Will OMCs' zero loss dreams come true?

Moneycontrol Bureau

State-owned oil marketing companies or OMCs have made losses for the most part of their existence. The total under-recoveries, or losses from selling diesel, LPG and kerosene at below market prices, stood at Rs 1 trillion (USD 16 billion) in the first nine months of the financial year.

However, there is good news. According to broking firm Goldman Sachs, if the new government allows the OMCs to continue with monthly diesel price hike, diesel losses are likely to fall to zero in the next six months.

This is assuming there is no major change in international oil prices, diesel cracks and USD-INR exchange rate. "We actually expect oil price to be stable and diesel cracks to moderate in the near term as a lot of Asian refiners come out of maintenance after June 2014," it said in its research note.

Also Read: Upstream oil cos to pay 48% of under-recovery bill

Continuing with the reform initiated by the previous UPA government of eliminating subsidy on the fuel through small doses of monthly price increases, the week-old BJP government yesterday allowed oil companies to raise rates by 50 paisa a litre.

The increase, the first under Narendra Modi-led government, together with appreciation in rupee value against the US dollar, helped trim losses on diesel sales to Rs 2.80 a litre from Rs 4.41 a litre last week, officials said.

The UPA government had in January, 2013 decided to raise diesel prices in small doses of 40-50 paisa a litre every month till the losses, which are made good through government subsidy, are completely eliminated.

Officials said the monthly increases had trimmed losses to less than Rs 3 a litre in May last year before a fall in rupee value led to losses on diesel sale widening to Rs 14.50 per litre in September, 2013.

Since then, monthly increases have continued and rupee has strengthened.

The losses have fallen rapidly since March as prospect of a stable and decisive government under Modi helping rupee gain against dollar. Losses on diesel stood at Rs 8.37 per litre in March.

"While the losses from diesel retail sales would likely fall to zero in the coming months, boosting operating cash flows and reducing working capital debt of OMCs, we believe actual deregulation would need more steps on the policy front to ensure that retail diesel prices move with international fuel prices, on any sudden and substantial changes even in a high inflation environment," Goldman's note said.

It estimates FY15E gross under-recovery to be Rs 1,064bn (below FY14 levels), reducing government subsidy burden by Rs 335 billion. "While we assume that OMCs will be almost entirely compensated for their losses every year, we estimate upstream subsidy burden to gradually fall from the FY14's US$56/bbl to USD 54/48per bbl over the next two years," it said.

"We continue to prefer OMCs (downstream) over upstream, given more clarity on cash flows, relatively inexpensive valuations and more upside in blue-sky scenarios. We have Buy on HPCL /BPCL," Goldman said.

Another broking firm Credit Suisse too believes diesel price increase under new government is positive but adds that subsidy policy is now critical. "We prefer BPCL on better operations/balance sheet," it said in its research note.

Also Read: If rupee gains to 55/$; these sectors will feel most pain

BPCL stock price

On June 02, 2014, at 11:12 hrs Bharat Petroleum Corporation was quoting at Rs 541.45, up Rs 19.90, or 3.82 percent. The 52-week high of the share was Rs 588.50 and the 52-week low was Rs 256.00.

The company's trailing 12-month (TTM) EPS was at Rs 56.16 per share as per the quarter ended December 2013. The stock's price-to-earnings (P/E) ratio was 9.64. The latest book value of the company is Rs 286.20 per share. At current value, the price-to-book value of the company is 1.89.