We expect the I-Sec oil & gas universe to post 11.9% YoY earnings growth with 42.2% YoY revenue growth in Q1FY09E. Strong refining margins would lead to impressive earnings growth for Reliance Industries (RIL) while higher net realisations would support earnings of ONGC. Gas distribution companies, Gujarat Gas Company (GGCL) and Indraprastha Gas (IGL), would also post impressive earnings growth. Gross under-recoveries are expected to increase 3.2x led by 79% YoY rise in crude prices. We are positive on GAIL and GGCL (due to increased visibility on gas supply) as well as RIL (due to sustained uptrend in GRMs). OMCs as well as ONGC are likely to remain subdued due to uncertainty on the eventual subsidy sharing in FY09.
· Crude surprises for OMCs, ONGC. High crude prices have led to serious concerns on liquidity and profitability of OMCs as bonds are difficult to sell and these OMCs are forced to sell petroleum products at discount to consumers. Due to the
ad hoc nature of subsidy sharing and Rs400bn unresolved subsidy burden, as per the latest Government policy, we believe that ONGC would remain subdued as the additional burden may be borne by the company.
· GRMs improve, retail remains under pressure. GRMs improved 4% YoY to US$6.3/bl led by higher spreads on HSD & SKO. Rise in crude due to depreciating US dollar and geo-political tensions led to spurt in global product prices. This resulted in 321.2% rise in under-recoveries to Rs544bn despite Rs5/litre, Rs3/litre & Rs50/cylinder increase in MS, HSD & LPG prices respectively.
· Crude worries on horizon. We expect burgeoning crude prices to impact sector earnings and valuations. OMCs would suffer from increasing under-recoveries while upstream companies (ONGC, GAIL) would be impacted by higher share of subsidy burden. Refining & petrochemical margins are expected to decline further due to demand destruction at higher crude prices.
· Earnings growth to continue for now. We expect earnings for the I-Sec oil & gas universe to improve 11.4% YoY to Rs109bn (21% growth QoQ). RIL & ONGC are likely to lead the pack due to superior refining margins and favourable subsidy sharing scheme. Gas stocks (IGL & GGCL) would post impressive earnings growth on higher sales volumes & margins. We estimate Hindustan Petroleum Corporation (HPCL) to register marginal profit in the quarter and GAIL to register flat YoY earnings growth. However, future earnings are at risk due to risk to refining & petchem margins on account of demand destruction from high crude prices and uncertainty on subsidy sharing, especially if crude prices remain firm.
· We prefer GAIL & GGCL on the back of increasing gas supplies in the country and possible upside to earnings. We remain upbeat on RIL due to recent correction and improved profitability from the refining and E&P businesses. GGCL, though under a cloud of uncertainty regarding gas supplies, may be the key beneficiary of the proposed gas allocation policy and initial supplies from the KG Basin.
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