Brokerage Firm Downgrades OMC Stocks Amid Overvaluation Risks

Brokerage Firm Downgrades OMC Stocks Amid Overvaluation Risks

VoM News Desk | January 9, 2024 | 12:38 PM IST | Breaking News | Follow on Google News

Brokerage Firm Downgrades OMC Stocks Amid Overvaluation Risks/Mint_Print

Brokerage Firm Downgrades OMC Stocks Amid Overvaluation Risks

The recent surge in the shares of Oil Marketing Companies (OMCs) over the past two months has prompted JM Financial Institutional Securities to downgrade several OMC stocks, citing concerns about their overvaluation and unfavorable risk-reward ratios. The brokerage firm pointed out that the absence of valuation comfort post the recent rally has led to this adjustment, with OMCs currently trading at a 10-30% premium to historical Price-to-Book (P/B) valuations.

Key Observations and Downgrades:

• Stock Performance: OMC shares, including HPCL, BPCL, and IOCL, have escalated by 30-70% in the past two months, driven by various factors such as increased auto-fuel gross marketing margins, delay in fuel price cuts, resolution of rights issue-related concerns, and overall bullishness across PSU stocks.
• Downgrades: JM Financial has revised its stance on these OMC stocks, downgrading HPCL to ‘sell’ from ‘buy’ with a revised target price of ₹370, IOCL to ‘sell’ from ‘hold’ with a revised target price of ₹110, and BPCL to ‘hold’ from ‘buy’ with a revised target price of ₹450.
• Factors Influencing Valuations: The brokerage firm has revised OMCs’ FY24 EBITDA estimates upward by 26-38% due to robust gross refining margins (GRMs) and recent hikes in marketing margins. However, it expects only a limited 2-3% upgrade in FY25-26 EBITDA estimates.
• Valuation Metrics: JM Financial adjusted its valuations to March 2025 and increased the EV/EBITDA multiple for the marketing segment to 5.5 times from 5 times earlier, considering enhanced visibility in marketing segment earnings following a drop in crude oil prices.

Concerns and Forecasts:

• Sustainability of Margins: The firm is cautious about the sustainability of the recent surge in auto-fuel gross marketing margins, which currently stand at ₹7-8 per litre versus a normalized ₹3.5 per litre. It anticipates possible auto-fuel price cuts before the General Elections in Apr-May 2024 and/or hikes in auto-fuel excise duty, along with strong pricing power from OPEC+, which could maintain Brent crude prices near $80 per barrel.
• Refining Margin Normalization: JM Financial expects a normalization of refining margins to $7-8 per barrel from FY25 onwards, considering factors such as easing supply-side concerns, diminishing windfall tax benefits, and the narrowing of Russian crude discounts.
• Project Concerns: The brokerage firm expressed concerns about OMCs’ project execution, citing historical cost- and time-overruns in large projects that have failed to create long-term value for shareholders.

JM Financial’s assessment indicates a cautious stance regarding OMC stocks, highlighting potential challenges in sustaining recent margin growth and a cautious outlook on refining margins, influencing its revised target prices for these stocks.

VoM News Desk

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