IGI Logo

PLNG strong value play amid limited opportunities.

* The O&G sector has had a strong run in the last four months, with OMC stock prices up 35-50%, CGDs up 10-30% and upstream stocks up 10-30%. In this short note, we highlight that : 1) domestic mutual funds’ relative underweight position in the O&G sector vs. BSE 200 continues to decline, down only 2% now (FY22: ~5%); 2) average one-year fwd. P/E for our O&G coverage is 16.8x, up significantly vs. LT avg of 13x; 3) while OMCs are well owned, we see the possibility of a sharp excise duty hike in 2QFY26, which could halt share price momentum; 4) with the O&G sector trading above the LT average, we see PLNG as the only strong value play in the sector (Tide is turning, slowly).

Sharp auto fuel excise duty hike could be coming in 2QFY26

* Three key takeaways: Based on historical trends, we believe that: 1) the possibility of an excise duty hike in 2QFY26 remains high (given high gross marketing margins); 2) the next excise duty adjustment will likely be sharper than the modest INR2/lit for both MS/HSD in Apr’25; 3) often duty adjustments happen when gross marketing margins cross the INR8-9/lit mark. Note that the current MS/HSD marketing margins are above this level.

* Sharp duty adjustments in the past: During the Nov’14 to Feb’16 period, the government increased MS/HSD excise duty by INR11.8/INR13.6 per lit. During this period, crude prices fell from highs of USD100+/bbl to USD35/bbl. In Mar’20, MS/HSD excise duty was increased by INR3/lit when the marketing margins averaged INR8-9/lit. Later, with crude prices plunging below the USD20/bbl mark and marketing margins soaring above INR18/lit, an additional MS/HSD duty hike of INR10/INR13 per lit was implemented in May’20.

Continue to believe excise duty adjustments preferred over retail price cuts

* Limited retail price cut in the past: We continue to believe that an excise duty adjustment has higher profitability than a retail price cut. Note that in the last few years, the central government has taken limited price cuts for MS/HSD.

* No major elections scheduled in next six months: Apart from Bihar, which accounts for ~7% of seats in Lok Sabha (elections due in Oct/Nov’25), there are no other major elections scheduled in the next six months. Also, instead of a pan-India retail price cut by the central government, individual states might resort to fuel price adjustments, thus lowering the impact on OMC gross marketing margins.

Capex cycle tapering off; ND/EBITDA to improve across OMCs

* Capex cycle tapering at HPCL/IOCL: We think the probability of excise duty adjustments remains high, as barring BPCL, the capex cycle is set to taper off at OMCs and FY27E ND/EBITDA metrics at 2x-3x are within control, thus reducing the need for super-normal profitability. With the recent commissioning of Chhara LNG Terminal, expected completion of Bottom Upgradation Unit at Visakhapatnam refinery in 2QFY26, expected completion of HRRL refinery by Jan’26, and no mega-projects in pipeline, HPCL’s capex intensity is expected to soften. IOCL is also expected to increase refining capacity by 17.3mmtpa during 4QFY26-1HFY27. However, beyond this, the capex will start to moderate.

* BPCL though is embarking on new capex: BPCL has already entered a new capex cycle with the ongoing Bina Refinery expansion, and the clarity on a 9- 12mmtpa Andhra Refinery is yet to come. ND/EBITDA ratio for OMCs is expected to improve to 2x-3x in FY27E from 5.5x-7.5x in FY20

At least partial LPG reimbursement likely; under-recovery declining

* With strong marketing margins, LPG compensation might be limited: LPG under-recovery was a key concern for OMCs during FY25, with combined underrecovery for OMCs amounting to INR413b (INR199/INR104b/INR109b for IOCL/BPCL/ HPCL). No support has been provided by the government yet, even as OMCs continue to earn super-normal MS/HSD marketing margins. Our base case remains for at least partial LPG compensation as under-recovery per cylinder has continued to decline.

