Why Jefferies Prefers HPCL To Other Fuel Retailers
Jefferies prefers Hindustan Petroleum Corp. over its state-run oil-retailing peers even as fuel demand falls amid the second wave of Covid-19.
While Indian Oil Corp. has surpassed price targets and offers no upside, the research house said in a report that pressure on marketing margins may cloud the privatisation outlook for Bharat Petroleum Corp.
Lack of pricing freedom during the state polls has impacted what oil firms earn by selling every litre of fuel. That, Jefferies said, could dampen interest from private bidders for BPCL. Ongoing Covid-related restrictions could delay the due diligence process, it said.
Jefferies expects a weak first half of 2021-22 for oil marketers citing narrower marketing margins and lower volumes due to renewed pandemic-related restrictions. Every Rs 0.2 a litre change in auto fuel marketing margins impact estimated earnings per share for 2022-23 by 5.5% for HPCL and 6.5% for BPCL.
Jefferies prefers HPCL as it trades at a 60% discount to BPCL on the forward book value compared to the historical average of 35%.
After the elections for five states ended, oil retailers started increasing the prices of auto fuels last week after a gap of 65 days. Petrol has since turned costlier by Rs 1.65 a litre, selling for a record 92.05 a litre in Delhi. Diesel is up Rs 1.88 at Rs 82.61. That’s, however, not enough to cover losses on marketing margins.
The Indian basket of crude has surged 30% year to date, while petrol and diesel prices have risen 10% and 12%, respectively in 2021, according to data compiled from Bloomberg.
Negative Marketing Margins
Jefferies said the marketing margins based on daily prices are deep into negative territory for petrol. And they are a fraction of normative levels for diesel. An increase of Rs 2.3 per litre for diesel and Rs 6.7 for petrol is required to restore normal margins, it said.
Such hikes mean while diesel prices will peak below Rs 95 a litre, petrol would cross Rs 100 in many more places. Petrol prices have already surpassed that mark in cities like Bhopal, Indore, and Sri Ganganagar. Keeping petrol below Rs 100 would put pressure on marketing margins.
Yet, more than a surge in crude, retail prices are high because taxes account for more than half of the price. And a reduction in excise duty is unlikely given the government’s weak tax collections.
IOCL, BPCL, and HPCL share prices jumped 14%, 13%, and 11%, respectively, in the last week buoyed by the increase in retail prices. But Jefferies said a recovery in gross refining margins—what oil firms earn for processing every litre of crude—is required for sustained outperformance. And the Singapore GRM, the Asian benchmark, remains weak amid renewed restrictions at $2.5-3 a barrel compared with a 10-year average of $6.2.
Petrol spreads are expected to strengthen on higher-than-normal demand during the U.S. driving season in June-July, Jefferies said. But continued restrictions in India and weakness in global aviation fuel demand impacts the diesel outlook, Jefferies said.
Diesel cracks have lagged petrol’s in the past few months—a negative for Indian refiners since diesel constitutes a larger share.
- Jefferies has a price target of Rs 370 for HPCL, implying an upside of 41%. Higher crude prices and price controls are the key risks.
- For BPCL, the research firm has a 12-month price target of Rs 500, a potential upside of 11.3%. Failure to find a private buyer is the key risk.
- IOCL is trading at Rs 103 apiece, higher than Jefferies’ Rs 90 price target. Meaning, there’s no upside potential and the valuations may be stretched.