BPCL divestment making progress; ‘Buy’ retained on OMCs given low valuations

Our global team highlighted recently that nearly 31% of US refinery capacity and c22% of Japan’s refining capacity (together c9% of world capacity) was impacted from mid-February due to weather/earthquake-related issues spiking up margins and product prices. The winter storm has caused power blackouts and brought many refiners and petrochemicals plants offline.

In addition, healthy marketing margins add comfort: The HSBC margin tracker implies healthy margins of about Rs 2-3.5/litre for auto fuels despite rising crude prices as OMCs continue to increase retail fuel prices. With the government’s focus on divesting BPCL, the autonomy in setting retail prices will allow OMCs to make reasonable returns on marketing, in our view.

We believe this boosts investor confidence in the OMCs. Also, we expect materially higher profitability for the OMCs in FY21 than in FY20. The recovery in auto fuels demand has been better than expected, although February appears to have been weaker. Diesel demand fell by 5% y-o-y in February while petrol demand continues to grow (+1.5% y-o-y).

Two steps taken towards BPCL divestment: There were two pre-cursors to the BPCL divestment: (i) It needed to sell its 61.65% stake in Numaligarh refinery; and (ii) the BORL JV needed to be consolidated. With the NRL stake sale announced on 1 March and BPCL buying the remaining 36.62% equity capital in BORL, we believe the BPCL divestment remains on track to be completed by FY22. Valuations for these deals have been higher than our estimate and when executed would likely increase our current valuation of BPCL by around 3%.

Maintain Buy on OMCs: OMCs have underperformed the Nifty 50 by 5-15% in the past six months. Retail fuel volumes are recovering, and we expect normalcy in retail products except aviation fuel. So we prefer OMCs with higher exposure to stable income portfolios such as pipeline and retail market vs refining (IOC and HPCL).