OMCs: Earnings recovering, multiples yet not in Indian Oil & Gas sector: IIFL Capital Services

6 Jun 2023 , 10:58 AM

If the current auto-fuel margins hold steady (Rs9-10/ltr), OMCs will report all-time high earnings in FY24. However, this is not the base case, as either a spike in oil, price cuts by OMCs towards H2, or a combination of both may play out — thereby normalising margins. Regardless, FY24 should be a good year, which is not reflected in their multiples. On the other hand, upstream companies may see a relatively muted year. OIL with superior volume growth vs ONGC is better placed; valuations are equally cheap: 8-9% dividend yields on FY24.

OIL better placed on volume growth: 

ONGC & OIL have drawn plans to scale up their O&G production by 3-5% pa, for which the capex is likely to average Rs300bn/49bn p.a., respectively. Relatively, OIL’s execution has been superior to ONGC in short term. On a medium-tolong run, both have poor history. Despite consistent capex for past several years, their 2P reserves are static/down. In FY24 at US$75/bbl oil and unchanged APM gas, ONGC should report 23%/54% growth in standalone/consolidated PAT (one-off in FY23 + HPCL profits in FY24), while OIL’s earnings should grow 3% YoY (moderation in oil). Visibility on FY25 earnings remains low, given the volatile commodity prices.

Dream year ahead for OMCs: 

On the back of benign oil, stable growth in consumption, and normalisation of marketing margins — OMCs should register “V” shaped recovery in earnings. After its maiden loss, HPCL should report profits; while BPCL and IOCL should earn 147/61% YoY higher PAT on a low base. Analysts of IIFL Capital Services forecasts are 6-17% below consensus. Hypothetically, if the current auto fuel margins (Rs9-10/ltr) were to stay, OMCs collectively will report Rs1.2trn PAT in FY24 – the highest-ever earnings. This is not the base case, as analysts of IIFL Capital Services see either a spike in oil, price cuts towards H2 or a combination of both playing out. 

Policy support key for re-rating: 

Upstream companies trade at 3- 3.6x FY24 P/E and offer 8-9% dividend yield. Their multiples can compress further if oil prices collapse (not base case); but the upside is likely when there is firm clarity pricing of auto fuels and stability in oil. This argument is applicable even for OMCs, which are trading at 6-8x normalised earnings, and offer asymmetric payoffs.