* LPG under-recovery down to INR115/cyl now (vs. INR180 in 4QFY25): As per our estimate, LPG under-recovery per 14.2kg cylinder stood at ~INR180 in 4QFY25. With average Saudi propane prices down ~3% QoQ and a price hike of INR50/cyl in domestic LPG cylinder (media article), we estimate LPG underrecovery to reduce to INR115/cyl in 1QFY26. Further, we believe that propane prices should start correcting further, leading to higher earnings momentum for OMCs.

* Last compensation payment was in CY22: In CY22, the government had announced a compensation of INR220b for OMCs for a cumulative loss of INR280b they incurred. Assuming INR200b compensation (~50% of current outstanding) is received by OMCs in FY26, INR7/INR12/INR25 would be added to FY26E BVPS of IOCL/BPCL/HPCL.

OMC valuations no longer inexpensive, but still below historical highs

* Only BPCL trading below LTA: OMC valuations are not inexpensive any more, although they are still significantly below the historical peak. Only BPCL is trading below its 1yr fwd. LTA P/B, though re-rating for the stock might be crimped by the commencement of a heavy capex cycle. While we do not think that valuations are inexpensive, a weak crude price outlook, declining LPG under-recovery and recent strength in GRMs can sustain valuations for OMCs. HPCL currently trades at 1.6x one-year fwd. P/B, marginally below its mean +1SD P/B. IOCL/BPCL trade at 1x/1.5x one-year fwd. P/B, at par/below their LTA.

* ROE has to ramp up sharply for OMC valuations to sustain at mean + 1 S.D.: All OMCs traded comfortably above their mean +1SD P/B during FY17/18, even touching highs of 1.8x/3.1x/2.5x one-year fwd. P/B, as ROE stood at 20%+/30%+/35%+ for IOCL/BPCL/HPCL, respectively. Current MS/HSD marketing margins, zero LPG under-recovery and stable mid-cycle GRMs will imply RoE of 25%+/35%+/45%+ for IOCL/BPCL/HPCL in FY26/27 (our current FY26E ROE: 7.9%/17.9%/22%).

Domestic MFs’ underweight position in O&G vs. BSE 200 falling

* O&G sector trading above historical average valuation: The average one-year fwd. P/E valuation for the 15 O&G stocks in our coverage is 16.8x now, up 20% vs. Feb’25 and above LTA of 13x. Similarly, average one-year fwd. P/E valuation for the O&G coverage excl. Reliance is 9.6x now, up 15% vs. Feb’25 and above LTA of 8.6x. PLNG, currently trading at ~10x FY27E P/E, is the only inexpensive play left now in O&G.

* Domestic MFs underweight position in O&G vs. BSE 200 down from 5% to 2%: Domestic MFs’ underweight position in the O&G sector, which was as high as ~5% in FY22, has been consistently falling and is down to only 2% now. At 6.1% in Jun’25, MF weightage in the O&G sector is higher than the two-year low of 5.8%, and we believe it is heavily tilted toward OMCs.

PLNG only strong value play remaining amid limited opportunities

* PLNG’s valuations imply the stock is at a point of maximum pessimism: We recently upgraded PLNG to BUY (Tide is turning, slowly). PLNG trades at 10x FY27E EPS compared to its historical one-year forward P/E of 10.4x. Under a variety of bearish scenarios, our DCF-based valuation implies -5% to 20% returns from the current price. Our DCF-based TP of INR410/sh (WACC: 11.2%, TG = 2%) assumes a 10% tariff cut in FY28, followed by a 4% increase for both the terminals. While we have incorporated the full capex for the petchem plant, we value it conservatively at 0.5x FY29E P/B and discount this back to FY27E.

* HPCL momentum play, PLNG value play: We like HPCL as a momentum play and PLNG as value play as we await better buying opportunities in the sector. Our sector preference remains for OMC-CGD > upstream. After a 10-30% run-up in CGDs over the last four months, we prefer PLNG over CGDs at current levels.

For More Research Reports : Click Here 

For More Motilal Oswal Securities Ltd Disclaimer
http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html
SEBI Registration number is INH000000412