Fuel Price Cut To Squeeze Oil Marketers’ Margins

India’s aim to cushion consumers from rising crude prices and a weaker rupee will hurt the marketing margins of state-run oil retailers.

While the government lowered the excise duty on petrol and diesel by Rs 1.50 per litre, it also asked the oil marketers to cut retail prices by Re 1 per litre. The decision sent shares of Indian Oil Corporation Ltd., Bharat Petroleum Corporation Ltd. and Hindustan Petroleum Corporation Ltd. tumbling. They ended today’s trade 11-14 percent lower.

That’s because the retailers will have to absorb the price cut by lowering gross marketing margins. And HPCL would be the worst hit as marketing is the biggest contributor to its overall operating income, according to data compiled by BloombergQuint.

The move would cost the oil marketers nearly Rs 7,000 crore—or about 18 percent of their net profit for the year ended March 2018—said Deven Choksey, managing director at broking house KR Choksey.

A Re 1 per litre cut in fuel price would bring down the gross marketing margins of the oil marketing companies to a five-month low, according to the data compiled by BloombergQuint. In the last one year, margins fell to such levels twice – in the run-up to Gujarat and Karnataka state elections when the companies froze prices despite a rise in crude oil.

Auto fuel prices in India change every day after the government deregulated them. The move to impose such arbitrary decisions on oil retailers will not be taken positively by markets, said Choksey. It will also hurt the government’s plans for initial public offerings and divestment of public sector companies, he said.

In an earlier note, Kotak Securities projected a negative impact of 12-21 percent on the earnings per share of fuel retailers if their marketing margins were to drop by Rs 0.5 a litre.

Brokerages’ Take

JPMorgan

• Today’s policy step makes the entire Indian energy space un-investable in the near term
• Subsidies effectively return for OMCs
• Earnings impact is manageable for IOCL and BPCL; much larger for HPCL
• Positives: private sector market share effectively capped, oil price point much higher than expected

CLSA

• Government's move will bring down the EPS by 23-46 percent.
• Raise fears of return of subsidy regime if crude spikes further in upcoming elections.
• ONGC and Gail may also be impacted but these already build-in risk.
• IOCL: Maintained ‘Sell’; cut price target to Rs 105 from Rs 155.
• BPCL: Maintained ‘Sell’; cut price target to Rs 240 from Rs 390.
• HPCL: Maintained ‘Sell’; cut price target to Rs 150 from Rs 270.

Motilal Oswal

• Marks U-turn from deregulation and raises possibility of return to subsidy regime.
• Changed scenario warrants different valuation method; value OMCs on price-to-book.
• Cut in marketing margins would result in 24-28 percent cut in EPS.
• IOCL: Maintained ‘Buy’; cut price target to Rs 164 from Rs 254.
• BPCL: Maintained ‘Buy’; cut price target to Rs 393 from Rs 535.
• HPCL: Downgraded to ‘Neutral’ from ‘Buy’; cut price target to Rs 203 from Rs 428.

Goldman Sachs

• HPCL has the highest exposure to fuel retailing followed by BPCL and IOCL.
• Move confirms reversal of de-regulation of fuel retail market.
• Lower EV/EBITDA multiple to four times - low end of OMCs trading range in last 10-years.
• IOCL: Maintained ‘Neutral’; cut price target to Rs 125 from Rs 185.
• BPCL: Downgraded to ‘Sell’ from ‘Buy’; cut price target to Rs 260 from Rs 470.
• HPCL: Downgraded to ‘Sell’ from ‘Buy’; cut price target to Rs 170 from Rs 345.