India Refining &Marketing:Q2FY18e preview,Strong GRMs to boost earnings

Strong GRMs in Q2FY18 to boost earnings. Led by the sharp spike in refiningmargins in late Aug’17 and then Sep’17, the Singapore complex GRMs have averagedUSD8.2/b for Q2FY18. The hurricanes in the US were one of the key reasons for theGRMs jumping up. In addition, the Brent crude price also averaged slightly higher atUSD51.7/b, against USD50.1/b in Q1FY18. The closing Brent crude prices for Q1 & Q2quarters show a starker difference of more than USD8/b. Considering the quarterlyBrent crude averages for Q1FY17 & Q2FY18, we estimate that Oil MarketingCompanies (OMCs) should benefit by roughly USD1/bbl of inventory gains in Q2FY18.

    Overall, the combined effect (GRMs + inventory gain) implies that the OMCs are likelyto report GRMs of USD8.5-9.0/b even on a conservative basis. On the marketing side,based on the data released so far until Aug’17 by the Ministry of Petroleum & NaturalGas, we are expecting volume growth 3-4% y-o-y for Q2FY18 for OMCs for allpetroleum products. Also, note that this will be first quarter where GST impact will beseen on OMCs’ earnings and this will be key data point for which to look out.

    HPCL & BPCL likely to see sharpest improvement sequentially. Based on our Q2FY18estimates, HPCL and BPCL should report the sharpest improvement in earnings q-o-q asapart from the GRM benefit, the inventory gains will aid the marketing EBITDA as well. ForIOC, the pipeline and petchem earnings are likely to be steadier.

    We continue to like HPCL within OMCs. HPCL’s stock (up 50% YTD) has outperformedIOC by 22% and BPCL by 36% YTD driven by robust marketing business earnings andoverall sharp earnings improvement. We continue to like HPCL within OMCs as we feelthat it provides much superior earnings predictability due to 60-70% earnings coming frommarketing business. Further, though it is entering a capex cycle, the RoE profile of 20%+will still warrant valuation multiples that are higher than the current valuations. We retainBuy on HPCL and Holds on BPCL & IOC.