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UBS Investment Research
India Oil and Gas
Looking beyond deregulation
Value emerging from non-regulated business
The share prices of oil marketing companies (OMCs) have declined recently on a
lack of industry reform. We now expect high oil prices and rising inflation to delay
diesel price deregulation beyond our earlier estimate of March/April. We believe
some OMC stocks are now attractive due to their non-regulated business and
dividend yields, including Indian Oil Corporation (IOC) with a yield of 4.2%.
Upgrade rating for IOC to Buy and BPCL to Neutral due to valuations
Given uncertainty on deregulation, we believe EV/EBITDA is a better valuation
tool than P/BV, which we used previously. Despite EV/EBIDTA being more
conservative, we upgrade our rating for IOC to Buy and our rating for Bharat
Petroleum Corporation (BPCL) to Neutral on valuations. Recent expansion in
upstream petrochemicals and refining should support the earnings of both IOC and
BPCL. Expansion has been delayed at Hindustan Petroleum Corporation (HPCL),
and we downgrade our rating on the stock to Sell.
No diesel deregulation means the government pays, rather than consumers
We are not changing our earnings estimates for FY13 and beyond as: 1) we
previously expected only diesel prices to be deregulated; 2) we assumed
conservative diesel margins on rising competition; and 3) OMCs should continue
to generate margins irrespective of deregulation (from government subsidies, rather
than from consumers).
Among OMCs, we prefer stocks with low leverage to deregulation
Deregulation plays are policy linked, and we believe gains for incumbents will be
short-lived due to increased competition; hence we upgrade IOC and BPCL, and
downgrade HPCL—the OMC most leveraged to deregulation, in our view. Essar
Oil is our top sector pick on its timely refinery upgrade and attractive valuations.
Investment summary
We update our price targets and ratings for India oil marketing company (OMC)
stocks following recent share price declines. We have not changed our stance on
the country’s oil and gas sector; we still prefer companies that have sustainable
growth potential and/or are supported by valuations, rather than just considering
upside from any future deregulation. We believe the market is now pricing in a
delay to deregulation and now expects partial deregulation—that is, diesel pricing
reform—rather than one-off full deregulation, in line with our assumptions.
We push back our expectation of diesel deregulation by six to nine months from
our earlier expectation of March/April. However, we are not lowering our
earnings estimates as we expect the government to allow the OMCs to generate
some margins in diesel while asking the companies to sell LPG and kerosene
below market prices. In the past, the government and upstream companies have
paid out 80-100% of the sector under-recovery and we expect them to continue
to do so, until the government introduces reforms.
We lower our price targets for IOC, HPCL, and BPCL. We now use more
traditional EV/EBIDTA methodology to value the OMCs given uncertainty on
deregulation (we previously used a premium to historical P/BV; however, for
IOC and BPCL we would reach the same valuation if we remove the
deregulation premium).
Table 1: Price target derivation
P/BV approach
(Rs)
EV/EBIDTA
approach without premium with deregulation premium
IOC 390 400 430
HPCL 350 400 440
BPCL 661 660 680
Source: UBS estimates
We upgrade our rating for IOC to Buy due to its valuation. We upgrade our rating
for BPCL to Neutral, but we downgrade our rating for HPCL to Sell. Non-regulated
business provides support for the earnings of both IOC and BPCL, in our view. IOC
commissioned its US$3bn petrochemical complex and raised refining capacity in
late 2010. For BPCL we have priced in some of the upstream option and the
commissioning of its long-awaited Bina refinery. In the case of HPCL, however,
there is negative news (see our 20 December 2010 note Lower PT on possible
refinery delay) as we believe its new refinery will be delayed until 2012.
Delay to diesel pricing freedom means oil marketing companies continue to
receive subsidies from the government, rather than revenue from the consumer.
We are not making changes to our earnings estimates for FY13 and beyond as 1)
we were already expecting only diesel price deregulation; 2) we assumed
conservative margins in diesel due to rising competition; 3) companies should
generate these margins irrespective of deregulation as a result of subsidies from
the government.
