We remain cautious on the SOE R&M space. Elevated subsidy losses
(c$33bn), despite reform, will be a drag on earnings delivery, leaving
BPCL/HPCL/IOCL dependent on government/upstream support. Refining
performance has been volatile, compounded by large inventory losses. We
prefer BPCL – while earnings are sensitive to subsidies, we think an
emerging E&P portfolio will lead to value creation. HPCL remains the
least preferred, with high sensitivity to policy measures.
Reform – is it enough? Despite the recently announced reform
measures, we estimate a subsidy loss of Rs1.77tn (~$33bn) in FY13.
Less than regular adjustments to petrol prices adds a further burden to
downstream earnings – we expect the downstream to collectively bear
~Rs50bn of subsidy losses in FY13/14.
Refining remains volatile: Refining performance has been volatile, with
significant variation in margins across periods. While all 3 companies are
carrying out upgrades/commissioning new refineries, we are cautious on
the refining space regionally, and expect to see benchmark margins trend
lower over 2013.
Prefer BPCL: BPCL is our preferred pick in the SOE space. While
BPCL earnings remain leveraged to policy measures, we expect its
emerging E&P portfolio to create value. While offshore developments
are not without risk, we see the potential to de-risk the domestic
business. Recent transactions (Cove Energy) also provide valuation
comfort.
HPCL least preferred: With high sensitivity to policy measures
(Rs20bn additional subsidies for R&M cut EPS by 43%). While falling
crude would be positive for HPCL, we still expect subsidy losses to
remain elevated over FY13-14 (US$33bn/$28bn). With the expectation
of only modest reforms to come, we expect HPCL to underperform.
Valuations, ratings: We are OW BPCL, N IOCL and UW HPCL. We
value all three at 6x EV/EBITDA (in-line with regional refiners), while
building in Rs50bn in total marketing losses borne by the downstream
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