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Refining into Asia’s heart
India on its way to be Asia’s refining hub
India’s refining story continues to bolster with substantial capacity
additions, leading the country to assume a significant share (15%) in
the Asian refining capacity. In the next five years, we expect India to
add 35MMT in refining capacity, making it a vital refining player in
Asia.
However, we expect the refined products surplus to be capped at
~50MMT due to the strong domestic demand growth, driven
predominantly by transport fuels as both petrol and diesel are
expected to grow at a CAGR of 4%-6% over the next five years. In
addition to this, the incremental capacity will be more complex in
nature, making the product slate more inclined towards high quality
standards demanded by export markets.
Medium term view: Global refining outlook remains subdued
Refiners in the US and Europe have continued to moderate their
refinery runs in an effort to recover margins lost since mid-CY10. With
the Asian maintenance season coming to an end, it should add some
more capacity to the markets. With this in mind, the overall product
markets are expected to be weak over the next 2-3 quarters, leading to
a flattish refining margin profile.
Crude price outlook – Range bound and to stay that way
So far in CY10, crude prices have remained within a fairly established
range of USD70-85/bbl; sometimes fluctuating due to factors such as
mixed macroeconomic data and uneven pace in global economic
recovery. For the next 12 months, the prevailing ample crude supply is
already reflected in higher stocks for both crude and products.
Secondly, with the sentiment in the refined product market being
bearish, refiners would be forced to cut utilization rates thus
withdrawing any support through crude off-take. Consequently, we
maintain our in-house forecast of crude price range of USD70-85/bbl.
In the medium term, crude prices may pull back slightly from the
current higher-end of the range, towards the mid-point of the range.
Valuation
Essar Oil is our top pick among Indian refiners as we believe its
current valuations fail to capture the potential upside that may
emerge from its E&P portfolio. Further triggers may also come from
an uptick in its GRMs due to the complexity upgrade and news flow
on diesel deregulation. We value Essar’s refining business at 6.5x
EV/EBITDA on its post expansion earnings in FY13 (INR110/sh) and
E&P business at INR70/share on a conservative valuation methods.
Alternatively, we recommend investors a switch from Mangalore
Refinery (MRPL) to Chennai Petroleum (CPCL), as we find that
MRPL’s current valuations capturing extreme bull case earnings, and
its recent run-up unwarranted. CPCL, on the other hand, is trading
at cheaper valuations, similar ROE and higher dividend yield of 5%.
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