Numaligarh Oil refinery tanks stand in Golaghat, Gujarat (Photographer: Adeel Halim/Bloomberg)

Even After World-Beating Rally, Refiners are Cheap for SBI Life

(Bloomberg) -- Indian refiners that have benefited from the scrapping of fuel subsidies still have room to extend their world-beating surge on improving margins and cheap valuations, according to SBI Life Insurance Co.

The rally still hasn’t caught up with fundamentals, said Gopikrishna Shenoy, chief investment officer at SBI Life, India’s second-biggest private insurer by assets under management. Indian Oil Corp. and Bharat Petroleum Corp. are the top and No. 3 performers on the Bloomberg World Oil & Gas Index over the last three months as India took a first step toward ending kerosene subsidies, following the freeing of diesel prices in 2014.

“Refining margins are getting better and better,” Shenoy, who oversees $12.9 billion, said in an interview in his office in Mumbai. “There is more juice left” in the rally and valuations are still “very cheap,” he said.

The progressive removal of subsidies means state-owned refiners have seen their interest expenses fall as they no longer have to sell most fuels below cost and then take out short-term loans to manage cash flow. At the same time, India is set to surpass Japan as the world’s third-largest oil consumer after demand rose the fastest on record last year.

Prime Minister Narendra Modi scrapped diesel subsidies in October 2014, completing a process started by his predecessor, Manmohan Singh, who got rid of gasoline subsidies in 2010. Support remains for liquefied petroleum gas and kerosene, although state refiners have been authorized to start increasing prices of the latter.

Even After World-Beating Rally, Refiners are Cheap for SBI Life

Bharat has rallied 123 percent since Modi swept into power in May 2014, the best performance in the Bloomberg world gauge. Indian Oil is the third-biggest gainer over the period, climbing 76 percent, while Hindustan Petroleum Corp, which isn’t in the index, has more than tripled. All three refiners dropped at the close on Tuesday. Indian Oil fell 2.8 percent, Bharat declined 3.6 percent and Hindustan tumbled 5.3 percent.

India’s three state-run refiners still trade at 12-month forward price-to-earnings ratios that are well below the benchmark S&P BSE Sensex Index. The multiple for Indian Oil is 9.5, while it’s 11 for Bharat Petroleum and 8.6 for Hindustan Petroleum. That compares with 16.2 for the Sensex.

The real test of Modi’s resolve not to reintroduce subsidies will come when oil goes back up to $70 to $80 a barrel, said Mihir Vora, the Mumbai-based chief investment officer at Max Life Insurance Co. It currently trades at around $50.

Stable Margins

A 57 percent drop in the price of Brent crude since mid-2014 coupled with rising local demand benefited the refiners. The oil marketers haven’t passed all of the decline through to consumers, resulting in higher margins, said Rahul Prithiani, a Mumbai-based director at CRISIL, a unit of S&P Global Ratings. Marketing margins should remain stable at current levels, he said.

Investors were unwilling to give a high multiple to earnings when the margins from selling fuel were unpredictable, said Max Life’s Vora, who has been overweight refiner stocks for several quarters. “Now with predictability, the acceptable multiples have increased.”

Indian Oil, Bharat Petroleum and Hindustan Petroleum have also seen interest costs drop, with their combined payments declining 60 percent to 42 billion rupees ($626 million) in the 12 months through March from a year earlier, according to company financial reports.

Indian Oil’s net profit more than doubled to 104 billion rupees in the financial year through March 2016 from three years earlier. Its gross refining margin also doubled to $5.06 a barrel over the same period. Bharat Petroleum’s net profit has nearly tripled over the three years to 74.3 billion rupees, while its refining margin increased 33 percent to $6.59 a barrel. Hindustan Petroleum’s first quarter net income rose 30 percent to 20.98 billion rupees from a year earlier, the company said on Monday.

“With these kind of numbers and earnings doubling, we will continue to hold,” said SBI Life’s Shenoy, who turned bullish on oil refiners after Modi came to power and has been adding to his holdings. “In terms of the bottom line, we can see good growth.”