OMCs HPCL, BPCL and IOCL surge up to 40% in November; will this rally continue?

Brokerage house Dolat Capital sees this rally continuing going forward.

It has maintained BUY calls on BPCL and HPCL, and an Accumulate rating on IOCL. This recommendation is based on factors such as a super normal Gross Refining Margin (GRM) becoming the new normal, a well-diversified crude basket with substantial discounts for Indian refiners, anticipated bumper dividends from OMCs, and the government’s budgeted capital infusion of ₹30,000 crore, guaranteeing the protection of book value and a reduction in the net debt to EBITDA ratio, explained the brokerage.

It has a target price of ₹550 for BPCL, implying an over 25% upside. Meanwhile, it has targets of ₹450 and ₹137 for HPCL and IOC, indicating a 30% and 18% upside, respectively.

As per the brokerage, the recent announcement of major state election results signals the initiation of the General Election 2024 code of conduct, expected to be effective from the second week of March. Consequently, the analysis suggests that there won’t be an auto fuel price cut in Q3FY24. Hence, OMCs are projected to report healthy Q3FY24 EBITDA/PAT with year-on-year growth, noted the brokerage.

The brokerage also informed that during H1FY24, BPCL/HPCL/IOCL’s consolidated Book Value Per Share (BVPS) stood at Rs329/Rs318/Rs121. By the end of Q3FY24, the visibility of earnings indicates BVPS is expected to reach Rs354/Rs328/Rs124. Historical evidence suggests that OMCs have traditionally implemented petrol/diesel price changes even during the code of conduct period, potentially causing volatility in Gross Marketing Margins (GMM) for a brief period. However, it is anticipated that post the General Election, GMM will return to normal or above-normal levels, it predicted.

After the election, a resumption of auto fuel price adjustments to normal marketing margins of approximately Rs3/lt is expected, providing clarity on OMC earnings in FY25 and beyond, added Dolat.

Stock Price Trend

In the last 1 year, HPCL surged the most, over 71 percent, followed by IOC at 58 percent and then BPCL, up 41 percent. Meanwhile, in 2023, HPCL rallied over 68 percent, IOC jumped over 58 percent and BPCL gained 43 percent.

Just in December, HPCL has advanced 10 percent after an over 40 percent rise in November. BPCL as well has risen 9 percent in December till date after a 25 percent gain in November. Meanwhile, IOC also added over 8 percent in December till date after a 24.5 percent increase in November.

HPCL hit its 52-week high of ₹396 in trade today (December 7). It has now advanced 87 percent from its 52-week low of ₹211.70, hit on February 27, 2023. IOC also hit its 52-week high of ₹122.50 in intra-day deals today, rallying over 69 percent from its 52-week low of ₹72.35, hit on December 26, 2022.

Meanwhile, BPCL hit its 52-week high of ₹482.05 in the previous session. It has also jumped over 53 percent from its 52-week low of ₹314.10, hit on Feb 28, 2023.

Investment Rationale

Supernormal GRM a new normal

In the past 18 months, Indian refiners have processed over 45% discounted crude from Russia and Iraq, according to commerce ministry data. The purchase of Russian and Iraqi crude at discounts of US$6.2 and US$1.6 per barrel, respectively, compared to the Indian crude basket price, has significantly boosted Gross Refining Margin (GRM) by US$3 per barrel. Russian crude has gained a substantial market share in the Indian crude basket, and attractive terms from Iraq and some African oil exporting nations have contributed to this trend. In November 2023, Russia and Iraq alone accounted for over 45% of crude supply to India, noted the brokerage.

The expectation is that OMCs will continue to benefit from discounted crude, thereby enhancing overall GRM. Consequently, it is anticipated that OMCs will maintain above-normal GRM in FY25E and FY26E. Additionally, each US$1 per barrel increase in GRM is expected to result in a 15%/12%/12% jump in EBITDA for BPCL/HPCL/IOCL in FY25E, respectively, it forecasted.

Jumbo dividend from OMCs

The fiscal year 2024 is shaping up to be a remarkable year for OMCs, marked by strong dividends. Following a robust first half, the second half has exceeded expectations, with the exception of potential inventory losses in Q3 if oil prices stabilise at US$80-85 per barrel, informed Dolat. Despite this, strong core earnings are anticipated in Q4.

Projections estimate BPCL/HPCL/IOCL to report Rs246/Rs154/Rs354 billion Reported Profit After Tax (RPAT) in FY24, accounting for refinery commissioning risk for HPCL. This implies an impressive 8%/9%/10% annual dividend yield for FY24, with BPCL and IOCL already declaring 5% each in the interim. Anticipation is that the macro-political environment will improve post the general elections, predicted the brokerage.

Right issues a protection from net-worth erosion

Aligned with the government’s budgeted capital support of ₹30,000 crore to OMCs in FY24, both BPCL and IOCL have received board approval for right issues of Rs180 billion and Rs220 billion, respectively. HPCL is also expected to declare a similar initiative soon. The expectation is that these right issues would be accretive to Book Value Per Share (BVPS) if the issue price is set at a lower discount to the Current Market Price (CMP). This move is seen as a strategic step to safeguard against net worth erosion and enhance the net debt to EBITDA ratio for the concerned OMCs, said Dolat.

Estimates

Considering the all-state elections are over, the brokerage does not see any price cut in auto fuel which leads to no risk to Q3FY24 earnings. It also increased GRM assumptions for the FY25E & FY26E as the discounts on the crude from various countries will continue.

BPCL: Overall, earnings change by 23%/28%/86% in FY24/FY25/FY26E.

HPCL: Overall, earnings change by 22%/27%/27% in FY24E/FY25/FY26E.

IOC: Overall, earnings change by 15%/15%/17% in FY24E/FY25/FY26E.

Disclaimer: We advise investors to check with certified experts before taking any investment decision.