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UBS Investment Research
Bharat Petroleum Corporation
I rrational exuberance: downgrade to Sell
Event: stock’s outperformance due to diesel price hike
Bharat Petroleum (BPCL) has outperformed the BSE Sensex 12.4% over the past
three months. We believe this was mainly in anticipation of: 1) a fuel price hike;
and 2) petroleum product pricing reforms. Post the 24 June price hike/duty cut, we
do not expect further positive action by the government this year.
Impact: BPCL is unlikely to be the beneficiary of the price hike
BPCL and other oil marketing companies (OMCs) retail diesel/cooking fuels at
government-capped prices. The government pays them to make up for: 1) any
losses they make on selling the fuels below market price; and 2) a governmentdetermined
notional profit. The latter is in lieu of the profit the OMCs would have
made were the fuel prices market determined. We believe these are below the
actual margin a private player would make.
Action: downgrade to Sell on valuation and lack of catalyst
BPCL does not benefit from fuel price hikes unless there is full pricing freedom for
LPG, kerosene and diesel; at best, diesel prices may be deregulated over the next
one year. However, that benefit would only be short term as private companies
(RIL, Essar, etc) would then come in and take away market share. Currently, the
OMCs still make a notional loss of Rs6/litre on diesel. We downgrade our rating to
Sell and lower our price target from Rs660 to Rs630 on higher closing debt. We
maintain our estimates.
Valuation: Sell with price target of Rs630
We calculate EV at 6.5x FY13E EBITDA and add treasury shares and upstream
business to arrive at our price target. The stock is trading above its 5-year historical
P/BV multiple. We prefer upstream companies such as ONGC (large cap) and Oil
India (mid cap).
Downstream losses are primarily due to lower
margins
We believe downstream companies’ net reported losses (net under recovery) are
primarily opportunity losses as government subsidy and upstream discounts
cover the actual losses, leaving some notional losses due to lower margins. We
estimate this is and has been the case for diesel and LPG in most years.
We illustrate below how a hike in diesel retail prices actually does not affect the
profit that BPCL makes (if we do not factor in the interest on the additional
short-term borrowing due to the lag in receipt of subsidy).
Say the diesel market price is US$105. Of this, US$5 is the margin (opportunity
cost) and US$100 is the cost of diesel.
Case 1—Pre hike: when BPCL sells it at the government-capped price of 90
BPCL records a loss of US$105-90=15 on selling it below the cost of
manufacturing and selling. Its US$15 loss includes actual loss + notional
margin.
BPCL does not make the margin of US$5. In lieu of this, the government lets it
make a notional margin of US$3 (through government and upstream
contribution), leaving it with a net loss of US$2.
Case 2—Post hike: when BPCL sells it at the government-capped price of 95
BPCL records a loss of US$105-95=10 on selling it below the cost of
manufacturing and selling.
Again, BPCL does not make the margin of US$5. In lieu of this, the government
lets it make a notional margin of US$3 by reducing its own and upstream
contribution and keeping BPCL absolute margins the same as in Case 1.
And BPCL’s selling price is above the cost of producing diesel + the margin
the government allows BPCL i.e. S> A+M
We believe this can happen only if oil prices fall below US$90/bbl as diesel
margins turn positive, but then the likelihood of higher duties increases.
Further, as prices become more market determined, private players such as
Reliance Industries and Essar Oil will likely step up their retail foray and take
away market share.
Downgrade to Sell
We believe price hikes are beneficial for the upstream companies i.e. ONGC and
Oil India as this leads to an increase in their net realization, while the retailers’
margins remain unchanged.
BPCL has outperformed the BSE Sensex 12.4% over the past three months. We
believe this was mainly due to (an anticipation of):
a) Fuel price hike (diesel, LPG and kerosene prices were raised in end-
June by 9%, 14.5% and 20%, respectively).
b) Reforms in duty structure, method of subsidy payout and beneficiaries
of the subsidy.
The notional profit is in lieu of the profit the OMCs would have made were the
fuel prices market determined (opportunity cost), but are normally slightly
below the actual margin a private player would have made.
BPCL does benefit from fuel price reforms to the extent that less capital is tied
up till it receives the subsidy payment. We downgrade BPCL as we believe the
stock outperformance has been better than justifiable due to lower short-term
debt. BPCL does not benefit from fuel reforms until the retail price is high
enough not only to lead to nil subsidies, but also higher profits than the notional
profits. However, that benefit will also be short-lived—as prices become more
market determined, private companies (RIL, Essar, etc) will come in and take
over market share.
Valuation
The stock is currently trading at 1.6x FY12E P/BV. We value the enterprise
value at 6.5x FY13E EBITDA and then adjust for treasury shares and upstream
business to derive the equity value. We use the EV/EBITDA approach to value
the stock, given the uncertainty over deregulation.
Table 2: Target price derivation
(Rs m) Comments
Enterprise value 284,363 6.5x FY13E EBITDA
Less: Net debt 95,647
Add: Treasury shares 17,148 Valued at 84% of the market value
Add: Upstream business 23,000 Valued at US$ 500m, 8tcf, 50% risk adjusted
@US$6/boe; BPCL has a 10% interest.
Equity value 228,864
Outstanding shares (m) 361.5
Target price (Rs/share) 630
Source: UBS estimates
Bharat Petroleum Corporation
Bharat Petroleum Corporation Limited (BPCL) is a 54.93% Government of
India (GoI) owned enterprise. Its two main businesses are refining and
marketing. It has a total refining capacity of 22.5mmtpa. While the marketing
part of its business (diesel, LPG and kerosene) is regulated, its refining business
is free market and tracks international trends.
Statement of Risk
We believe change in regulation is one of the major risks to our analysis. The
performance of the company is sensitive to international oil prices.
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