latter. "BPCL definitely has better refining and E&P assets, but HPCL is looking attractive on valuation terms because BPCL has already run up a lot and on valuation front BPCL is looking fairly valued, whereas HPCL is still at a significant discount to BPCL. So there could be a valuation catch-up, which could happen," he adds. Tiwari also likes IGL.

The reform hope

Bank of America Merril Lynch is bullish on ONGC and OIL with a higher target price expecting more gains from oil reforms. It has upgraded ONGC to buy from neutral. ONGC is better off under equal subsidy sharing than under the Parikh formula, it adds. BoAML feels that equal sharing will ensure that the firm’s subsidy falls along with a fall in oil subsidy on diesel deregulation and cut in LPG-kerosene subsidy.

The brokerage also retains buying rating on Oil India. It has raised target price on OIL to Rs 777.

Meanwhile, Sheth adds that the reason for one to to gung-ho on this sector is because the government is getting its act right. "This is a multi-year story. There are has been a re-rating as many companies stocks have doubled and more in the last year, but I still fell there is tremendous upside from hereon," he says. 

But some like Kotak Institutional Equities feel that the party in oil and gas stocks is over for now. It sees limited upside in key state-owned oil and gas stocks from the current level. "We do not see meaningful scope for earnings upgrades unless the government allows higher net realization for the upstream companies for incentivizing indigenous production and enhancing India’s energy security," it says in a report. The research firm believes that earnings boost from reforms related to fuel pricing and subsidy-sharing mechanism is already in the price and has revised EPS estimates for these stocks.

(Posted by Harsha Jethmalani)