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2QFY22 preview: Strong quarter for upstream companies

We expect RIL’s 2QFY22 EBITDA to grow 10% QoQ due to some improvement in refining margin, strong subscriber addition, and recovery in Retail business. OMCs’ core earnings are likely to improve QoQ on the back of a) sharp rise in marketing margin; and b) some improvement in refining margin; however, reported earnings are likely to decline QoQ on account of lower inventory gains. Upstream PSUs are likely to report strong earnings due to higher crude prices.

CGD companies’ are likely to see QoQ recovery in volume after weak 1QFY22; however, jump in spot LNG price could put pressure on margins. GAIL could see a strong QoQ growth in earnings due to volume recovery across segments and strong margin in gas trading and LPG business. PLNG’s volume could also recover QoQ on a low base. We have upgraded our estimates and TP of oil PSUs factoring in higher commodity prices and some improvement in downstream margin.

However, we have moderated our near term margin estimates for CGD companies due to spike in gas cost while maintaining our long term margin estimates. We maintain BUY on oil PSUs on valuation grounds amidst gradual improvement in fundamentals. Further, we prefer gas companies due to their structural volume growth story and strong pricing power — IGL and Gujarat Gas (GGas) being our preferred play.

* RIL EBITDA likely to rise 10% QoQ: RIL’s 2QFY22 EBITDA is likely to be up 10% QoQ at INR 256bn based on following assumptions: a) O2C EBITDA is likely to rise only 2.7% QoQ to INR 126bn due to weak petchem margins and major plant shutdown; refining margin may improve slightly QoQ to USD 7.5/bbl; b) Digital EBITDA is likely to grow 6% QoQ to INR 98bn with net subscriber additions are likely at 13mn QoQ, APRU is expected to increase only to INR 140 (from INR 138 in 1QFY22); and c) Retail EBITDA likely to show sharp uptick by 54% QoQ at INR 30bn due to easing of lockdown restrictions.

* OMCs’ core earnings likely to improve QoQ on account of sharp rise in marketing margin; reported earnings likely to decline QoQ: OMCs’ core earnings are likely to improve significantly due to: a) sharp ~INR 2/ltr QoQ rise in auto fuel gross marketing margin to ~INR 5/ltr led by sharp jump in diesel margin; b) rise in S’pore Dubai GRM to USD 3.8/bbl (vs. USD 2.1/bbl in 1QFY22) led by improvement in petrol cracks. However, reported PAT is likely to decline QoQ (except for BPCL) due to lower inventory gains.

* Expect a strong quarter for Upstream PSUs due to higher crude prices: Upstream PSUs’ (ONGC and Oil India) PAT are expected to rise 40-50% QoQ on the back of higher crude prices (Brent averaging at USD 73/bbl in 1QFY22 vs. USD 69/bbl in 1QFY22). Domestic gas realisation continues to be flattish; however, it will jump sharply in 2HFY22 and in FY23 (as per the gas price formula) driving upstream PSUs earnings, going forward. Crude and gas sales volumes are likely to continue to witness muted growth.

* CGD companies’ earnings could improve QoQ on the back of volume recovery; jump in spot LNG price could put pressure on margins: We expect IGL’s PAT to grow 37% QoQ as we expect its overall volume to jump 31% QoQ to 6.9mmscmd (led by 35% QoQ jump in CNG volume due to easing of lockdown restrictions).

However, despite positive operating leverage, margin (EBITDA/scm) is likely to be flattish QoQ at 7.9/scm due to impact of high spot LNG prices. For Gujarat Gas (GGas), we expect its PAT to decline 47% QoQ due to high dependence on expensive spot LNG, which is likely to result in its margin (EBITDA/scm) declining to INR 4.1/scm (vs. INR 7.9/scm in 1QFY22); while we expect its volume to grow 13% QoQ to 11.2mmscmd.

* GAIL could see volume recovery across segments; PLNG’s volume could also recover QoQ on a low base: GAIL is likely to see a 15% QoQ growth in EBITDA due to volume recovery across segments after a weak 1QFY22. For GAIL, we expect: a) gas transmission volume at 111mmscmd (up 3% QoQ) and trading volume at 98mmscmd (up 2% QoQ); b) petchem sales volume at 207kt (reverting back to full utilisation) while LPG sales volume up 18% QoQ at 295kt.

Further, its earnings would be boosted by rise in gas trading margin to INR 600/tcm (vs. INR 483/tcm in 1QFY22) and improvement in LPG segment margins (given rise in global LPG prices) while gas transmission tariff is expected to continue to be steady. PLNG’s earning is likely to grow ~9% QoQ due to some recovery in volumes after a weak 1QFY22. GSPL’s volume (at 38.5mmscmd) is expected to rise 4.5% QoQ while tariff is expected to be steady.

* Upgrade in estimates and TP of oil PSUs on higher commodity prices and recovery in downstream margin: Given gradual recovery in global oil and gas demand, we have revised our following assumptions: a) Brent crude price assumed at USD 68/bbl in FY22 and USD 65/bbl in FY23 and onwards (vs USD 60/bbl assumed earlier); b) S’pore Dubai GRM assumed at USD 4/bbl in FY22 (vs USD 3.5/bbl), USD 5.0/bbl in FY23 (vs USD 4.5/bbl) and USD 5.5/bbl in FY24 (vs USD 5.0/bbl); c) Domestic gas price revised to USD 2.35/mmbtu in FY22, USD 5.5/mmbtu in FY23 and USD 4.5/mmbtu in FY24 and onwards given the spike in global gas prices.

We have rolled forward our valuations for all companies to Mar’23. We have raised our RIL’s FY23 EBITDA estimate by 2% factoring in slightly higher GRM and subscriber number; TP stands revised to INR 2,800 (from INR 2,500) primarily due to roll-forward. For upstream PSUs our FY22-23 EBITDA estimates has been raised by 16-30% factoring higher oil and gas prices; TP has been revised to INR 215 for ONGC (from INR 150) and to INR 300 for Oil India (from INR 180). For OMCs, our FY22-23 EBITDA estimates have been raised by 2-19% and TP has been revised to INR 370 for HPCL (from INR 310), INR 560 for BPCL (INR 520) and INR 140 for IOCL (INR 110).

* Moderation in near term margins for CGD companies due to higher gas cost: We have moderated our margin estimates for Gujarat Gas for FY22-23 due to sharp jump in spot LNG prices; hence, our FY22/FY23 EBITDA for Gujarat gas have been cut by 21%/8% and TP has been cut to INR 780 (from INR 860). We have moderated our FY23 margin estimate for IGL to factor in the likely sharp jump in domestic gas price for 1HFY23. Hence, our FY23 EBITDA for IGL has been cut by 9% while our DCF based TP remains unchanged at INR 635. Our FY22-23 estimates for GAIL have been raised by 3-6% due to higher Brent crude price assumption; while our TP remains unchanged at INR 190.

* Maintain BUY on oil PSUs on valuation grounds; IGL and GGas continue to be our structural BUY ideas: We maintain BUY on oil PSUs (ONGC, BPCL, HPCL and GAIL) on valuation grounds amidst gradual improvement in fundamentals (refer our note India PSUs: Building blocks for value creation being put in place?). Further, we continue to prefer gas companies due to their structural volume growth story and strong pricing power — IGL and GGas being our preferred picks.

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