CLSA study shows overpricing in OMC stocks amid record rally, warns of headwinds

Global brokerage CLSA retained the sell rating on the oil marketing companies

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A sensitivity analysis by CLSA into the recent record-breaking rally in oil marketing companies (OMCs) has revealed that these stocks are priced significantly higher than historical marketing margins, maintaining near-record refining margins, and holding a notable premium to the global peer average EV-EBITDA multiple.

While a cut in retail fuel prices seems unlikely, a 5-7 percent crude price rally could spark concerns about marketing margins of OMCs. The government’s fiscal consolidation goal may prompt a review of fuel taxes after the elections. Coupled with substantial global refining capacity additions, doubts may arise on the sustainability of current high margins.

The global brokerage firm retained the ‘sell’ rating on the stocks after Indian Oil Corp, Bharat Petroleum Corp and Hindustan Petroleum Corp Ltd rallied 39-45 percent so far in 2024 and 63-80 percent in the last three months.

As national elections near, the likelihood of a fuel price cut turns bleak, according to CLSA. They estimate the breakeven in diesel/petrol prices at $86/$96 a barrel of Brent equivalent, and a 4-5 percent rise in Brent crude to $83 may concern investors about the marketing profitability of IOCL, BPCL, and HPCL.

CLSA notes that even with elevated pre-Covid marketing margins for diesel and petrol (around Rs 2 a litre) and double-digit refining margins – rarely witnessed by these companies – a 10-20 percent higher EV-EBITDA multiple than global peers is required to justify the current market prices of IOCL, BPCL, and HPCL.

“At 5.5x FY25 EV-EBITDA (global peer average of 4.9x), the prices of IOCL, BPCL and HPCL are baking in GRMs of $9-12/bbl and marketing margins of Rs 2.5-3.0/litre.  Even if we consider a 6.0x FY25 EV-EBITDA, a steep 25 percent premium to global peers, these stocks are baking in Rs 2.5-3 a litre marketing margin and $8-11 a barrel GRMs,” CLSA said.

The Budget 2024-25 emphasises fiscal consolidation, potentially leading to excise duty hikes on auto fuel after the polls if the global crude prices allow. The current high margins are viewed as an anomaly, permitted by the government to recover previous losses. CLSA deems the combination of high margin expectations at a premium to the global peer average as unsustainable.

The absence of retail fuel price adjustments in the last two years exposes the vulnerability of profits for IOC, BPCL, and HPCL in a higher crude price environment (above $90-100 a barrel). Policy uncertainty in marketing and limited non-fuel retail business offset the superior refining operations, potentially eliminating any justification for IOCL, BPCL, or HPCL to command a premium over global peers, in CLSA view.

Additionally, with approximately 4 percent dividend yields and PEs ranging from 7x-10x on consensus estimates, relative multiples, aside from EV/EBITDA, also stand at a premium compared to the global peer average for OMCs, CLSA said.

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