Maintain Buy on BPCL - Motilal Oswal

BPCL: Management hopeful of diesel de-regulation; To invest Rs500b in next 3-5 years; E&P reserve potential clarity by March-11; Buy

Motilal Oswal interacted with BPCL (BPCL IN, Mkt Cap US$6.2b, CMP Rs787, Buy) management to get an update on business development and their views on oil sector policy reforms.

- Expects clarity on diesel deregulation by Dec-10: Post partial de-regulation of retail fuel prices on June 26, OMCs increased petrol prices last week for the first time by Rs0.27-0.29/ltr; BPCL price hike being the highest. In terms for mechanism for petrol price change, BPCL mentioned that 1) there will be no fixed periodicity for price change as it would trigger speculation and stocking/de-stocking of fuel, and 2) price change would be effected only when the gap relative to international prices is substantial.

- On diesel de-regulation: Management believes there would be clarity on diesel de-regulation and subsidy sharing mechanism before the likely divestment/FPO in ONGC and IOC. Also, it believes good monsoon and lowering of inflation rates would help government expedite a decision on the same.

- To invest Rs500b in next 3-5 years: BPCL plans to invest Rs500b over the next 3-5 years with 70% of the capex earmarked towards refining and supporting marketing infrastructure. Also, it plans to invest Rs75b in E&P assets including Rs30b on exploration, Rs35b on development and Rs8b on shale gas initiative. Capex in the refining segment would increase its overall refining capacity from current 30.5mmt (incl Bina) to 45mmt in 36-42 months. It will increase refining capacity at Bina from 6 to 15mmt and at Kochi from 9.5 to 15mmt with a combined capex of ~Rs250b.

- Clarity in E&P reserves likely by March 2011: Currently, BPCL has not yet given out any guidance on the potential of its discoveries in Brazil and Mozambique and expects its partner (operator) in these blocks to give the resource/reserve estimates by March 2011. The current drilling program envisages 3 more wells to be drilled in its Brazil blocks in next 6-8 months. Revenues from its E&P business are expected towards end-FY14. Management clarified that it does not plan to divest any meaningful stake in any of its E&P blocks.

Other key takeaways:

1. BPCL has 33.7m treasury shares (9.3% of current outstanding equity with an implied value of Rs27b) created during amalgamation of Kochi Refineries. Management indicated the sale of treasury stock would be at an appropriate time, however, ruled out sale in near term.

2. Dividend policy will be maintained with payout ratio at 30%.

3. The under-recovery for 2QFY11 for BPCL would be ~Rs22-25b (v/s Rs46b in 1QFY11).

4. The company doesn't have any major plans to enter the power business.

Valuation and view: We currently model net under-recovery sharing of 11% by downstream companies (HPCL, BPCL and IOC). We expect BPCL to report EPS of Rs57.3 in FY11 and Rs60.3 in FY12. If we were to model nil subsidy sharing by BPCL, its FY12 EPS would increase to Rs75, 24% upgrade from our base case. BPCL trades at FY12E P/E of 13x and P/B of 1.7x. We expect government to clarify on diesel de-regulation and subsidy sharing in the next few months. Though, BPCL trades at its historical high valuation levels, we believe that the E&P potential upside would be the key positive surprise in the stock. Maintain Buy.

Rs120b capex to develop retail infrastructure

- BPCL plans to expand its product pipeline network from Cochin to Bangalore.
- Also it plans to augment capacities for LPG import facilities, however, there is no indication about the size of expansion.
- It plans to aggressively open retail outlets in rural India and has a proposed capex outlay of Rs2b per annum.
- BPCL plans to enter CGD business only through JVs similar to its plans of laying gas pipelines, wherein it has entered into JV with GSPL.

Source : Equity Bulls

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