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Pure Refining play of robust GRMs

With 10.5mtpa refining capacity at Manali, Chennai Petroleum Corp (CPCL) produces petroleum products, lubricants, and additives. Besides, it provides high quality feedstock (propylene, superior kerosene, butylene, naphtha, paraffin wax and sulphur) to other industries. IOC holds a strategic 51.9% stake in CPCL, as the latter fulfils product requirements for south India. CPCL has operational synergies with IOC, including pooled sourcing of crude oil through the latter, and benefits from the parent’s bulk purchases. Besides, IOC purchases over 90% of Chennai Petroleum’s input. The latter’s sales volumes are therefore unlikely to be affected in the event of any new refinery coming up in the southern region.

Healthy GRM environment - Lower global gasoil stocks and robust demand for petroleum products are expected to sustain, pushing key product cracks higher. The company sources over 25% of its crude requirements from Russia, and 20%+ from Iraq, at a discount. Consequently, GRMs are impressive (discounted crude basket 50-55%, one of the highest amongst the Indian refiners). The benchmark Singapore GRM and the company’s GRM are trending higher than their last 10-year averages, supported by stronger demand, reduced supply, and lower stocks. We assume FY25 and FY26 GRMs of respectively $8.1 and $7.2/bbl vs the last 7-year average reported GRM of $7.3 and the Singapore GRM of $5.4.

Dividend bonanza: We believe CPCL could report higher profitability in FY24, marginally lower than bumper FY23. This should be supported by higher GRMs and larger sourcing of discounted crude from Russia and Iraq. As per our expectations, CPCL could declare a dividend of Rs32/share in FY24 (yield of ~4.7% at CMP, lower than OMCs) vis-à-vis Rs27/share declared in FY23.

9MTPA Refinery complex: The Rs 320bn Nagapattinam, TN refinery is expected to be completed by FY26. It will be executed through a JV with parent IOC (25% stakes each) at initial investment of Rs25.7bn. CPCL will fund ~Rs14bn of its remaining equity contribution by FY26. Other seed investors are Axis Bank, ICICI Bank, HDFC Life Insurance, ICICI Prudential Life Insurance and SBI Life Insurance. The project JV name, ‘Cauvery Basin Refinery and Petrochemicals’ was incorporated on 6th Jan’23.

Operating performance boost through past project developments: like re-gasified LNG, boilers IV and V, hydrogen generation units, etc. As part of fuel quality upgrading, the company commissioned new instrument air compressor, associated dryer units and demountable flare. It installed and commissioned booster pumps and laid pipelines to receive TTRO water of CMWSSB at 4 MGR Reservoir.

RLNG to fetch better yield and flexibility: To replace furnace oil/naphtha, the company plans to source 1.6 mmscmd of R-LNG, which produces more hydrogen and offers more flexibility in sourcing crude oil (furnace oil requires lighter crude to meet emission norms). The company will source these volumes only when LNG is available at a lower cost than furnace oil/naphtha.

Outlook: High GRM sensitivity: a $1/bbl change in GRM changes EBITDA by Rs 6.9bn. Expected dividend of Rs 32/share in FY24 (4.3% yield), 4.4/4.1% FY25e/26e, would be key for shareholders. The BV/share for FY25e/26e: Rs 718/800, debt on books is towards working capital requirements. At CMP, the stock trades at 3.5x/3.8x FY25e/26e EV/EBITDA and 1.0x/0.9x P/BV. We initiate coverage with a BUY rating and TP of Rs1040, valuing the stock at 1.3x FY26e P/BV.

Risks: Lower GRM environment, change in crude prices and inventory losses, adverse government policy – subsidy-sharing, more capex for new refinery.

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