Strong marketing offsets weak Refining: IIFL Capital Services

9 May 2023 , 10:44 AM

If the trend continues, OMCs would earn well-above normative marketing margins (Rs6-7/ltr) as well as IIFL’s base case assumptions for FY24 — which offsets weak Refining margins; their stocks offer asymmetrical payoffs. Now, whether they will cut auto fuel prices in light of this, remains to be seen.

Oil cools off

Regardless of the surprise production cuts announced by OPEC+ starting May 2023, Oil prices are down 11% MoM to US$76/bbl (YTD US$80/bbl). An announcement of further production cut by OPEC+ in June may cause a spike in Oil prices again. SG GRM is down to US$2.1/bbl in May-TD versus US$3.5/bbl in April owing to weak gasoline, gasoil and ATF spreads; though FO cracks are holding up well. As such, QTD, the PP, Px and PTA deltas are up, while PE and PVC deltas are down. Analysts at IIFL Capital Services remain cautious on Petchem spreads, but see recovery in GRMs.

Strong marketing offsets weak Refining

Relative to FY23, earnings visibility for OMCs has improved considerably and they may V-shaped recovery in FY24. If the trend sustains, OMCs would earn marketing margins well-above normative, as also IIFL’s base case assumptions for FY24; which offsets weak Refining margins. Notably, a Re1/ltr change in marketing margins assumption leads to 31-47% swing in earnings forecasts. Meanwhile, with the reduction in APM gas prices and benign LNG prices (down 9% since April), CGDs are in sweet spot and should continue volume-driven earnings growth. With normalization of LNG supplies, GAIL and PLNG should also see relief on their TOP contracts.

Analysts at IIFL Capital Services like OMCs, GGAS and IGL

While upstream companies trade cheaply on P/E and dividend yield, analysts at IIFL Capital Services believe these are, at best, trades. Rather, they prefer to own OMCs, given their robust revenue models and ability to grow profits on volume and margin expansions; their valuations are also cheap (0.8x-1.3 FY24 BV). While analysts at IIFL Capital Services like CGD players in general, GGAS is their preferred pick.