State-run oil marketing companies (OMCs), which suffered losses due to a prolonged retail price freeze on petrol and diesel, recently saw improvement in their marketing margins, thanks to a decline in international crude prices. Global benchmark Brent crude tumbled below $90 a barrel earlier this month, its lowest level since Russia's invasion of Ukraine in February, amid fear of global economic recession and weak demand due to aggressive rate hikes by central banks globally and Covid-19 restrictions in China.

According to an ICICI Securities report, the recent decline in crude prices has been reflected in the sharply higher marketing margin on petrol, as gasoline prices have dropped in line with Brent crude. Also, while diesel margins have remained strong despite overall worries about global demand for petroleum fuels, absolute prices for diesel have also dipped, helping retail fuel losses to narrow for diesel and for petrol margins to move to positive territory by August 2022.

As per the report, earnings for all the three OMCs – Indian Oil Corporation Limited (IOCL), Bharat Petroleum Corporation Limited (BPCL), and Hindustan Petroleum Corporation Limited (HPCL) - have shown a clear improvement over July and August 2022, even though first two weeks of September 2022 (so far) have once again shown a reversal of these trends.

The report noted that the prospects for Q2 FY23 look slightly better with softer crude and product prices helping narrow marketing losses and GRMs (gross refining margins) still at strong levels, albeit lower than the record levels for Q1. “We continue to factor stronger fuel margins for H2FY23E, with the recent dip in crude and product prices, a key driver of our optimism for the rest of FY23E,” it said.

So, will the improvement in margin mix boost the stocks of OMCs, especially HPCL, BPCL and IOC? Here's what the experts believe.

According to analysts at ICICI Securities, the balance between muted refining margins and improved marketing earnings will be the key monitorable for meeting FY23E base case estimates for the three OMCs. The agency has retained its “BUY” call on IOCL, and kept BPCL at “ADD” and HPCL at “REDUCE”.

The brokerage has recommended a Buy call on IOCL, owing to its most balanced business profile between refining and marketing, with the petrochemical business also being a useful hedge.

The agency maintained ADD call on BPCL, citing that there is limited upside despite weak valuations. However, it remains optimistic about the company’s long-term prospects and sees risk-reward at attractive levels at current prices. “We believe current valuations at just 7.3x FY24E P/E and 7.1x EV/EBITDA underplay the delta from refining improvement, comfortable leverage, steady return ratios and growing fuel consumption for BPCL,” it said.

The brokerage reiterated a REDUCE call on HPCL, saying that current valuations are not favourable due to volatility of marketing margin trends and muted return ratios in the backdrop of rising CAPEX and leverage. “Given our misgivings on the sustainability of GRMs, volatility of marketing margin trends and muted return ratios due to rising CAPEX and leverage, we believe current valuations of just 4.5x FY24E P/E and 8.1x EV/EBITDA are not favourable.”

Besides, in a major boost to OMCs, the government is also planning to provide ₹20,000 crore compensation to state-owned OMCs for the losses due to higher petrol, diesel, and LPG prices. The BPCL, HPCL, and IOCL are likely to be the biggest beneficiaries of the compensation move.  

The trio reported a combined loss of ₹18,480 crore due to a decline in the margin on petrol, diesel, and domestic LPG in the backdrop of a rise in international crude prices. During the April-June quarter of 2022, IOC, BPCL, and HPCL did not revise fuel prices despite a record surge in Brent crude, the global benchmark for oil prices, to help the government contain inflation, which breached 7%. Adding to the woes, the government slashed excise duty on petrol and diesel to provide some respite to consumers instead of being used to square off mounting losses on fuel sales.

At the time of reporting, shares of IOCL were trading 0.3% lower at ₹72.45 on the BSE, while BPCL's stock price rose 0.44% to ₹344.1 apiece. Meanwhile, HPCL shares were down 0.9% at ₹247.7. 

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