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BPCL — Raise PO by 14% but prefer HPCL
Country Overview
Raise PO by 14% to Rs739 to reflect likely re-rating; Neutral
The government on June 24 hiked fuel prices and cut taxes to cut subsidy by over
US$10bn. However, there is no clarity on subsidy sharing. It is therefore difficult
to estimate the gains from subsidy cut especially to R&M companies. Therefore
changes in BPCL’s FY12-FY13 EPS are modest. However, investors are likely to
be enthused by the fact that diesel would be deregulated if oil price declines by
11%. To reflect the likely re-rating we have raised PE multiple used to value
BPCL to 9.5x from 8x earlier. This has meant 14% upgrade in its PO to Rs739.
BPCL has the best leverage to reforms among R&M but we prefer HPCL, which
is cheaper and we think also has good leverage to reforms. We retain our
Neutral..
R&M companies high risk-high return play on reforms
R&M companies’ stock price always reacts more positively to reforms than
upstream. R&M company stocks were up far more than upstream peers after the
fuel price hikes in June 2010. HPCL was the best performer followed by BPCL.
Risks to R&M: high share in subsidy & large inventory loss
The main driver of R&M earnings is compensation of subsidy from government
and upstream. High share in subsidy is thus one of the risks. The other risk is
large inventory loss due to steep decline in oil price. In FY09 R&M companies
had their lowest earnings due to inventory loss despite not having to bear any
subsidy.
Expect investors to look at the glass as half full
R&M earnings are difficult to predict but this may also mean positive surprise like
in FY10-FY11. There was unexpectedly higher compensation from upstream in
FY11 and from government in FY10. This should make investors optimistic. Even
in case of large inventory loss due to oil price collapse investors may focus on the
better outlook for FY13 rather than the poor outlook in FY12.
