See more upside in HPCL, BPCL; buy Cairn on dips: Religare

What needs to be seen is that whether in the coming quarters, government basically reduces their subsidy or abolishes that completely in the coming quarters because with the crude oil prices declining the way they are declining the average for this year would not be more than USD 90 per barrel. So in that scenario, the old formula of USD 56 per barrel cannot be continued. It needs to be brought down. So either the subsidy burden needs to come down in the coming quarter or it needs to go away completely so that ONGC is able to make a decent realisation.

Now at Rs 380, ONGC is building in a certain improvement in its net realisation. Over and above USD 40 per barrel that they earned in FY14. So the bet now becomes that whether one foresees that improvement happening or not.

Ekta: What are you going with?

A: My sense is that in Q3 and Q4, subsidy burden on ONGC and Oil India should come down. On an average for the year the subsidy that has put on them should not be more than USD 30-35 per barrel giving them a net realisation of about USD 55-60 per barrel for this year but that remains to be seen.I haven’t changed my earnings estimates as yet. 

For the entire year, even if the crude oil prices remain where they are from nowon, we are going to look at an average gross price of about USD 90 per barrel. So there is still scope of a reduced subsidy on them and then a higher net realisation but the caveat that I would want to put over is that remains to be seen. That is basically government to act upon.

Ekta: Is the cut of 25 percent plus in Cairn since June 2014 lucrative enough for you to possibly suggest buying the stock on just good and cheap valuations?

A: Cairn is pricing in the current weakness in crude oil prices and its fortunes are directly correlated with the crude oil prices. So if the view is that like crude oil prices are going to recover from hereon, Cairn is definitely positioned very well for taking long positions. But a broader sense is that the weakness in crude oil prices could persist for some more time like even as we move into first half of next financial year or next calendar year, the weakness in crude oil prices could persist. So my sense is that one would be better positioned in the refining and the downstream stocks as of now in the near-term rather than in the upstream stocks.

Anuj: In terms of your pecking order for oil marketing companies (OMCs), how would you put them because they are clearly making profit on both diesel and petrol now and even under-recovery on liquefied petroleum gas (LPG) and kerosene is coming down but Bharat Petroleum Corporation Ltd (BPCL) also has this upstream angle, so what is your pecking order among the three large ones?

A: I would prefer Hindustan Petroleum Corporation Ltd (HPCL) because valuation wise HPCL is still at a significant discount to BPCL. So if one looks at BPCL, the stock is trading at about 1.9 to 2 times one year forward earnings whereas HPCL would be at a significant discount about 0.9 to 1 times. Now, one definitely needs to take into picture the upstream investment that BPCL has but even like adjusted for that BPCL is at a significantly expensive valuation as compared HPCL. So there could be some amount of valuation catch up that can happen in case of HPCL. Other than that business wise BPCL is definitely a better business to own. That said the valuation gap like does make HPCL more attractive as compared to BPCL as of now.

I feel that even HPCL can have about 10-15 percent upside from hereon as well. I feel that even Reliance is very well placed because refining margins if you see are recovering with the decline in crude oil prices. So my sense is that as we move into winter months, the product prices could remain firm whereas if the weakness in crude oil prices persists, we could see better refining margins vis-à-vis Q2 and Q3 and Q4 could have better margins as compared to Q1 and Q2. So that would be earning accretive for Reliance Industries as well which looks like attractively positioned and valued as well.

Ekta: Just on that point with regards to Reliance, it might be a more larger question and might not impact them in this year but what about the shale gas business? Do you think it will become uncompetitive simply because the Organisation of Petroleum Exporting Countries (OPEC) is now focusing on higher competition and more focused towards shale gas?

A: It is not such a simple question in the first place that if crude oil prices decline in a near-term to medium-term then shale could go out of business because even different shale assets and shale in different regions have different breakeven prices. So my sense is that only 4 percent of shale’s production comes at a breakeven of about USD 80 per barrel whereas there are significant amount of production, which can be profitable even at USD 42 per barrel to USD 28 per barrel. I am talking about in terms of production cost and some reasonable margins. So significant amount of shale is profitable between USD 28 per barrel and USD 42 per barrel as well.

So it looks difficult at a near-term blip in crude oil prices, would put these assets out of production because these are rather longer-term investment decisions that are made. What it could do is that any further investments could either be delayed or postponed. So the supply growth usually gets affected in a rather longer time period than in a shorter time period and the expectation that OPEC might have a shorter-term supply would actually prop-up the prices because US shale assets would cut down on production or go out of production is slightly far fetched. OPEC understands that supporting the price through production cuts is not that easy that is why they have also decided to play the market share game rather than a price increase game through a quota cut.

Disclosures:

Nitin Tiwari doesnt have any positions in the stocks discussed but his clients could have positions in those stocks.