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HPCL v/s BPCL: Relative standing (Part –III) - Views on News from Equitymaster

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HPCL v/s BPCL: Relative standing (Part –III)
Aug 24, 2006

After comparing HPCL and BPCL’s business models and financial performances, we conclude the series by providing an insight into the historical valuations enjoyed by the two companies in the recent past. The last few years have been quite eventful for oil marketing companies (OMCs), right from ‘so-called’ deregulation (margin boost in FY04) and disinvestment controversies to the current problem of subsidy burdens - they have seen it all.

Relative valuations over the recent past…
BPCL, due to its diversified business model and various revenue generation streams, has earned higher sales per share as compared to HPCL. In FY02, per share sales of BPCL was higher by 31% as compared to that of HPCL. However, the same declined to 16% in FY05. This was on the back of better performances of HPCL from FY03 to FY05. The subsidiaries and JVs of HPCL also helped the topline growth, as their share in consolidated sales increased to 5% in FY05 from zero contribution in FY02.

Valuation based on consolidated numbers…
Particulars FY02 FY03 FY04 FY05
  HPCL BPCL HPCL BPCL HPCL BPCL HPCL BPCL
Sales per share (Rs) 1,169 1,527 1,473 1,679 1,576 1,852 1,856 2,147
Price/Sales (x) 0.2 0.1 0.2 0.2 0.3 0.2 0.2 0.2
Cash per share (Rs) 0.3 16.2 0.8 38.5 6.5 34.1 6.2 23.7
Return on networth 13.4% 22.6% 23.1% 30.3% 26.3% 31.0% 17.0% 20.1%
Earnings per share (Rs) 23.2 31.0 43.3 51.8 58.2 67.8 41.7 51.4
Earnings yield 10.7% 13.6% 17.4% 19.9% 14.4% 18.0% 10.2% 14.0%
Price/Earnings (x) 9.3 7.4 5.7 5.0 7.0 5.6 9.8 7.1
Book value per share (Rs) 173.8 137.2 187.4 170.6 221.1 218.6 245.8 255.2
Price/Book value (x) 1.2 1.7 1.3 1.5 1.8 1.7 1.7 1.4
Dividend per share (Rs) 10.0 11.0 20.0 13.0 22.0 17.5 15.0 12.5
Dividend yield 4.6% 4.8% 8.0% 5.0% 5.4% 4.6% 3.7% 3.4%
EV/EBDITA (x) 5.9 5.2 3.8 3.5 4.9 3.6 7.0 4.6

BPCL is a cash-rich company, as its cash per share is much higher than that of HPCL. Given that there is not a major difference in the number of shares of both these companies, even the absolute cash figures are significantly higher for BPCL. The company’s JVs are cash-rich companies, which add value to BPCL. Thus, the financial position of the company gets a boost. Return on networth is also higher for BPCL over the recent past on the back of an equal presence in refining and marketing, (leading to higher profits, as BPCL has to rely less on third-party purchases as compared to HPCL) along with higher margin JVs in gas distribution (Indraprastha Gas).

The energy sector as a whole historically has had higher earnings yield due to lack of visibility in the profit numbers coupled with inherent risks in the business and greater government regulation (higher the risk, higher the return). Therefore, the historical P/E ratios commanded by energy companies have tended to be on the lower side. However, based on intra-sector comparison, BPCL is priced lower than HPCL on a consolidated basis.

Considering valuation on the basis of intrinsic worth (book value), both the companies have traded within a narrow range. This signifies that due to lack of visibility in earnings coupled with the fact that the sector is asset-intensive in nature, markets are pricing these stocks based on a book value basis. On a standalone basis, BPCL has commanded a premium in P/BV terms, possibly due to factoring in of investments in JVs. On an EV/EBITDA basis, BPCL has traded at a slight discount to HPCL. Here again, we believe markets have relied upon standalone numbers rather than the consolidated figures and seem to have ignored BPCL’s investments in successful JVs.

Based on EV/replacement cost, both the companies are priced in line with each other and have traded at a discount of 27% to their replacement cost. However, the data is for FY05 and thus, the recent capacity addition by BPCL at its Mumbai refinery is not factored in. After factoring in the same, BPCL will be relatively at a discount to HPCL in terms of EV/replacement cost.

Replacement cost (Rs m)…
Particulars BPCL HPCL
Refining assets (MMT) 17 13
Replacement cost per MMT (Rs,m) 8,100 8,100
Total value of refining assets (Rs,m) 140,940 105,300
Marketing assets    
Product pipelines(Kms) 610 733
replacement cost per Km (Rs,m) 10 10
Replacement cost of pipeline (Rs,m) 6,100 7,330
retail outlets( as on 31.3.05) (Nos) 6,426 6,667
replacement cost per outlet (Rs,m) 10 10
Value of retail outlets (Rs,m) 64,260 66,670
ATF stations (Nos) 19 10
replacement cost per station (Rs,m) 115 115
value of ATF stations (Rs,m) 2,185 1,150
LPG bottling plants(TMT) 1,500 1,500
replacement cost (Rs,m) 13 13
value of LPG bottling plants (Rs,m) 19,500 19,500
Total tankages (MKL) 3.05 3.07
replacement cost per tankage (Rs,m) 5,000 5,000
Total cost of tankages (Rs,m) 15,250 15,350
Total value of marketing assets (Rs,m) 107,295 110,000
Market value of investments    
Listed investments (Rs,m) 8,310 11,589
Unquoted investments (Rs,m) 1,474 1,285
Total value of investments (Rs,m) 9,784 12,874
Minority interest (Rs,m) 16,757 -
Total asset value ( Rs,m) 241,261 228,174
Note: As annual report for FY06 is yet to be published the replacement cost is for FY05.

Valuations in FY06
In FY06, BPCL reported an EPS of Rs. 4.3, while HPCL reported an EPS of nearly Rs 12.0, on a standalone basis. However, it should be noted that the P/E ratio as a measure of comparison lost its value in FY06, as the P/E on standalone basis for BPCL was around 100 times, while the same for HPCL was around 25 times, given the crashing of profits due to the controlled petro-product pricing regime. The visibility in earnings got further deteriorated in the year and investors sidelined these stocks, due to a higher risk-to-reward ratio.

Conclusion
BPCL is merging its subsidiary Kochi Refineries (KRL) with itself and the merger is expected to be complete in the next 2-3 months, with the Central Government giving clearance for the same. The benefits perpetuating from the merger are an improved business mix (equal refining and marketing presence of the company) and savings on the sales tax front, as currently, sales from KRL attract sales tax. Post-merger, there will be savings to the tune of Rs 1.5 bn from the same. With KRL quoting at a discount to peers, the merger will enhance the value of the merged entity.

Oil marketing companies (OMCs) continue to be plagued with the issue of subsidy burden. Their fortunes depend on international crude prices. With the government reluctant to increase the prices of subsidized products, only a softening of crude prices could save the day for these companies. If crude prices remain stable over the medium term, the earnings visibility will be missing for these companies. We believe that the risk-reward equation is currently skewed towards risks for these companies (OMCs), with BPCL and HPCL being no exception.

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