INVESTORS would have by now lost faith in Indias three public sector, Fortune 500 companies Indian Oil, BPCL and HPCL due to their topsy turvy performance last year. Last year proved very tough for these public sector Navaratnas due to huge underrecoveries.
However, the industry seems to have shown signs of revival with the companies reporting first signs of profitability in the June 09 quarter, which is likely to continue.
Steady but slow:
Despite a total lack of control over their own profitability, the stocks of these companies did not fall with the overall market in the last August 08 to February 09 period. The share prices of these three biggies found strong support around their book value. In the last quarter, however, the performance of these companies has been somewhat subdued despite the market revival. Since the start of April 2009, the shares of Indian Oil, BPCL and HPCL have gone up by around 37%, compared to over 60% gains in the benchmark Sensex to 15,160 on August 7, 09.
Wiping the slate clean:
The June 2009 quarter was a turnaround for the oil marketing companies (OMCs), as they posted healthy profits and cash flows compared to losses earlier. Their refining operations were under pressure due to the global economic turmoil, however, the sharp reduction in marketing losses helped them. The crude oil prices ruled at $60 per barrel during the quarter nearly half of the year ago period which helped these players to cut down their underrecoveries on marketing operations to negligible levels. As a result, there was no need for any oil bonds and very low upstream support.
Two other changes provided great support to the financials of these companies. Strengthening of rupee meant that the companies recorded forex gains during the quarter, as against heavy forex losses in the corresponding quarter of previous year. At the same time, their interest burden receded considerably thanks to lower interest rates and also reduced debt burden. The interest cost of these OMCs had jumped nearly threefold in FY 09 to Rs 8200 crore twice that of their annual aggregate profit.
Indian Oils quarterly numbers were also boosted by the merger of Bongaigaon Refinery with effect from 25th March 2008. Hence its financials were included in June 09 numbers, but not in the June 08 figures. Indian Oil also benefited from the improving performance of its petrochemical operations , the profits of which segment tripled during the quarter.
Better future seems to await these three oil majors, particularly in the light of the recent Budget announcement about setting up of an expert group to decide a viable and sustainable petroleum pricing system.
The recent increase in prices of auto fuels starting July 2009 has reduced the under-recoveries of these OMCs on petrol and diesel to a level below Rs 2 per litre. These transport fuels represent over half of Indias total consumption of petroleum products, while the other two subsidized products kerosene and LPG represent just 15% portion. As a result, the increase in auto fuel prices will help these companies report profits in the coming quarters.
At the same time, these companies are investing in improving and expanding their refinery operations. The 6 million tonne Bina refinery of BPCL is expected to start operations by the end of 2009, while HPCLs 9 million tonne Bhatinda refinery will be ready by February 2011. Indian Oil is also in the process of expanding its Panipat refinery and start polymer production.
Thanks to the profits in the June 2009 quarter as against losses in the corresponding quarter of last year, the valuation of oil marketing companies has become attractive. Indian Oil is currently trading at a price-to-earnings multiple of 10.9, BPCL at 7.8 and HPCL at 5.9 We expect these companies to remain profitable in the next two quarters, wiping out over Rs 9500 crore of losses incurred in the same period of the last year. This will boost the per share earnings of these companies giving a booster to their performance on the bourses.
The main risk lies in crude oil prices zooming up in a short span, without corresponding increase in the retail prices of the petroleum products. However, considering the weakness in demand and heavy potential supply that could enter the market at a short notice, we rate this risk as low in the coming quarters.