Prefer OMCs over upstream oil PSUs; buy BPCL, HPCL, IOC

Nomura

We maintain our preference for oil marketing companies (OMCs) over upstream PSUs. We continue to believe that fuel pricing reforms (unlikely in the near-term) are a must for OMCs to re-emerge as an LT investment idea. Even as OMC stocks have seen some rally over the last one month, valuations remain undemanding. We have a 'buy' rating on all three OMCs — BPCL (target R430), HPCL (target R380), and IOC (target R325).

Macro concerns remain elevated and upstream oil PSUs are vulnerable to higher subsidy sharing. With the government's priority on fiscal deficit control this year and likely doling out of populist measures in FY14 ahead of the 2014 elections, the near-term outlook remains weak for upstream oil PSUs. We have a 'reduce' rating on ONGC (target R225) and Oil India (target R400).

We value BPCL's core refining and marketing business (including Bina and NRL) at 0.9x FY14f P/B, based on adjusted book value per share of R209 per share. We give a value of R175 per share to E&P. We value BPCL's investments in listed entities like Petronet, Indraprastha Gas and Oil India at a 20% discount to the current market price. We value current treasury shares at market price.

For HPCL, we value the core refining and marketing business at 0.8x FY14f P/B, based on adjusted book value per share of R400 per share. We value HPCL's investments in listed entities like MRPL and Oil India at 20% discount to current market price.

We value IOC core refining and marketing business at 0.9x FY14f P/B, based on an adjusted book value per share of R272 per share. We value IOC's investments in listed entities at a 20% discount to the current market price.

With so much anticipation built up, we think OMCs will soon announce a diesel price hike. But, both quantum and timing remain uncertain. Based on last fortnight's prices, OMCs have under-recoveries of R9.6 per litre. To offset this, a price hike of R10.8 per litre is needed. It seems unlikely OMCs will be able to take such a sharp increase. A price increase of R1.25 per litre in diesel is needed just to offset the subsidy cap increase on LPG cylinders. In our view, a price increase of R3-4 per litre on diesel should immediately be taken.

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