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Synopsis: Kotak Institutional Equities recommends selling shares of oil and gas PSUs, including IOC, BPCL, HPCL, GAIL, Petronet LNG, and Oil India, due to high capex and weak returns. The brokerage maintains a cautious view on the sector, citing large investments that have not yielded strong returns, volatility in earnings, and market overvaluation.
Kotak Institutional Equities has issued a cautious outlook on oil and gas public sector undertakings (PSUs), suggesting 'Sell' ratings for Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL), Hindustan Petroleum Corporation (HPCL), GAIL, Petronet LNG, and Oil India. The brokerage also holds a 'Reduce' rating on Oil and Natural Gas Corporation (ONGC).
High Capex and Weak Returns
Kotak highlights that oil PSUs have significantly increased their capital expenditure (capex) over the years. From FY2019-24, capex has tripled compared to FY2005-09, yet the returns on these investments have been relatively weak. This large and rising capex is a primary reason for Kotak's cautious stance on the sector's prospects.
Earnings Volatility
The report notes that near-term earnings estimates are optimistic, assuming favorable prices and margins. However, past earnings have shown volatility due to macroeconomic conditions and government policies. Despite a strong market performance, Kotak believes the Street is overlooking the potential weak returns from large capex.
Sector-Specific Challenges
Upstream Companies: Despite significant capex, oil and gas production and reserves are declining.
Refining Sector: There is surplus capacity, making the creation of new capacity questionable.
Petrochemicals: This new focus area for PSUs has seen dismal performance historically.
OMCs (IOC, BPCL, HPCL): Gross refining margins (GRMs) have been unusually high, raising concerns about sustainability.
Market Valuation Concerns
Kotak argues that the market is giving generous multiples to near-term elevated earnings, ignoring the large capex and likely weak returns. The brokerage maintains a cautious view on oil PSUs, noting that high capex has resulted in low free cash flow relative to profit after tax (PAT).
Conclusion
Kotak's analysis suggests that the conventional oil and gas sector is a sunset industry with low returns, and the current high capex trend among PSUs will likely continue to yield weak returns.
Disclaimer: The views expressed are those of the analyst and brokerage firm and not of this publication. Investors are advised to consult their financial advisor before making any investment decisions.
