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Robust 3QFY25 trends for OMCs so far

* In 3QFY25’TD, refining margins have remained stable with current SG GRM at USD5.2/bbl (2QFY25: USD3.6/bbl), even as MS/HSD GRMs are stable QoQ at USD10- 13/bbl.

* MS/HSD marketing margins have remained robust, averaging INR13.6/INR10.7 per lit in 3QFY25’TD (vs. INR3.3/lit each, we assume for FY26E-27). While crude prices have corrected sharply over the past six months, further downside risks to oil prices remain a source of upside earnings risk for OMCs’ marketing business in FY26.

* Based on 3QFY25’TD refining and marketing margins and LPG prices, we estimate that OMC EBITDA may rise by 60-80% QoQ in 3QFY25. While LPG’s under-recovery has risen QoQ, it will likely be offset by higher marketing margins. We believe that lower inventory losses QoQ in both refining and marketing could also boost profitability.

* Assuming 3QFY25’TD profitability to continue in 2HFY25, we see 20%-40% upside risk to our FY25E EBITDA for OMCs. HPCL is our preferred pick among OMCs with a BUY rating and a TP of INR470

Refining segment: SG GRM expands

* In 2QFY25, IOCL/HPCL/BPCL posted a 57%/41%/42% miss on our EBITDA estimates due to subdued refining margins, with reported GRMs coming in at USD1.6/USD4.4/USD3.1 per bbl. The weak profitability was a combination of soft core GRMs as well as inventory losses as Brent prices corrected from 1QFY25 average of USD 85/bbl to USD 79/bbl (2QFY25).

* Singapore GRM (SG GRM) has shown steady recovery in 3Q, averaging USD5.2/USD6 per bbl in 3QFY25’TD/Oct’24 (vs. USD3.6/bbl in 2QFY25). MS/HSD GRMs have been stable at USD10-13/bbl range in 3QFY25’TD. We believe that stable to modestly improving refining GRMs, together with lower inventory losses (amid stable to slightly lower crude prices), can drive healthy refining segment EBITDA growth QoQ for OMCs.

Marketing segment: MS/HSD marketing margins rise strongly QoQ

* Marketing margins for both MS and HSD were up 34% QoQ in 3QFY25’TD. Note that the 2QFY25 profitability for OMCs was also impacted by marketing inventory losses due to MS/HSD cracks correcting sharply in 2QFY25 vs 1QFY25.

* In 3QFY25, stable MS/HSD cracks QoQ, together with robust marketing margins, should deliver sequentially strong marketing segment performance in 3Q, we believe.

LPG’s under-recovery may increase ~18% QoQ

* In 2Q, OMCs’ earnings took a significant sequential hit due to the LPG underrecovery, amounting to INR37b/INR21b/INR21b for IOCL/HPCL/BPCL.

* With Propane prices averaging USD630/ton in 3QFY25’TD (vs. USD592/ton in 2QFY25), we estimate LPG under-recovery to increase ~18% QoQ in 3QFY25.

* We also estimate that for every USD100/ton change in propane prices, the 2QFY25 LPG under-recovery shall change by ~47%.

* With LPG prices averaging USD645/ton and touching a peak of USD940/ton over the last three years, we continue to believe that LPG under-recovery remains a risk to OMCs until any support is received from the government of India.

OMCs the best way to play downside risk to crude price theme

* IEA estimates global oil demand for CY25 to be ~1mb/d. The persistent weakness in oil demand, as per IEA, is driven by low demand in key oil markets such as China, resumption of crude output from Libya, planned unwinding of OPEC+ production cuts, an expanding EV fleet, and an increase in vehicle efficiency.

* Apart from the gradual unwinding of 2.2mb/d voluntary cuts by OPEC+ from Jan’25, IEA estimates another 1.5mb/d oil supply growth from non-OPEC players in CY25. IEA projects that even if the OPEC+ cuts remain in place, global supply shall exceed demand by more than 1mb/d in CY25.

* While we are building in oil prices of USD75/bbl in FY26, we believe risks to a lower oil price curve continue to rise, given the strong non-OPEC supply response in CY25 and beyond. We think that the best way to play a rangebound oil price environment with rising downside risks is OMCs, where HPCL is our preferred pick

Valuation and view: HPCL remains our preferred pick

* HPCL/BPCL/IOCL are currently trading at FY26 PB of 1.6/1.5/1 vs the historical average of 1.8/1.9/1.4, respectively.

* HPCL: We model a marketing margin of INR3.3/lit for both MS and HSD in FY26E-27E, while the 3QFY25’TD MS/HSD marketing margins are INR13.6/lit and INR10.7/lit, respectively. HPCL is our preferred pick among the three OMCs.

* We see the following as key catalysts for HPCL: 1) demerger and potential listing of the lubricant business, 2) the commissioning of its bottom upgrade unit in 4QFY25, and 3) the start of its Rajasthan refinery in 1QFY26’end.

* HPCL currently trades at 1.6x FY26E P/B, which we believe offers a reasonable margin of safety, as we estimate an FY26E RoE of 15.3%. Our SoTP-based TP includes:

* The standalone refining and marketing business at 7x Dec’26 EV/EBITDA;

* INR38/share as the potential value unlocking from the de-merger of the lubricant business;

* HMEL at 12x P/E based on its FY24 PAT (HPCL’s share), deriving a value of INR52/share;

* Chhara Terminal at 1x P/B and HPCL’s HRRL stake at 0.5x of HPCL’s equity investment in the project to date. The MRPL stake is valued at MOFSL’s TP. ? All these lead to a TP of INR470. Reiterate BUY.

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