Risk-reward turns negative for OMCs

Unmatched Valuations

• Stock prices of HPCL/BPCL/IOCL rallied by 30-70% in last 2 mths

• Sharp jump in auto-fuel gross marketing margin fuelled share prices

• OMCs trading at 10-30% premium to historical P/B valuations

New Delhi: JM Financial Institutional Securities said in a report that in the absence of any valuation comfort post recent rally (OMCs trading at 10-30% premium to historical P/B valuations), the risk-reward has turned unfavourable and therefore downgrade of HPCL, IOC, BPCL.

Stock prices of OMCs (HPCL/BPCL/IOCL) have rallied by 30-70 per cent in the last two months driven by sharp jump in auto-fuel gross marketing margin (GMM) on account of moderation in crude price/product cracks; near-term delay in auto-fuel price cuts; end of rights issue related overhang; and bullishness across all PSU stocks.

The report said: “We believe the recent sharp jump in auto-fuel GMM to Rs7-8/ltr is not sustainable as government is highly likely to either cut auto-fuel prices ahead of critical general elections in April – May 2024 and/or hike auto-fuel excise duty; and OPEC+ strong pricing power will support Brent crude price $80/bbl. Further, we believe OMCs’ refining margin will normalise to $7-8/bbl from FY25 (Vs $10-20/bbl in FY23/FY24) driven by normalisation of diesel cracks due to easing supply side concerns and rise in Chinese diesel exports; end of windfall tax benefits following normalisation of diesel cracks; and narrowing of Russian crude discount.”

Moreover, OMCs’ aggressive capex plans accentuate our key structural concern as many of the projects fail to create long-term value for shareholders, with several of them being undertaken from the country’s strategic energy security perspective, it added.