Why OMCs will take a hit on earnings?

Let us understand why oil marketing companies may be up against a difficult few quarters in FY21!

May 08, 2020 11:05 IST India Infoline News Service

Since the beginning of the year 2020, the two major stocks in the OMC space i.e. BPCL and IOCL have grossly underperformed the Nifty.  While the Nifty did manage to bounce back post the March 23rd, the oil marketing companies have remained under pressure. This is largely due to the hit on earnings in the fourth quarter of FY20 and beyond.

Data Source: NSE

Absorbing the excise burden in petrol and diesel

The government during the week announced a sharp spike in the excise duties on petrol and diesel. While the excise duty on petrol was hiked by Rs10/litre, the excise duty on diesel was hiked by Rs13/litre. That is obviously a steep spike and will generate additional revenues of Rs160,000cr for the government in the current year. With GST and direct tax revenues likely to take a hit on account of COVID-19 driven economic contraction, the government has little choice but to rely on good old fossil fuels. Clearly, in the midst of all this economic chaos, the government does not want to burden households with more expensive petrol and diesel. Instead, government has asked the OMCs to absorb this additional cost. The argument is that when crude prices had crashed post January 2020, OMCs had not passed on the cost benefit to consumers. This will not impact FY20 earnings, but is likely to be an overhang for OMCs in FY21.

Higher inventories and lower inventory valuations

This could be the real pain point for OMCs. Firstly, the lockdown and the demand dent since January had already led to a pile-up of inventories with OMCs. The OMCs are expected to post huge losses on the inventory front and in forex translation. The slowdown in demand and the subsequent lockdown has come as a double whammy for OMCs. Firstly, weak demand has resulted in an above median pile-up of inventory stocks. But the bigger problem was in inventory valuations. Normally, the inventory values are carried forward at market price. With crude falling from $66/bbl in January to $30/bbl in March, the translation losses are likely to be massive for the OMCs. INR has also weakened from a median level of 72/$ last year to $76/bbl this year. This will result in deep cuts on forex translation for OMCs.

How IOCL and BPCL are likely to be impacted?

Let us look at IOCL first. India’s largest oil company, IOCL is expected to post an inventory loss of Rs.11,000 crore during the March quarter on account of crude oil prices falling from $66/bbl to $30/bbl. In addition, the forex loss on account of weakening of the rupee is expected to be above Rs.2500 crore. The forex loss is expected to compensate for higher auto fuel margins. That is likely to leave profits for the quarter lower by Rs.11,000 crore on account of inventory value depletion. IOCL is expected to post negative EBITDA of over Rs.5700 crore in the March 2020 quarter.

BPCL could see relatively lower losses compared to IOCL due to its relatively smaller scale. BPCL is expected to take a loss of Rs.4000 crore on account of inventory depletion, over and above forex translation losses to the tune of Rs.1000 crore. Despite the offsetting impact of higher auto fuel margins, the company is expected to post operating losses in excess of Rs.1200 crore in the March quarter.

Of course, the losses in the Mar-20 quarter may just be the tip of the iceberg. The real challenge will be absorbing the sharply higher excise duties on petrol and diesel. That could really challenge the financials of OMCs in the coming quarters. Oil marketing companies may be up against a difficult few quarters in FY21!

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