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Pricing Deregulation & Reforms Could Re-Rate Downstream PSUs: Macquarie

  • ``The changes do not alter our fundamental view on any stock, except Cairn India. However, the possibility of substantially increased subsidies are a concern for the Indian economy as a whole, and pricing deregulation and reforms may need to be resorted to sooner rather than later, in our opinion, which could re-rate the downstream PSUs, and relieve the whole sector,`` said Macquarie Capital Securities India.

  • Macquarie`s new global oil economist Vikas Dwivedi has sharply hiked house assumptions for FY13-16E Brent crude prices by 20-50%. He believes that the probability of demand growth and constrained supplies more than offset global macro concerns and Libyan/Iraqi/ US shale gas production growth.

  • Further, boosted by a 21% depreciation of the Rupee, the FY13-14E subsidy loss (under-recovery) estimates have ballooned 2-3x to USD 34-40 billion. In our view, this is neutral for upstream producers (ONGC, Oil India); but downstream marketers (IOCL, BPCL, HPCL) could face near-term pressure, given political considerations preventing full pass-on of higher domestic prices and the poor state of government finances restraining cash reimbursement.Subsidies to balloon to USD 34-40 billion, Govt to share much higher burden:The double whammy of higher crude prices and a depreciating rupee could increase under-recoveries of subsidized fuels, which are already very high. The government could need to provide increased reimbursements (68% vs our earlier estimates of 57% of total subsidies) to Oil Marketing Companies (OMCs) or raise prices to ensure they make reasonable profits for sustenance

  • OMCs could bear higher subsidy losses, and increased interest costs:As higher under-recoveries and constrained reimbursements imply a larger burden on OMC balance sheets for the usual 1-2 quarter delay for the government provided cash, we see OMC interest costs remaining high. We cut FY12-14E PAT estimates for OMCs by 6-18%, and TPs by 13%-17% (see alongside).

  • Upstream PSUs may scrape through unscathed, but un-benefited:ONGC and Oil India have a natural hedge to subsidies, and hence the negative impact is blunted. However, we reduce upstream sharing estimates for FY13- 14E to 28% from 33% earlier (Fig 5-6), as we believe the government could try to maintain their revenue-neutrality, for better realization in their planned FPOs. We broadly maintain earnings estimates & TP for ONGC, Oil India and GAIL.

  • Cairn India to benefit substantially:As India`s (and arguably Asia`s) only pure crude play, we upgrade Cairn India`s FY13-14E PAT by 18-28%, TP to Rs 389/sh, and rating to Outperform. (see detailed note)

  • RIL`s minor benefit:As RIL`s oil production is small, the positive impact of crude prices is minor. However, ramp-up of shale liquids in FY14E increases RIL`s leverage to crude. The impact of depreciated rupee assumptions has already been incorporated in our recent note, and we maintain earnings & TP.

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