Black gold, as crude is popularly known, is hovering above US$ 36 per barrel. Although prices of crude oil have risen to phenomenal levels earlier, it should be remembered that they were all an effect of supply side shocks. This time, high demand from developed nations such as the US and the developing economies such as China and India have led to the price momentum, with OPEC members unable to meet the demand.
Historically, developing economies are less efficient than the developed economies in terms of oil usage and have been known to utilise more crude per unit of GDP as compared to the Organisation for Economic Cooperation and Development (OECD). Just to put things in perspective, India uses 2.5 times more crude oil for a single unit of GDP as compared to the OECD. In the face of it, we import nearly 70% of our crude requirements and domestic production has remained stagnant at around 33 MMTPA (million tonnes per annum). To add to their misery, oil marketing PSUs are a victim of subsidies and political decisions as far as pricing of products are concerned. For example, these OMCs (oil marketing companies) had to bear a loss of Rs 13 bn during FY04 on account of under-recoveries on LPG and kerosene. Also, the fact that retail product prices have not been allowed to rise for the last six months in the face of high input costs have not helped matters.
Keeping this background, let's look at the impact of high input costs with less than proportionate price increase on the performance of BPCL. Please note that the assumptions here are that crude prices shall stabilize at US$ 35 per barrel in FY05 (US$ 1 = Rs 44.25) and that the FY04 levels of subsidies of Rs 45 per cylinder of LPG and Rs 1.6 per litre of kerosene shall continue.
In our FY05 projections, we have estimated that crude prices will average around US$ 31 per barrel. From the above graph it becomes clear that BPCL would be one of the worst hit in case crude oil prices continue to rise and in the Indian context, stabilize at US$ 35 per barrel. Operating margins take a hit of nearly 230 basis points while the net profit margins take a hit of 160 basis points. A major reason for this drop, apart from low realisations, is that BPCL purchases petroleum products from other refineries to which it pays international parity prices at the refinery gate. To that extent, the company loses on the gross refining margins. High demand for crude is largely due to robust demand for petroleum products therefore providing robust refinery gate prices.
At Rs 354, the stock is trading at a price to cash flow of 6.4x FY05E earnings (P/E multiple of 11.0x FY05E earnings), if crude prices are considered at US$ 35 per barrel. However, we believe crude prices shall stabilize at around US$ 31 per barrel and therefore at the current levels, the stock is trading at 4.3x FY05E earnings (P/E multiple of 6.0x FY05E earnings). The rationale behind our view is that the demand is likely to ease by the end of August when the US peak driving season comes to an end and at the same time, China has shown signals of slowing down the already overheated economy.
The True Picture...
In the recent times, the stock has taken a hard beating on the bourses on account of lower realisations on products and disinvestment blues. However, disinvestment is more of a sentimental reason and to that effect the prices do reflect the non-event. However, the company has plans to enter into newer areas to expand its business and is actively pursuing the use of LPG as fuel. Further, upgradation of the refinery by setting up a FCCU (Fluid Catalytic cracking unit) and HCU (Hydro cracking unit), shall enable the company to produce higher yield products thereby improving realisations and at the same time expand the operational capacity to 12 MMTPA (currently the refinery processes nearly 8.7 MMTPA). We believe this upgradation shall help the company reduce its dependence on external sources for products and at the same time, effectively save on the gross refining margins that it pays on the products purchased from external sources.
All said and done, the stock is risky to the extent government controls the pricing of the products and subsidies eat into the profits. Currently, BPCL is one of the companies, which receives crude from ONGC at discounts on account of the latter sharing the subsidy burden. Earlier, this mechanism was to be in place only till FY04 but there are indications that this shall continue. However, if this policy is eliminated, it might increase the input costs and result in additional burden on the company. The company has announced a dividend of Rs 17.5 per share (final and interim), thereby giving a yield of 4.9% at the current price.
LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India. Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407