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BPCL KRL merger: Our view - Views on News from Equitymaster
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BPCL KRL merger: Our view
Jan 25, 2005

Recently, the boards of BPCL and Kochi Refineries approved the merger of the latter with its parent company at a swap ratio of 1:2.25, i.e., for every 9 shares of Kochi Refineries, the shareholders shall be given 4 shares of BPCL. The merger is likely to be a win-win situation for both the companies from the long-term perspective. Let us now analyze the benefits of the merger from the point of view of a standalone refiner (Kochi Refineries) and the oil marketing major (BPCL):

Refining capacity (MMTPA) 12.0 7.5
FY05E Revenues (Rs m) 563,853.4 128,938.7
FY05E PAT (Rs m) 18,002.2 8,230.7
No. of shares outstanding (m) 300.0 138.5
EPS (Rs) 60.0 59.4

Kochi Refineries:

  • Integrated business:  Kochi Refineries, which has a capacity of 7.5 MTPA (million tonnes per annum) is currently a standalone refinery (i.e. only refining and no retail presence). While the company has no expertise in the retail space, the merger would enable it to come under the umbrella of BPCL, which has a major market share in the retail fuels segment (22% of volumes sold through retail outlets in FY04). Further, with Kochi Refineries crude requirements being met by BPCLs imports, the marketing major would ensure optimum crude mix to produce value added products, thereby resulting in higher refining margins.

  • Diversified revenue structure:  The merger would enable the company to withstand the volatility in gross refining margins (GRM). Currently, the refining margins are at record highs of over US$ 5 per barrel. However, with the merger, Kochi Refineries could enter into the marketing segment with BPCLs expertise and this would enable it to diversify its revenue structure and profitability, which is currently heavily dependent on gross refining margins.

  • Healthy cash flows:  Kochi Refineries is currently planning to set up crude receipt facilities consisting of single buoy mooring, a shore tank and connected pipelines in order to reduce costs. The project has been delayed due to cost overruns as the bidders bid for nearly 40% over the estimated budget. Given BPCLs strong balance sheet, Kochi Refineries would be better off riding on its parents back for the project to avail of the lower interest rates and favourable finances over the long run.


  • Strong downstream presence:  Currently, BPCL has a refining capacity of nearly 8.7 MTPA (million tonnes per annum) and is likely to rake it up to 12 MMTPA by the close of the current fiscal. While more than 59% of its sales requirements in the present scenario are met through purchase from external sources (from subsidiaries and other marketing majors), the merger would help the oil major reduce its dependence and thereby improve the margins going forward. In other words, BPCL pays import parity prices to external refineries to purchase the products at the refinery gate. The refining margins thus add on to those refineries. Now that BPCL would have access to over 7 MMTPA of products from its own refinery (post merger, KRL would reflect on BPCLs books), the refining and marketing margins would remain in BPCLs balance sheet, thereby reflecting a healthy bottomline.

  • Refining margins to compensate:  Post FY04, the oil-marketing majors have been witnessing a perilous squeeze in marketing margins, while refining margins have remained robust (as refinery gate prices are linked to import parity prices and prices in the international markets have increased). Due to political considerations, the oil-marketing majors were not allowed to increase product prices in line with costs and as a result, the PSUs witnessed a net loss per litre of petrol and diesel sold during 1HFY05 in some states. However, high refining margins have enabled these companies to overcome the marketing blips, to some extent. To put things in perspective, BPCLs standalone Mumbai refinery witnessed GRM of US$ 4.6 per barrel while the same for Kochi Refineries is hovering above US$ 5 per barrel.

BPCL is currently trading at Rs 388, implying a P/E multiple of 6.5x our FY05E earnings while on the other hand, Kochi Refineries is trading at Rs 177, implying a P/E multiple of 3x our FY05E earnings. The recent upsurge in crude oil prices and the resultant high product prices have led to strong refining margins. We believe that the strong refining margins in the near term have been factored into the price of Kochi Refineries and to that extent it is fairly valued. On the other hand, 1HFY05 has not been kind to the downstream marketing business and for that reason BPCL witnessed a sharp decline in stock price. Having said that, the recent decisions taken by the ministry on product prices have helped the stock. Over the long-term, prospects of the company remain attractive.

Post merger scenario
No. of shares alloted to KRL (m) 61.6
Current price of BPCL (Rs) 387.0
Market Cap (Rs m) 23,822.0
KRL FY05E earnings (Rs m) 8,230.7
P/E (x) 2.9

However, to boil it down to one major beneficiary over the other, the P/E of 2.9x FY05E earnings at which BPCL has completed the transaction to add nearly 63% of the refining capacity is rather cheap. In effect, BPCL is likely to pay Rs 23.8 bn (market cap of KRL post-merger). Given KRLs cash balance of Rs 3.2 bn as per FY04 annual report, the net amount paid is likely to be in the range of Rs 20.6 bn.

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