Top picks: Deregulation plays are policy linked and gains will be short-lived, in
our view. This is reflected in our Buy rating for IOC, rather than the more
deregulation-leveraged HPCL and BPCL. IOC has surprised the market by
falling 23% in the past three months, while the BSE Sensex has fallen 14% in
the same period. We believe Essar Oil stands to benefit more from deregulation
in the longer term through rising market share.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Oil and Gas
Looking beyond deregulation
Value emerging from non-regulated business
The share prices of oil marketing companies (OMCs) have declined recently on a
lack of industry reform. We now expect high oil prices and rising inflation to delay
diesel price deregulation beyond our earlier estimate of March/April. We believe
some OMC stocks are now attractive due to their non-regulated business and
dividend yields, including Indian Oil Corporation (IOC) with a yield of 4.2%.
Upgrade rating for IOC to Buy and BPCL to Neutral due to valuations
Given uncertainty on deregulation, we believe EV/EBITDA is a better valuation
tool than P/BV, which we used previously. Despite EV/EBIDTA being more
conservative, we upgrade our rating for IOC to Buy and our rating for Bharat
Petroleum Corporation (BPCL) to Neutral on valuations. Recent expansion in
upstream petrochemicals and refining should support the earnings of both IOC and
BPCL. Expansion has been delayed at Hindustan Petroleum Corporation (HPCL),
and we downgrade our rating on the stock to Sell.
No diesel deregulation means the government pays, rather than consumers
We are not changing our earnings estimates for FY13 and beyond as: 1) we
previously expected only diesel prices to be deregulated; 2) we assumed
conservative diesel margins on rising competition; and 3) OMCs should continue
to generate margins irrespective of deregulation (from government subsidies, rather
than from consumers).
Among OMCs, we prefer stocks with low leverage to deregulation
Deregulation plays are policy linked, and we believe gains for incumbents will be
short-lived due to increased competition; hence we upgrade IOC and BPCL, and
downgrade HPCL—the OMC most leveraged to deregulation, in our view. Essar
Oil is our top sector pick on its timely refinery upgrade and attractive valuations.
Investment summary
We update our price targets and ratings for India oil marketing company (OMC)
stocks following recent share price declines. We have not changed our stance on
the country’s oil and gas sector; we still prefer companies that have sustainable
growth potential and/or are supported by valuations, rather than just considering
upside from any future deregulation. We believe the market is now pricing in a
delay to deregulation and now expects partial deregulation—that is, diesel pricing
reform—rather than one-off full deregulation, in line with our assumptions.
We push back our expectation of diesel deregulation by six to nine months from
our earlier expectation of March/April. However, we are not lowering our
earnings estimates as we expect the government to allow the OMCs to generate
some margins in diesel while asking the companies to sell LPG and kerosene
below market prices. In the past, the government and upstream companies have
paid out 80-100% of the sector under-recovery and we expect them to continue
to do so, until the government introduces reforms.
We lower our price targets for IOC, HPCL, and BPCL. We now use more
traditional EV/EBIDTA methodology to value the OMCs given uncertainty on
deregulation (we previously used a premium to historical P/BV; however, for
IOC and BPCL we would reach the same valuation if we remove the
deregulation premium).
Table 1: Price target derivation
P/BV approach
(Rs)
EV/EBIDTA
approach without premium with deregulation premium
IOC 390 400 430
HPCL 350 400 440
BPCL 661 660 680
Source: UBS estimates
We upgrade our rating for IOC to Buy due to its valuation. We upgrade our rating
for BPCL to Neutral, but we downgrade our rating for HPCL to Sell. Non-regulated
business provides support for the earnings of both IOC and BPCL, in our view. IOC
commissioned its US$3bn petrochemical complex and raised refining capacity in
late 2010. For BPCL we have priced in some of the upstream option and the
commissioning of its long-awaited Bina refinery. In the case of HPCL, however,
there is negative news (see our 20 December 2010 note Lower PT on possible
refinery delay) as we believe its new refinery will be delayed until 2012.
Delay to diesel pricing freedom means oil marketing companies continue to
receive subsidies from the government, rather than revenue from the consumer.
We are not making changes to our earnings estimates for FY13 and beyond as 1)
we were already expecting only diesel price deregulation; 2) we assumed
conservative margins in diesel due to rising competition; 3) companies should
generate these margins irrespective of deregulation as a result of subsidies from
the government.
Top picks: Deregulation plays are policy linked and gains will be short-lived, in
our view. This is reflected in our Buy rating for IOC, rather than the more
deregulation-leveraged HPCL and BPCL. IOC has surprised the market by
falling 23% in the past three months, while the BSE Sensex has fallen 14% in
the same period. We believe Essar Oil stands to benefit more from deregulation
in the longer term through rising market share.
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