Bharat Petroleum Corporation - Well oiled

Many factors like volatile crude prices and under-recoveries are hampering the bottomline, which are making investors shun the scrips of oil marketing companies (OMCs). However, at current levels, we are of the opinion that the risk-to-reward ratio favours the OMCs. This is evident from the fact that OMCs are outperforming the broader index. Hence, we are recommending BPCL as a choice scrip.

On the macro front, under-recoveries are expected to stay capped. Rather under-recoveries are expected to decline, with the government going ahead and hiking petrol prices. Also, one cannot rule out the price de-control of diesel. Secondly, with the Libyan crisis coming to an end, there will be additional supply of crude oil, which will result in some price correction. Thus, the OMCs will enjoy best of both the worlds. Further, other factors, like the company’s strong Exploration and Production (E&P) portfolio of around 26 blocks, are expected to create wealth for investors in the long run.

We feel that the under-recoveries have already been priced in. Also, under recoveries are already declining, as the government has decontrolled petrol prices. Further, over the long run, one cannot rule out the government taking the bold step of diesel deregulation for cars. On the micro front, its new 6 MMT refinery at Bina has been commissioned in FY11, and should see its first full year of operations in FY12. This will make BPCL self-sufficient in meeting the demand, and will also improve its GRMs.

On the operations front, with a Nelson Complexity of 9.1, it is also expected to improve the GRM profile from the current level of USD 3.02/barrel. While the above mentioned are the medium-term factors, in the long run the company’s E&P portfolio is expected to be a major growth driver. BPCL, through its subsidiary Bharat Petro Resources, holds a portfolio of over 26 blocks, of which 17 are located outside India in countries like Brazil (10), Australia (3) and one each in Mozambique, Oman, UK and Indonesia. Most of the acreages are deep water, and the production may still be seven to nine years away, but we are of the opinion that the market will see consistent positive news flows and new data points. The public data shows a reserve figure of 300 million, resulting in a USD 500 million valuation at current levels. This is expected to improve with more positive news flow.

We are not considering the latest quarterly results of the company, wherein it posted a net loss of Rs 2561.89 crore in Q1 FY12. The quarterly results for public sector OMCs have become less relevant, as its financial performance is mostly based on budgetary support by the government and the upstream sharing of subsidy burden, which is decided only at the end of the year. On the valuation front, the CMP of Rs 692 discounts its FY11 earnings by 16x and the EV/EBITDA stands at 9.50x. However, considering the macro and micro factors, we recommend that investors buy the scrip with a perspective of 18-24 months.