The past month has witnessed major buying interest in refinery stocks, with three of the top five gainers in the energy sector being the standalone refineries. Post dismantling of the APM, it was felt that standalone refineries could be merged with oil marketing companies, as the standalone model does not stand to benefit. Although the merger happened, there was still an arm’s length distance between the parent and the refineries. One of these is Bongaigaon Refineries and Petrochemicals (BRPL), which is the major gainer by nearly 28% during the last one month.
Let us have a look at the various factors that changed the investors’ mindset.
Better realizations: Crude prices have shown signs of strengthening since the latter half of FY04 and are currently hovering above 50% as compared to FY04 prices of US$ 29 per barrel in the Indian context. It should be remembered that this hike in prices is largely due to increasing demand from the US and developing nations. As a result, petroleum product prices in the international markets have shot up. Given that the domestic refineries are compensated at import parity prices, BRPL has witnessed a major turnaround post FY02.
Better capacity utilization: The last five years have witnessed a major improvement in the capacity utilization, which has brought in benefits of economies. The refinery has a rated capacity of 2.35 MMTPA (million tonnes per annum). Of this, the capacity utilization increased sharply to 90.5% as against 62.0% during FY03. The steep rise in capacity utilization is the result of strong product prices, which enable these capital-intensive companies to ride the wave and benefit from the same.
Government support: BRPL, being a refinery in the Northeastern region has benefited from the government concessions allowed to the businesses in the region. As a result, BRPL enjoys the 50% excise duty benefit offered by the government thereby helping the company reduce its costs. Further, allocation of 1.5 MMTPA of Ravva crude (light crude) helps the company process light and middle distillate products which are high value yielding. Further, parent IOC’s support to offtake products gives an assured market for the company.
Petrochemicals business: BRPL restarted its petrochemicals business after a gap of 2 years as the petrochemical segment is currently witnessing an uptrend. With the assistance of Reliance Industries (a global petrochemicals player), BRPL is likely to benefit in the operations of the plant and sourcing of raw materials.
Increasing raw material costs: Currently, crude prices are hovering above US$ 44 per barrel (Indian context) and this is likely to continue in the medium term. Although refineries benefit from import parity pricing, any change in government stand on customs duties, as was the case during 2QFY05 shall result in reduction of margins for the company. Also, weak US Dollar against the rupee enabled the company mitigate some of the risks of rising crude oil prices (as crude is quoted in dollar terms). Currently, the US dollar is strengthening against the domestic currency and this might result in higher outgo by way of crude purchase.
ONGC’s output: ONGC’s output has been stagnating for the last few years and now that the company has acquired MRPL and plans to increase its capacity, a portion of its crude allocation shall be passed on to MRPL. This would result in decline in allocation to other refineries. Thus, it could be that BRPL may have to source crude from international markets. This would be a negative for the refinery, as instead of assured supply as per government allocation, the company might need to find international suppliers. Also, the fact that being a party to subsidy sharing scheme of the government ONGC supplies crude at a discount to other refineries. Any reduction in allocation may increase costs.
At Rs 86, the stock is trading at a P/E multiple of 3.2x 1QFY05 annualized earnings (P/E multiple of 5.7x FY04 earnings) as against its peers such as Chennai Petroleum Corporation (P/E multiple of 4.6x 1QFY05 annualized earnings). We believe this strength is likely to continue in the current fiscal with prevailing high product prices. However, with the gains that the stock has witnessed during the previous month, we believe investors need to exercise caution ahead of the results season, as the price seems to have factored in the aforesaid positives.
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