OMCs to experience another wave of heavy inventory losses

Regulated POL products’ prices were lowered for the second time in the last two months, raising concerns of possible inventory losses for Oil Marketing Companies. Whether these inventory losses would hinder profitability in the upcoming quarter is dependent on the movement in products’ prices in June and July.  

To recall, the Power Division estimated that the OMC sector collectively incurred ~  PKR 9 BN month in inventory losses during April, as a result of downward revision in prices and lower offtakes that caused storage capacities to fill up—repricing of higher inventory levels.

Ex-Refinery Prices of HSD dropped 55% from PKR 69.28/liter to PKR 30.99/liter, while that of MS dropped from PKR 55.71/liter to PKR 35.73/liter, down by 36%.

According to our estimates, assuming 15 days of MS inventory and 30 days of HSD, we estimate the four companies (PSO, APL, SHEL, HASCOL) to collectively incur inventory costs of ~ PKR 12 BN for the month.

To mitigate the challenge of determining what levels of inventory are being held at what time, we have provided a sensitivity in the Appendix, outlining different inventory losses at different inventory levels by company—(Annexure A: April Inventory Loss by company by inventory level).

Inventory Losses to ease going forward:

As earlier stated, the losses for the entire quarter are dependent on the trajectory followed by prices going forward. Furthermore, if the trajectory in first week of May is any indication, then the dust has settled, and prices are seen trending upwards.

The front month Gasoil and Gasoline active contracts have recovered 10% and 24%, respectively, since the beginning of the month (See Annexure B: Gasoil and Gasoline Active Contracts).

The recovery is explainable by the recovery in crude oil prices—Brent/WTI up 26%/10% since the beginning of May—and expectations of improving demands as the economies around the world step out of a global lockdown.

We view some form of stability having been introduced to the market, which is expected to keep prices in check, and opine an incredibly low probability of a similar slump in the products’ prices going forward.  

However, we do not foresee the inventory gains in the two months to be enough to mitigate the mammoth losses raked up in the month of April.

Recommendation:

Barring the risks posed by the inventory losses in the short-term, we opine that the long-term thesis of return of demand to the sector and inflationary hedge remains. Hence, we continue to like the sector and rate it “Outperform.PSO (TP: PKR 199/sh) and APL (TP: PKR 324/sh) remain our top picks, offering a 26% and 18% respective upside potential to current levels.

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