ICICI Securities: Sector update on oil PSUs: BUY all -AIL, hpcl, bpcl, Oil India, ONGC

We maintain positive stance on oil PSUs owing to anticipated clarity on diesel
reforms, eventual subsidy sharing by the Government before IOC and ONGC FPOs
in FY11 so to attract long-term investors. Though oil marketing companies (OMCs)
and upstream PSUs have already posted impressive gains post the announcement
of fuel price hike and MS price de-regulation in June ’10, we still see some upside
likely, as the market incrementally prices in the positive impact from these
changes. Based on management guidance, annual report update and Q1FY11
subsidy sharing, we raise end-FY11 target price for upstream PSUs (ONGC, OIL
and GAIL) 3%-13%, as we expect them to share a lower subsidy burden of 33%
(from 50% earlier). We also raise end-FY11 target price for OMCs (BPCL & HPCL)
23%-29% as we anticipate higher retail EBITDA led by higher MS/HSD retail sales
volume expectation during FY11-FY12 (based on Petroleum Planning & Analysis
Cell [PPAC] analysis and YTD FY11 sales volume growth).
􀁦 FY11E gross under-recoveries at Rs490bn are at comfortable levels, which can be
easily shared among oil PSUs and the Government. We have factored in 33.3%
sharing by upstream PSUs, 50% by the Government and the remaining by downstream
PSUs.
􀁦 Expect clarity on HSD price reform & subsidy sharing before IOC & ONGC FPOs.
Given upcoming ONGC & IOC Follow-on Public Offers (FPOs), we expect clarity from
Government on possible HSD reforms and subsidy sharing. Possibility of HSD price deregulation
within range bound crude prices (US$65-80/bl) can’t be ruled out. Moreover,
inflation is expected to dip in next six months which would support HSD price reforms.
􀁦 Low-cost infrastructure will help OMCs compete effectively with private players
as they can easily reduce their retail margins while maintaining higher RoCE vis-à-vis
private firms. Further, free pricing could allow them to raise MS/HSD prices outside
cities, offsetting higher fuel transportation costs and lower per outlet sales volume.
􀁦 BPCL net debt overstated; Prefer BPCL to HPCL. BPCL’s FY10 working capital
(WC) significantly increases by Rs39bn versus past trend and that of HPCL’s Rs2bn,
due to inventory build-up for Bina refinery commencement. Though this spike in WC
would come down to normal levels post Bina refinery’s IPO, it might mislead market as
it overstates BPCL’s net debt by ~Rs120/share. Furthermore, on reported FY11 P/BV,
BPCL (2.01x) may appear to be trading at premium to HPCL (1.57x), but after
adjusting for treasury stocks and investment stakes, BPCL’s P/BV at 1.38x is at par
with HPCL’s 1.41 (Table 9), while BPCL offers huge E&P upside potential.
􀁦 GAIL could benefit if its FY11 subsidy share falls in line with Q1FY11. GAIL’s
share of upstream subsidy burden in Q1FY11 came in at 6.7% - lower than 8.9% in
FY10 and below our FY11 expectation of 10.6% (based on past year’s profitability
among upstream PSUs). If FY11 subsidy burden continues to be at Q1FY11 levels i.e.
6.7%, GAIL’s fair value would jump 6% to Rs552/share, a huge positive for the stock.