Outlook of OMC stocks look promising

In the last one year, the combined market capitalisation of stocks of oil marketing companies (OMCs) rose mere 5%, while the Sensex gained 24% in the same period. This severe underperformance is mainly due to steep gains in the crude oil price to the extent of over 22% in the last one year. Since February 2016 lows, the oil price has moved up by exactly around 100% now.

The rising trend in oil prices is negatively correlated with the valuation multiples of OMC stocks. Substantial gain in oil price is always perceived to have an adverse impact on the OMCs in terms of possible share of subsidy burden and rise in working capital costs. However, this time, the PE multiples have fallen much more than any possible dip in the actual profits of OMCs. Now OMC stocks trade at or close to single-digit PEs on expected earnings of the current year, despite a massive bull run in the domestic equity markets.

In contrast to the historical trend, now the rising burden of oil prices has been largely shifted to the end consumers through substantial hikes in prices of both diesel and petrol in the last one year. Therefore, the fear of the potential burden on account of oil price spike for the OMCs is unwarranted.

Secondly, the strong momentum in the global oil price itself is likely to crack, possibly by the end of the year 2018, thanks to substantial increases in the oil production in the US which has surpassed 10 million barrels per day in November for the first time since 1970. US production is already on par with top exporter and Opec kingpin Saudi Arabia. The US drillers boosted the oil rig count to 759 in January 2018, about 34% higher than a year ago tally of 566 rigs. There are also signs that the Canadian oil production, already at 335,000 barrels per dsay, could start to rise as investment in its shale sector picks up.

On the domestic front, the existing automobile population remains robust. Now annual growth in automobile sales has also picked up. Passenger vehicle sales in India crossed 30 lakh mark for the first time in 2017, growing at a five-year high of 8.85% on the back of robust demand for utility vehicles, according to the industry sources. The vehicle sales across categories, including commercial vehicles and two-wheelers, grew a healthy 8.4% to 2,37,39,780 units in 2017.

Expected correction in the oil price and also an existing robust population of automobiles and steady growth in incremental sales of automobiles would provide stable and consistent growth outlook for the OMCs, which have a solid network of retail outlets for the sale of auto fuels and also the backward integration to produce the same. It is quite surprising to see OMC stocks (which are mainly large cap stocks, further offering safety in terms of liquidity and also some cushion on the downside in this volatile markets) are trading at or close to single-digit PEs when many mid cap stocks are still trading at over 25 to 30 times their current year’s expected earnings. It is quite possible for the OMCs to correct this aberration, and thereby reward the investors impressively in the near future.

The writer is founder and managing director, Equinomics Research and Advisory  Pvt Ltd