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BPCL: Into losses! Disinvest?
Aug 8, 2005

Performance summary
BPCL announced its 1QFY06 results towards the end of the last month. While the gross sales growth at 18% YoY in 1QFY06 is robust on the back of higher product prices at the refining level, poor realisations at the marketing level have severely affected profitability. As compared to a net profit in the corresponding quarter last year, BPCL has posted a loss in 1QFY06.

(Rs m) 1QFY05 1QFY06 Change
Net sales 130,608 160,157 22.6%
Expenditure 127,144 163,360 28.5%
Operating profit (EBDITA) 3,464 (3,203)  
EBDITA margin (%) 2.7% -2.0%  
Other income 548 826 50.7%
Interest 226 404 78.8%
Depreciation 1,536 1,525 -0.7%
Profit before tax 2,250 (4,306)  
Extraordinary items - -  
Tax 777 7  
Profit after tax/(loss) 1,473 (4,313)  
Net profit margin (%) 1.1% -2.7%  
No. of shares (m) 300.0 300.0  
Diluted earnings per share (Rs)* 19.6 (57.5)  
(*annualised)      

What is the company's business?
BPCL is India’s third largest oil refining and marketing company with refining capacity of 8.7 MMTPA (million metric tonnes per annum) and over 5,500 retail outlets, spread across the length and breadth of the country. The company is an aggressive marketing player with over 24% market share in retail fuels and 26% market share in LPG (liquefied natural gas) as against competitor HPCL, which has a market share of nearly 22% in retail fuels and 24% in LPG. BPCL is currently awaiting court approval for the merger of its subsidiary Kochi Refineries with itself.

What influenced performance in 1QFY06?
Volumes strong:  Crude throughput increased by 6% during the quarter under consideration. While diesel sales at the retail level was down on YoY basis (partly due to high base effect), demand for naphtha, lubricants and aviation turbine fuel (ATF) was higher in the same period. To put things in perspective, growth in ATF, lubricants and naphtha was 12%, 8% and 19% respectively. Unlike FY05, we expect demand for petroleum products for grow at a slower rate of around 3% to 4% in the next two to three years. For FY06, we had estimated BPCL to grow its topline by 9.7% and, post these results, we maintain the estimate. The faster rise in net sales as compared to gross sales is largely on account of the lowering of customs and excise duty on key petroleum products (in line with what we had estimated).

Margins 'Left' out:  As is evident from the table below, as a percentage of sales, raw material costs have increased by 530 basis points (5.3%), which has severely affected operating margins. Purchases has reduced in light of the capacity expansion in its Mumbai plant and we expect the external dependence to reduce in the next two years, until the expansion is fully absorbed. This reduction in external purchases will improve operating margins because the price at which BPCL purchases is benchmarked internationally. Even as operating margins are tumbling, the margins at the gross refinery level (selling price at the refinery and not through retail outlets) have been gaining ground, as is evident from the graph above. Given the spurt in crude prices globally, refinery prices have been strong, as a result of which BPCL was protected.

No pass-through…
(% sales) 1QFY05 1QFY06
Consumption of raw materials 20.3% 25.8%
Purchases 69.6% 68.7%
Staff cost 1.7% 1.1%
Other expenditure 5.7% 6.4%

Over the last few quarters:  As is evident from the graph below, while the rate of growth in market sales has been slowing down, EBDITA margins have plunged into the red for the first time. As compared to 2.8% in FY05, we had estimated EBDITA margins for BPCL for FY06 at 1.8%. We have clearly over-estimated margins and to that extent, there is a need to downgrade earnings of the company going forward.

What to expect?
The stock currently trades at Rs 357, implying a multiple of 1.7 times FY05 book value. As we had mentioned earlier, we have to revise our earnings estimates downwards based on current macro scenario. The government is contemplating reducing excise and customs duty on petroleum products further in order to protect consumers on the one hand and provide some relief to marketing companies. However, considering the 'consensus-led' policy making process of the current government, it is very speculative in nature. The only respite that companies like BPCL could hope for is from softening of crude and in turn, product prices. Until then, the performance will be affected. Having said that, if one takes into account the investment of BPCL in companies like Indraprastha Gas and other oil venture combined with its asset-quality, the downside risk is limited to the extent of lack of any decisions by the government on product prices. Beyond that, for high-risk investors, there is value from a long-term standpoint.

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