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BPCL merger: Who got the better deal?

Sep 3, 2004

The recent announcements of a possible merger of Kochi Refineries with its parent, BPCL has led to a spur in the stock prices of the former (gained over 6% during the week). On the other hand, BPCL has lost nearly 2% over the same period. 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):

Capacity (MTPA)8.7 7.5
Sales (Rs m)482,543 98,921
3-yr CAGR5.0%11.4%
EBDITA (%)5.9%10.2%
NPM (%)3.5%5.6%
RONW (%)29.0%29.6%
ROA (%)9.5%12.2%
P/E (x)17.83.8
P/CF (x)4.6 3.7
P/BV (x)1.8 1.3

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 BPCL's imports, the marketing major would ensure optimum crude mix to produce value added products, thereby resulting in higher refining margins.

  • Strong balance sheet of the parent: Kochi Refineries has planned capacity expansion by 3 MTPA. The merger with BPCL would enable Kochi Refineries to have better finance options in terms of its parent's balance sheet strength.

  • 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 nearly US$ 5 per barrel. However, with the merger, Kochi Refineries could enter into the marketing segment with BPCL's expertise and this would enable it to diversify its revenue structure and profitability, which is heavily dependent on gross refining margins.


  • Strong downstream presence: Currently, BPCL has a refining capacity of nearly 8.7 MTPA (million tonnes per annum), while more than 50% of its sales requirements are met through purchase from external sources (from subsidiaries and other marketing majors). As a result of this merger, BPCL would be able to reduce its external dependence on other sources and at the same time, have better control over products.

  • Refining margins to compensate: Post FY04, the oil-marketing majors have been witnessing an acute 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 liter of petrol and diesel sold during 1QFY05. However, high refining margins have enabled these companies to overcome the marketing blips, to some extent. To put things in perspective, BPCL's standalone Mumbai refinery witnessed GRM of US$ 4.6 per barrel while the same for Kochi Refineries is hovering at US$ 5 per barrel.

BPCL is currently trading at Rs 348, implying a P/E multiple of 17.8x annualized 1QFY05 earnings while on the other hand, Kochi Refineries is trading at Rs 170, implying a P/E multiple of 3.8x its annualized 1QFY05 earnings. However, we believe, 1QFY05 performance of the oil marketing major was largely due to political repercussions while the current merger would help the company withstand such pressure going forward. On the other hand, Kochi Refineries would benefit from the strong marketing presence of its parent assuring product offtake and the strong balance sheet size would enable the company to raise debts more efficiently.

However, to boil it down to one major beneficiary over the other, we believe that Kochi Refineries has got a better deal as compared to BPCL. In the short term, BPCL shall benefit on account of high refining margins compensating for marketing margins. However, over the long-term, with crude prices likely to fall (and are falling) and product demand stabilizing, refining margins are likely to decline. Being a standalone refinery, Kochi Refineries has little bargaining power and as a result of the merger, it would have an integrated retail presence and better revenue model.

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