OMCs: Strong auto fuel margins offset volume drop, price hikes awaited as oil nears USD40/bbl
* With an uptick in oil prices, markets may be anticipating a hike in auto fuel prices by OMCs. We also observe that diesel/petrol gross marketing margins are down to ~Rs0.2/2.7/ltr and can now turn negative, with Brent prices nearing USD40/bbl.
* Nevertheless, against Rs100bn+ of normative quarterly auto fuel earnings, the AprilMay’20 run-rate was Rs130bn+ (despite a 43-46% yoy volume decline), implying a cover up to July, ceteris paribus. RSP hikes would be required beyond that though.
* We believe that OMCs would focus on marketing margins this year due to an uncertain GRM outlook amid volatility in oil prices and product demand. Inventory gains can support. OMCs have drawn Rs467bn capex for FY21 as per government estimates.
* We maintain our positive view on OMCs with Buy ratings, expecting a material earnings recovery in FY21-22. We have an OW stance on HPCL and EW on BPCL and IOCL. We will further reassess our estimates and TPs post upcoming Q4FY20 results.
Q1FY21 auto fuel outlook comfortable, inventory gains to support: Against ~Rs3/ltr of normative gross margins each in diesel/petrol, OMCs earned Rs14/18/ltr in April and Rs7/10/ltr in May after Rs13/10/ltr excise hikes. Despite a 57%/61% yoy decline in sales volume in April and 31%/37% in May, monthly auto-fuel gross earnings jumped from the Rs35bn normative rate to Rs65bn in the April-May period. Q1FY21 auto fuel earnings outlook, hence, is stable even after assuming zero margins for June. Reported earnings would also be supported by inventory gains as crude is up by ~USD20/bbl vs. March end and the marketing segment’s pricing of most products is higher than the previous year’s close. The currency movement has also been stable. Against this, the core GRM and marketing margin of other product segments could be a dampener for the quarter, besides lower volumes pulling overall earnings down.
Marketing income to be key focus area as GRMs could be volatile in FY21: While the overall volume is expected to be down in FY21, the worst seems to be over with demand recovery underway. GRM visibility is low but we believe that a weak scenario would throw out sub-optimal units. Coupled with demand normalization and eventual oil price stability, GRMs can witness a major uptick as seen in similar past cycles. We estimate OMCs to see a 60-80% decline in FY20 PAT. Hence, earnings recovery should be a key focus area in FY21, primarily driven by marketing to cover for the Q1 overall volume hit and weak GRMs. OMCs’ capex target for FY21 is Rs467bn (Rs523bn in FY20). Along with ~Rs100bn of normalized dividend and Rs170bn of depreciation, we estimate a combined PAT of Rs300bn is required to keep leverage under control, assuming some leeway from the working capital release. We believe that OMCs are well-placed for proactive auto fuel pricing to boost FY21 earnings. Some excise duty rollback under rising oil prices can be materially supportive.
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