Macquarie:: Buy BPCL: Bharat Petroleum Lower volumes a drag; Cheap valuations

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Bharat Petroleum
Lower volumes a drag; Cheap valuations
Event
 BPCL announced a PAT of Rs1.87bn for Q3FY11, which was materially lower
than our estimates due to a one-off tax provision and reduced volumes (-10%
QoQ) on account of a longer than expected shutdown in the Mumbai refinery.
 We reduce FY11-13 earnings estimates by 14-18% on higher subsidy burden
expectations due to spiralling product prices, and we cut our TP to Rs788 (-
13%). However, we believe BPCL remains the best play amongst the Oil
Marketing Companies (OMCs), which are potential safe-havens in a falling
market. We our maintain OP.

Impact
 GRMs up 3.5x YoY to US$4.8/bbl; Volumes down 10% due to shutdown:
A longer than expected 45 day shutdown in the 12 MMTPA Mumbai refinery
reduced throughput to ~5.04MMT for the quarter. GRMs have risen to
US$5/bbl and US$4.4/bbl for the Mumbai and Kochi refinery respectively.
 Retail sales up 4.9% YoY; Under-recoveries rose 46% QoQ to Rs35bn:
With auto-fuel demand growing in excess of 10% YoY, retail sales of BPCL
have risen 4.9% YoY to 7.4MMT. With increased crude prices and growth in
sales, BPCL’s under-recovery YTD burden has risen to Rs23bn, despite a last
minute allocation of Rs18bn by the Govt, in addition to Rs29.5bn in Q2.
 Increased under-recoveries to dampen-earnings: Crude prices have been
spiralling up, with Brent having touched US$101/bbl on the back of a demand
pickup, aided by concerns on continuity of trade through the Middle East
(especially Egypt) due to socio-political unrest. High product cracks (US$ 14-
16/bbl for middle distillates Diesel, Jet-Kerosene) have further exacerbated
under-recoveries for OMCs, with Diesel margins hovering at a negative Rs7/lt.
We estimate OMCs shall bear Rs67bn (8%) of Rs750bn expected total under
-recoveries in FY11E vs Rs56bn in FY10 (BPCL to share ~Rs12bn).
 BPCL’s upstream upsides (Mozambique gas and Wahoo Oil), and higher
marketing efficiency than its peers makes it the best play amongst OMCs, in
our view. Mozambique especially could be highly prospective, with four
successful wells of large pays (~500m) and the operator indicating
possibilities of an LNG facility.

Earnings and target price revision
 BPCL FY11E PAT reduces ~6% for every increase of 1% in under-recovery
share of OMCs. We are cutting FY11-13E PAT estimates on the back of
increase in subsidy sharing assumption for the Oil marketing companies from
~5% to 8%. TP has consequently been reduced to Rs788 from Rs909 earlier.

Price catalyst
 12-month price target: Rs788.00 based on a Sum of Parts methodology.
 Catalyst: Diesel price hike / deregulation

Action and recommendation
 With inflationary concerns preventing price hikes and a high fiscal deficit raising
risks of a higher subsidy share for OMCs, the stocks have already declined 21-
36% in four months. We believe OMCs are good defensives, and BPCL is
available at cheap valuations of 1.3x FY12E P/BV and 9.6x FY12E PER