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Divestment: Consensus finally?

Nov 6, 2002

If one of the leading business dailies is to be believed, then confusion over the divestment of HPCL and BPCL seems to have been sorted out. HPCL is to be divested through a strategic sale, while BPCL is to be divested through the market route. In an informal meeting, post the cabinet meeting, ministers have apparently reached a consensus regarding divestment. However, we would urge investors not to jump at the news and wait for the divestment minister to make a statement in the parliament, which is likely to be made Monday. Many times in the past, news items reported have been found to be not-exactly correct. It would not be surprising if the Government comes out slightly different version of the outcome. More importantly, the timing sell-off continues to be uncertain.

Among the concerns are timing of divestment - which company should be divested first, if sold separately? As per reports, first on the blocks is likely to be BPCL due to higher valuations commanded by the company compared to its peer. Owned retail assets of BPCL are an estimated 65%, as compared to 50% for HPCL and 30% for IOC. Further, percentage of owned retail assets is much higher in urban centres. Therefore, company has a higher buffer against predators in a competitive environment. Management of BPCL is considered to be more marketing savvy -- company has launched several initiatives including Petro Bonus & Smart Fleet pre-paid cards to ensure customer loyalty. BPCL also has a favourable marketing/refining capacity ratio, which is important considering the wafer thin refining margins.

At the current market price of Rs 195, BPCL trades at a P/E multiple of 5x its 1HFY03 earnings. Considering the imminent sale of stake, we undertook a valuation exercise to get some indication of price bids. On conservative basis, we believe the fair value of BPCL share to be Rs 251 per share. Assuming a 25% premium to the fair value, fair value works out to Rs 313 per share. However, assigning a similar value to retail outlets based on Royal Dutch Shell's bid for IBP (Rs 13.4m/outlet), the price rises to Rs 333/share and with a premium of 25%, the share price stands at Rs 416 per share. On EV/EBITDA of 6.5x (based on 9mFY02 annualised EBITDA), the share price works out to Rs 226 per share. (Read more).

HPCL, is quoting at a P/E multiple of 7x its 1HFY03 earnings. Going by conservative asset valuation norms, we have arrived at a price of Rs 330 per share for HPCL. However, we may see aggressive bidding aided by factors other than merely asset valuation.

Both the stocks have historically traded at a P/E band of 4x-6x. While the valuations have not improved considerably, there have been very fundamental improvements at a sector level. Post dismantling of the Administrative Price Mechanism (APM) regime, R&M (refinery and marketing) companies are allowed to revise product prices. With flexibility in market pricing, the R&M companies are comparatively better positioned to cushion adverse movements in refining margins. The existing R&M companies have established retail outlets in key consuming markets at low historical costs. Although new players will now enter the market, marketing rights will be contingent on minimum investment of Rs 20 bn. Further, they will not be permitted to encroach on the retail network of incumbents. This should give players like BPCL & HPCL a significant first-mover advantage. In FY02, the Government decannalised import of crude oil for public sector refineries and RBI permitted refineries to hedge crude oil and petroleum product prices. These measures are likely to result in better procurement prices and lower volatility in margins.

In the recent past, expectations of aggressive bidding and therefore, significant gains from open offer have tempted investors to rush into the stocks to make quick buck. However, investors have had to face disappointment to the governments handling of the situation. There is no guarantee this will not occur again. However, both HPCL and BPCL are quoting at attractive valuations purely based on fundamentals. Therefore, investing with a long-term view could also be an alternative. Read our research reports to help you make the decision.


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