We reiterate our negative stance on OMCs, while seeing a possibility of further curtailment of profitability given the rising ask-rate of fuel prices hikes amid higher crude and a weaker rupee. We also see negative implications for upstream PSUs, but retain ‘Add’ on ONGC with the stock discounting lowest crude price realized over the past decade.

A sharp crude moderation may help, but seems unlikely in the near term. The government announced a reduction in retail prices of diesel and gasoline by (1) undertaking a cut in excise duty by Rs 1.5/liter, (2) asking OMCs to absorb Rs 1/liter implying a reduction in their marketing margins and (3) urging states to cut VAT by a similar amount of Rs 2.5/liter, to which states that are being ruled by the same party as the Centre, have obliged. The reduction in excise duty will reduce the government receipts by Rs 105 bn and curtailment of margins will impact OMCs’ profits by Rs 50 bn, for the remainder of FY19.

We see negative implications for the earnings of oil PSUs and more important, uncertainty around that in the near term, as the government attempts to prioritise between (1) lower fuel prices for end-consumers before state/central elections, (2) management of fiscal receipts amid continuing shortfall in GST collections and (3) profitability of oil PSUs.

The government’s ad-hoc interventions in fuel prices and subsidy sharing historically suppressed earnings and return ratios for these companies, while limiting visibility on profits until the end of every year during that time.

We cut our FY19-20 EPS estimates for OMCs by 9-15% for now, factoring in (1) lower marketing margins on auto fuels for FY2019, (2) our assumptions of higher crude prices and a weaker rupee, (3) lower underlying refining margins and (4) other minor changes.