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A double whammy for refining, petrochemicals a mixed bag
* Utilization of global refining capacity stood at ~82% in 2019, lower than 83.5% in 2018, which was the highest in the preceding decade. Lower utilization also reflected the rescheduling of several projects earlier to meet the increased diesel demand owing to IMO 2020.
* Also, recent are suggesting that global oil demand could contract by 4.5mnbopd in 2020 due to the lockdowns world-wide. A glance at BP’s Statistical Review indicates this to be the largest percentage decline witnessed since 1965 (from when the time series started).
* While the world is yet to come to terms with COVID-19, China has displayed immense control with its industries already ramping up. China, a net exporter of refined products, is likely to keep refining margins under pressure with ramp-up of its refineries. On the other hand, with its large contribution to global petrochemical consumption, the rise in China’s industrial activity could boost petrochemical margins, barring the huge expansions planned in China in 2020.
* With petrochemical margins being a mixed bag and the continued stress in refining, we reiterate our preference for RIL and the OMCs (Oil Marketing Companies). We prefer RIL due to its capability for better feedstock and product optimization and the OMCs for using marketing margins as a tool to weather poor profitability in refining.
China – a net exporter of refined products
* In 2019, China exported 21.4mmt of diesel and 16.4mmt of petrol (25-54% of total Indian consumption). China witnessed a decline in its refining utilization by ~20% YoY in Feb’20 due to the impact of COVID-19.
* However, tight controls and efficient handling of the pandemic has helped Chinese refineries spring back to life quite fast. Reports suggest that stateowned refiners have already raised their utilizations from record low of 67% in Feb’20 to 70% in Mar’20. Teapot refiners have also raised their utilization from 41.5% in Feb’20 to 52.1% in Mar’20.
* We believe that the ramp-up of Chinese refiners amidst increased slowdown in the rest of the world would result in continued stress in GRMs. SG GRM has been trending at -USD1/bbl for the past few days.
China – a large petrochemical consumer, but too many expansions ongoing
* 2020 is expected to witness ~14mmtpa of incremental ethylene capacity globally. However, due to the current scenario, actual addition could be far less. Out of this, 6.9mmtpa is expected to be in China alone. Most Chinese projects appear to be on schedule.
* However, China is a major consumer of petrochemicals. Its contribution toward global consumption has increased by 4-14% over the past decade. With import dependency of ~46%, Chinese PE imports are expected to increase significantly along with its economy normalizing. However, PP import dependency is expected to decrease by 4% YoY in 2020.
* Polyester intermediates supply is also likely to outgrow demand, which could keep margins under pressure.
RIL – better feedstock and product management provides an edge
* We expect high Nelson complexity and continuous improvement in using various crudes to help RIL maintain healthy GRM of USD8/bbl in FY21. We also highlight that USD1/bbl of refining margin contributes to incremental EBITDA of INR32.5b, 7%/3% of the standalone/consol. EBITDA.
* A fully integrated presence in petrochemicals and access to multiple feedstock also provides RIL’s petrochemical segment a unique advantage over others. We estimate that change of USD50/mt on implied petrochemical EBITDA/mt results in incremental EBITDA of INR44.4b, 10%/5% of standalone/consol. EBITDA.
* For RIL, CMP implies 3.4x FY22E EV/EBITDA for the standalone segment, much below ~5-6x that global peers are currently trading at. Valuing RIL’s core business at 6x FY22E EV/EBITDA and adding the equity valuation of RJio at INR500/share and of Reliance Retail at INR450/share, we value RIL at INR1,521 and reiterate it as our top Buy in the sector.
OMCs – marketing margins provide a breather
* Refining contributes ~35%/37%/30% of IOCL/BPCL/HPCL’s consol. EBITDA for FY22, in a normalized GRM scenario of USD6/bbl. In FY21, we estimate OMCs to garner core refining margins of USD5/bbl.
* While GRMs would be poor, the OMCs have not taken a price cut in auto fuels since 16th Mar’20. Our estimates suggest that OMCs currently make INR15/lit of gross marketing margins on auto fuels. While this is definitely not sustainable for the full year and is likely to decline to INR4-5/lit, it would nonetheless help them weather the poor refining margins substantially.
* We estimate that IOCL requires INR0.5/lit of incremental gross marketing margin on auto fuels for the full year to offset the decrease of USD1/bbl in GRM. The same stands at INR0.4/lit for BPCL and INR0.2/lit for HPCL.
* OMCs are trading at 0.6-1.1x FY22E PBV, much less than during FY15-18, a period of perfect deregulation (i.e. without any pricing intervention by the government).
* We value IOCL at 1.2x FY22E PBV and reiterate it as our top pick due to the free cash flow generation of ~INR17/share (~20% of market-cap) cumulative for FY21-22E.
* We value BPCL at 1.9x FY22E PBV and maintain Neutral on the stock with slim possibility of divestment in these circumstances.
* We value HPCL at 1.3x FY22E PBV and reiterate Buy with target price of INR330/share. However, we also highlight that the capex expected for HPCL is much higher than that for IOCL/BPCL. Project execution risk also exists at its expansion in Vizag.
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