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Healthy quarter; golden prospects

OMCs’ Q2FY22 aggregated EBITDA grew 9% YoY/7% QoQ driven by both strong marketing and refining segments. The planned shutdown at HPCL refineries however remained a drag on aggregate earnings.

We expect refining margins to remain strong on rising product cracks. Gasoline (MS)/Gasoil (HSD) cracks have increased 18%/16% QoQ on rising demand. Besides, we note good traction in domestic retail demand. While MS demand is back to pre-covid levels, HSD is yet to see traction. However, industrial/agriculture-led activity should drive HSD demand in H2. Indian OMCs are trading at a 21% discount to global peers despite their superior RoEs. Accordingly, we retain ‘BUY’ across OMCs given favourable risk-reward at their current valuations.

Strong refining on higher GRMs; HPCL’s planned shutdown offsets

While IOCL/BPCL’s throughput grew 10%/27% YoY, HPCL’s throughput fell 38% YoY owing to a planned shutdown of the Mumbai refinery. IOCL‘s throughput slid 9% QoQ on a planned shutdown of the Barauni refinery. In Q2, IOCL reported highest GRM of USD6.6/bbl (-23% YoY, flat QoQ), whereas HPCL reported the lowest at USD2.4/bbl (-53% YoY/-27% QoQ) among OMCs. BPCL’s GRM of USD6/bbl surged 4% YoY/ 47% QoQ. We expect utilisation to rise further in H2 with a ramp-up in industrial/ agricultural activity. This along with rising product cracks will yield strong margins. IOCL’s Haldia refinery (8MMT) will stay shut for maintenance in December.

Strong marketing in Q2; demand likely to rise further in H2

Domestic retail volumes grew 7–11% YoY in Q2FY22 (up 1–4% QoQ) in tandem with a ramp-up in demand on easing lockdown restrictions. Marketing margins remained strong given several prices hikes taken by OMCs amid rising crude prices. We estimate a 36% QoQ jump in diesel retail margins to INR7/ltr during Q2 (down 17% YoY). While MS demand is back to pre-covid levels on rising mobility, HSD demand is yet to pick up. We anticipate demand to normalise in H2 with a ramp-up in industrial and post-monsoon harvesting activity. Besides, network expansion spree continued across OMCs. BPCL/HPCL added 485/440 outlets in Q2.

Outlook and valuation: Strong outlook, inexpensive valuation; ‘BUY’

We indicated >USD8bbl GRM after CY23 (refer to Golden era of refining), but rising distillate cracks have advanced the timeline (refer to Christmas comes early). OMCs are well placed to capture the potential super cycle of GRMs. Furthermore, HPCL’s Vizag refinery’s capacity is poised to double by FY23, which along with rising distillate yields (90% post-bottom upgradation) will deliver two-digit GRM. OMCs also have an added advantage of a three-player oligopoly in the auto fuel retail business for structurally enhancing retail margins (refer to Structural fuel retail expansion). Despite high FY23E RoEs of >20% (global average: 13%), Indian OMCs are trading at 5x FY23E EV/EBITDA (global average: 7x). Retain ‘BUY’ across OMCs on favourable risk-reward. Besides, the Bina refinery subsidiary merger with BPCL shall save INR5bn/year, synergy benefits aside. HPCL remains our top picks in OMCs.

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