'IOC still a better pick than HPCL & BPCL, despite petrol/diesel excise hike'

After significant fall in oil prices due to low demand amid COVID-19 crisis, several states increased value added tax (VAT) on petrol and diesel in the lockdown period, which oil marketing companies (OMCs) passed on the benefits entirely to end consumers.

Any fall in oil prices is always good for oil retailers as they earn extra marketing margin on petrol/diesel sale.

Earlier this week, the central government significantly hiked record excise duty on petrol/diesel, which OMCs could not pass on to end consumers and as a result, their marketing margin fell sharply to single digit from double digits earlier. However, the government will get Rs 1.6 lakh crore in FY21 which can be a fiscal buffer.

With effect from May 6, the centre hiked excise on petrol to Rs 32.98 per liter from Rs 22.98 per litre, while excise on diesel has been raised to Rs 31.83 per litre from Rs 18.83 per litre.

"OMCs have absorbed the entire hike in excise duty without any increase in retail auto fuel prices, thus dragging down the supernormal marketing margins from Rs 17-19 per litre to around Rs 3.4 per litre for diesel and Rs 9.2 per litre for petrol," said Motilal Oswal.

OMCs had been enjoying huge marketing margins of Rs 17-19 per litre over the last couple of weeks as retail prices had not been changed since mid-March 2020 (except VAT changes in certain states that were fully passed on), but lower demand due to lockdown has posed a risk for OMCs.

"With the highest leverage to marketing, HPCL is the most vulnerable to any change in marketing margins and is the least preferred in pecking list though we reiterated buy rating with a target price of Rs 326 per share," Motilal Oswal said.

Hence, the brokerage further said, "our preference stays with Indian Oil Corporation (IOC) among the OMCs, which, despite capex of Rs 20,000 crore annually, is expected to throw free cash flow of around 15 percent of its market cap in FY21/FY22, cumulatively."

"IOCL is trading at 0.5x FY22 PBV, around 40 percent discount to the average during FY15-18 (the truly deregulated period without any pricing interference from the government). We reiterate IOC as our top pick, with a target price of Rs 168, valuing the company at 1.2x FY22 PBV," it added.

International Brent crude futures fell from around $70 a barrel levels to below $20 a barrel levels in April, while the same was trading around $30 a barrel at the time of publishing this copy.

Although Brent has risen around $5 a barrel in the last few days (which translates to an ask rate of around Rs 2.5 per litre on pump prices), diesel product benchmark prices have not risen.

"This means that despite the recent spike in crude, unless diesel cracks move up, OMCs do not need to take any significant hike in pump prices in the next few days if they are to maintain today's marketing margins," said Motilal Oswal.

Its assumption on gross marketing margins on auto fuels stands at around Rs 4.2-4.5 per litre for FY21. "While we do not see any threat to our assumptions yet, it remains to be seen whether OMCs are able to pass on the increase in oil prices to end consumers going forward," it said.

More importantly, the government aims to complete the divestment of BPCL, "which is less likely to take place if marketing margins are sacrificed," said the brokerage. It valued BPCL at 1.9x FY22E PBV and maintained neutral on the stock.