Are Indian Oil Marketing Companies Overvalued?

Indian oil marketing companies have experienced significant gains in the past month, and indications suggest the rally may continue.

Indian Oil Corp., Bharat Petroleum Corp., and Hindustan Petroleum Corp. have surged by 19–27% in the past one month against the backdrop of Brent crude oil prices fluctuating between $74 and $84 per barrel and increased global petroleum demand.

Remarkably, these OMCs still trade at lower EV/Ebitda multiples compared to their global counterparts.

As per recent market capitalization and Ebitda figures from the last 12 months, Indian OMCs trade at EV/Ebitda multiples ranging from 3.59 to 5.02, with HPCL being the most expensive and BPCL the least.

These multiples are notably lower than those of major global peers such as Chevron Corp., Saudi Arabian Oil Co., and Exxon Mobil Corp., which command higher valuations. For instance, Chevron holds the highest valuation at 13.27, while Saudi Arabian Oil Co. has an EV/Ebitda multiple of 7.69.

When considering historical EV/Ebitda multiples, Indian OMCs currently trade at a seven-year low. In contrast, global peers like Exxon Mobil Corp., Shell, BP Plc., Chevron Corp., Valero Energy Corp., and Marathon Petroleum Corp. saw lower multiples in FY22 and FY23 compared to the current figures.

The valuation of Indian OMC has notably decreased since FY20, when they traded at double-digit EV/Ebitda multiples ranging from 10–15. The higher valuations were on account of lower earnings due to the Russia-Ukraine war. The Indian OMCs, however, have recouped the losses since then, benefiting from India managing to get discounted Russian crude imports.

According to FY25 Ebitda Bloomberg consensus estimates and current enterprise value, forward valuations for the OMCs might surpass those of global peers like Exxon Mobil, Chevron, Shell, and BP.

Based on these estimates, HPCL would remain the most expensive among Indian packs at 7.39, while Indian Oil would be the least expensive at 6.93.

However, it's important to note that any positive shifts in forward estimates and subsequent stock performance could lead to variations in valuations.

The recent rally stems from several favourable factors, including stable Brent crude oil prices despite disruptions and production cuts by OPEC and its allies. Additionally, government policies and the absence of fuel price cuts have shielded oil marketing companies from margin erosion. Further, OPEC+ cuts and oil shortages have increased global petroleum demand, keeping petroleum product margins high.

JPMorgan's latest note on Feb. 23 highlights strong integrated margins, with petrol and diesel margins nearing $20 per barrel, twice the mid-cycle average. This is attributed to surprisingly positive transport fuel demand, according to the brokerage. JPMorgan also stated that a well-supplied oil market and hardware upgrades will drive the next leg of earnings upgrades within the sector.

The strengthened government focus on expansion and energy transition, as well as elevated capex, will allow the Indian oil and gas PSUs to clock higher profitability and stronger cashflows, according to Harhsraj Aggarwal, lead oil & gas analyst at Yes Securities.

Despite optimism, certain risks could dampen the rally. Increased Brent crude prices due to geopolitical tensions or further OPEC+ supply cuts may narrow crude discounts, affecting OMC margins. Moreover, higher windfall taxes and delays in investment execution could defer earnings estimates.

CLSA notes that current stock prices are much higher than historical marketing margins. While a fuel rate cut does seem less likely now, a 5–7% rally in crude prices may again raise worries over marketing margins, the brokerage said. Furthermore, large global refining capacity additions could also raise doubts over the continuation of current high margins.