Valuations are cheap, firm policy initiative would re-rate oil and gas stocks: IIFL Capital Services

27 Jun 2022 , 10:53 AM

Inexpensive valuations across the sector (<1SD on FY07-22 avg P/BV) reflect concerns about sustainability of the current macro environment and the uncertainty on forecasting earnings for the sector mega PSUs.

In a state of flux

While upstream companies are earning fully for the barrel of oil sold, as are refiners, the pricing power of fuel retailers is however constrained. Subsequently, upstream and refining players are set to log record-earnings in FY23, while OMCs are staring at staggering losses. Meanwhile the private sector is maximizing gains/bbl by exporting versus selling products domestically; hence, cases of product shortages are frequently reported by the media. Calibrated price hikes by OMCs is the most desired outcome on such a backdrop; given the price freeze at pumps for ~85 days, such hikes do not appear to be a top priority.

Delay in policy = overhang

Upstream companies on consensus earnings are trading at 25-35% earnings yields on FY23; such cheap valuations perhaps reflect the risks associated with the meltdown of commodity prices or an adverse policy action, given several incidents around the globe. The policymakers have a tough task of balancing the interest of consumers & companies and investor sentiment at large. Delay in promulgating a policy will be a key overhang for the stocks. And, to that extent, cheap valuations may linger for a while.

All PSUs trade cheap

Analysts at IIFL Capital Services have upgraded their FY23 PAT estimates for OIL/ONGC by 12-13% (US$90/bbl oil) and despite the 18-34% EPS cut for OMCs, they are hopeful on earnings, which need to be progressively tracked. Visibility on FY24 earnings is poor across the sector. But the stocks are trading near or below 1SD on P/BV plotted through FY07-22; typically, stocks have found fundamental valuation support here. Hence, they like PSUs in general. The sticky issue of governance and the limited flexibility to operating management linger; they however think it is a generic risk across PSUs and not specific to the 5 names (OIL, ONGC, HPCL, BPCL, IOCL).