India Refining & Marketing Window of opportunity emerges; prefer BPCL:: JPMorgan

Falling commodity prices, and regular diesel price hikes have created a
more benign environment that has seen a window of opportunity open for
the state-owned refining & marketing companies. The government’s
resolve to push through monthly hikes thus far is admirable – we do not
expect this to last the whole year, but see this contributing to a reduction
in subsidies. We continue to prefer BPCL, which adds its E&P portfolio
and more stable refining

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 Price hikes paying dividends: The diesel price hikes carried out
monthly, since January, have helped moderate subsidy losses (FY14E –
Rs1.16tn vs. Rs1.5tn). While this process remains tenuous (March hike
was postponed while Parliament was in session), it has helped prices
creep upwards, without the ructions seen with ad-hoc increases.
 Crude pullback provides comfort too: Commodity prices have
corrected sharply, with losses on diesel falling Rs6/lt. While the pullback
may prove to be temporary (we have seen corrections in the spring in the
past), we do expect the combination of rapidly rising crude supplies,
coupled with relatively moderate demand growth, to help keep crude
levels lower than levels seen in the past 2 years.
 Refining remains volatile: Refining performance across the three SOE
refiners has been volatile over the past 4-6 quarters, with margins
significantly lower than regional benchmarks. With margins starting
FY14 at subdued levels, and market likely to be oversupplied, we expect
refining to remain a pressure point. BPCL has, however, performed
better over the past year, with margins better placed than its peers.
 Is this a sustainable rally? While early to predict structural change, we
expect that 5-6 monthly hikes this year, coupled with moderating crude
prices, would see a rally in SOE R&M stocks continue in the near term.
 We prefer BPCL: BPCL (OW) remains our top pick in the space. While
providing leverage to policy/falling crude, its refining performance has
been more stable than peers. Its emerging E&P portfolio continues to be
a key value driver, with yet another positive test well in Mozambique
highlighting the value of the block. We upgrade HPCL to OW in the
backdrop of a more benign environment, and remain Neutral on IOCL.