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Great News for Oil Marketing Companies

After years of losses, lower crude prices mean oil marketing companies can gain from higher marketing margins they are now allowed to set

The fall in crude is great news for oil marketing companies (OMCs). At current crude prices, there are no losses in LPG and diesel. That could result in oil subsidies falling 62 per cent in FY16, estimates Deutsche Bank Research, which could reduce subsidies by as much as 81 per cent from FY14 levels.

After years of losses, lower crude prices mean OMCs can gain from higher marketing margins they are now allowed to set through the diesel price deregulation initiated in October 2014. The reforms allowed OMCs to price diesel at market prices and also charge a marketing margin. Here are the two biggest OMC gainers.

HPCL
HPCL stands to gain the most as it is more sensitive to higher marketing margins. A ₹50 paisa per litre expansion in petrol/diesel marketing margin, according to Axis Capital, could improve the company’s earnings per share by 50 per cent in FY16. Marketing EBITDA constituted 57 per cent of HPCL’s total EBITDA in FY14. That is set to go up to 72 per cent in FY17.

Monthly diesel price hikes have eased working capital loan requirements for OMCs. HPCL saw its debt reduce from ₹33,700 crore levels in FY13 to ₹31,900 crore levels in FY14. Additionally, the company is set to save ₹500 crore in interest costs (SBICAP Securities) as a result of monthly diesel price hikes. It paid ₹1,336 crore as interest payments in FY14.

What makes HPCL more attractive than its peers is that it does not have any exposure to the petrochem business (as IOC does) nor to exploration risks (as in the case of BPCL). That makes HPCL the best bet amongst OMCs in a falling-crude environment. Even with a 145 per cent price run-up in the stock price, HPCL trades at a reasonable 5.6 times its TTM earnings. Buy.

BPCL
BPCL is the second biggest beneficiary of the fall in crude. A 50 paisa expansion in marketing margin could improve the company’s earnings per share by 26 per cent in FY16. Marketing EBITDA constituted 54 per cent of BPCL’s total EBITDA in FY14. That is set to go up to 72 per cent in FY17 (Axis estimates).

Like HPCL, BPCL’s balance sheet has started showing effects of monthly diesel price hikes. BPCL had to resort to lower working capital loans, as a result of which gross debt fell 30 per cent to around ₹ 6,200 crore. Besides, the company still has to receive ₹ 1,500 crore from the government for under-recoveries and carries oil bonds worth ₹5,000 crore in its balance sheet.

The last quarter (Q2) though was marked with the company reporting inventory losses to the tune of ₹200 crore but with crude price falling further and no diesel under-recoveries ahead, the outlook appears better ahead. However, there is still a risk from rupee depreciation ahead. BPCL has doubled in the last 12 months. The stock now trades at 11.6 times its TTM earnings and appears to have more steam left. BPCL is poised to gain in the future and this is a good time to buy this OMC. The downside in the stock is capped and the upward potential is significant.