BPCL

Investors can consider exiting the stock of Bharat Petroleum Corporation Ltd (BPCL), given that its sharp run-up since the partial fuel price reforms in late June seems to be ahead of fundamentals, and ignores the low earnings visibility due to the subsidy burden. At its current market price of Rs 768, the stock has gained as much as 39 per cent in a couple of months and trades at around 17 times FY10 consolidated earnings, much higher than its peers, HPCL (12 times) and Indian Oil Corporation (10 times).



Some premium may be justified, given BPCL's capacity expansion initiatives in its existing refineries, initial successes in exploration and production in South American and African waters, commencement of the high-complexity Bina refinery (full commissioning expected soon), and recent foray into shale gas fields in Australia. Its investments in Indraprastha Gas and Petronet LNG, also add value.

However, the current price seems to have factored in these positives and some more. Among headwinds warranting caution is the continuing subsidy overhang (reduced but still substantial), the long-gestation and uncertain nature of the exploration and production business (where payoffs may take a long time and are by no means certain) and potential entry of private players in fuel retailing (which may cut into incumbents' market share).

Despite the announced intent to do so, diesel price decontrol seems unlikely, at least in the near-to- mid term, given the inflationary and political heat such a move is likely to generate. Also, the subsidy sharing mechanism remains hazy, though indications in mid-July were that downstream companies may have to bear up to 17 per cent of the total subsidy burden this year. At the upper end, this could work out to a higher absolute burden in FY11 than what was borne by BPCL and its ilk in FY10.

That the state of affairs has not really changed is also seen in the huge losses posted by downstream companies, including BPCL in the first quarter, thanks to non-receipt of cash from the Government towards subsidy compensation. As a result, BPCL posted losses of Rs 1,718 crore in the June quarter of 2010, against profits of Rs 614 crore in the same period of 2009 despite (and paradoxically also because of) sales growing almost 34 per cent to Rs 34,212 crore.

Though much of the remaining portion of the subsidy dues are expected to be paid by the Government at a later date, uncertainty about quantum and timing will result in continuation of concomitant pressure on cash flows. While the commissioning of the Bina refinery may help improve gross refining margins from $3.57 a barrel registered in the last quarter, and also improve the company's throughput to marketing ratio (helping reduce the vulnerability to under-recoveries), these benefits may be partly offset by higher absolute under-recoveries and an unfavourable subsidy sharing formula.