Shares of India’s oil marketing companies (OMCs) have doubled (or more) since Jan 2014 on expectations of rising earnings. These rest on optimistic margin hopes, in our view, but also appear to be anchored to the strong FY15 performance. Yet, 23-32% of this fiscal EPS came from one-offs. Admittedly, these may not be helping in the next fiscal but other factors are. Refinery tariff protection, for example, makes up 18-27% of EPS while the North East excise benefit lifts EPS for BPCL/IOCL by 8-15%. These buffers, together some 30% of EPS, may last forever but ignoring them leaves little margin for error too, when valuations also ignore balance sheet structures (non-debt liabilities in HPCL) and erosion in asset values (E&P for BPCL). The cheaper IOCL (OW) has more cushion.
EPS: Shares of India’s OMCs have surged 90-231% since 1 Jan 2014 (Sensex: 22%), underpinned by a similar rise in EPS estimates. The strong FY15 performance despite inventory losses appears to have been an anchor along with hopes of buoyant margins.
Margins: We expect refining to stay resilient but marketing margins may soften. Auto fuel margins have fallen from their earlier highs, and could rise more gradually from here than consensus expects, while industrial margins may normalise down as oil prices stabilise.
Octroi: The Octroi recovery comprised some 10-23% of FY15 EPS for the three OMCs. The scheme is set to end in May 2016.
One-offs: Other one-offs helped too in FY15—forex gains, write-backs of provisions and gains on derivatives, for example, offset in cases by E&P costs or new provisions. Indeed, together with octroi, the one-offs made up 23% of FY15 EPS for IOCL and 30% for HPCL and BPCL.
Tariff: Even so, applying multiples on extant earnings to assess fair value also overlooks the fiscal buffers that boost the bottom line. Tariff protection, for example, lifts refining margins by $1.0-1.5/bbl, on our estimates, making up some 18-27% of FY16-18e EPS.
Excise: This is well-known but perhaps the impact from excise benefits in the North East refineries is not. These have surged since the duty hikes on petrol and diesel in Nov 14 and now make up 8-10% of IOCL’s consol EPS and 11-15% for BPCL.
Cheap?: Such buffers may well continue forever but ignoring them and other one-offs to assess fair value also leaves scope for disappointment, especially if headline multiples also overlook the balance sheet.
Stocks: They also ignore stark changes in some pockets; BPCL’s E&P assets have little equity value even at $75 Brent, for example. We stay UW on BPCL and HPCL, but find valuations less stretched and expectations more modest for the larger IOCL, rating it OW.
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