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BPCL: Moves closer to divestment, upgrade to Buy

* With the lifting of COVID-related lockdowns, while various industries see an uptick in demand, margins, new business avenues, etc.; the global Oil and Gas industry continues to struggle with its own set of challenges.

* Refining margins continue its streak of poor performance, while marketing margins continue to offset the pain. Lately, petchem joined the club with better margins, providing further relief to the refining side of the business.

* In this report, we review the current conditions in the Oil and Gas industry, which would pave the way for privatization of BPCL (a hot topic for over a year now).

* While refining margin is yet to recover, BPCL’s management has done a commendable job in streamlining the challenges presented in the initial stages like divesting its stake in major JVs and rationalizing employee count. We upgrade the stock to Buy (note: it also has similar marketing EBITDA mix as that of HPCL).

* While debt has reduced considerably YoY for OMCs, HPCL’s Balance Sheet remains debt ridden – impacting its net debt profile (increasing from 0.9x in FY21E to 1.4x in FY23E – the highest among peers). In lieu of increasing debt and project execution risk at Visakhapatnam, we downgrade the stock to Neutral. However, privatization of BPCL remains the key risk to our downgrade as the stock could demand higher multiples.

* IOCL remains our preferred pick in this space on the back of a diversified EBITDA mix (marketing: 43%, refining: 23%, and others: 34% in FY19) – with the best free cash flow generation profile (15-18%) over FY22-23E (despite heavy capex of INR260b in FY21 - higher than sum of both BPCL’s INR90b and HPCL’s INR120b). Reiterate Buy.

Marketing margins higher than their long-term average

* Even as retail prices for Auto fuels in India touch record highs, OMCs are earning marketing margins of INR2.8-3.6/liter on Petrol-Diesel (higher than their longterm average of INR3/liter) due to regular price hikes.

* As highlighted in our report, ‘Marketing margins – an elixir for OMCs’, the government has intervened when retail prices peaked in Aug’17 and Sep’18.

* Excise duty collection for FY21RE stands at INR3.45t. The government is targeting INR3.2t in FY22BE. Thus, we see scope for an excise duty cut when required, although the exact timing for the same remains a question.

* The government (through excise) and OMCs (through gross marketing margins) have been using margins on Auto fuels as a key tool to manage their finances. OMCs have increased gross marketing margins to INR3-5/liter in FY19-20 as SG GRM compressed to USD3-5/bbl from ~USD6-7/bbl.

Refining margins continue to record a gradual uptick

* Refining margins are the true reflection of poor global demand, primarily impacted by worst ATF demand; Gasoil and Gasoline have seen some revival.

* Thus, refiners continue to face challenges in terms of adjusting product yields or blending ATF to Gasoil/Gasoline to disburse lack of demand for the product.

* Having said that, refining margins continue to record a gradual uptick, with SG GRM for Feb’21 YTD at USD1.9/bbl (up from USD1.4/bbl in Jan’21 and USD1/bbl in 3QFY21). The improvement is primarily due to Gasoil and Gasoline cracks (stands at USD6.5-7.1/bbl currently on a daily basis v/s USD3.8-4/bbl in Jan’21). This is most beneficial for Indian refiners who already have higher middle distillate yields.

* Various refinery closures in the US (due to the cold storm along the Gulf Coast) and Japan (due to the earthquake) are supporting better margins currently.

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