BPCL,HPCL and IOCL are going to be the big beneficiaries of the government’s decision to (1) bear the entire subsidy burden on cooking fuels (LPG and kerosene) and (2) bear subsidy on auto fuels along with the upstream oil companies. The petroleum secretary has guided to an overall subsidy burden of Rs300 bn on cooking fuels for FY2010E and has stated that the government will bear this entire burden through issue of oil bonds to the downstream companies.
The downstream companies are expected to report strong earnings in FY2010E and beyond in light of the above mentioned development. The stocks have been historically cheap on P/B and replacement cost. But there were concerns about lack of a transparent pricing system and stable subsidy-sharing mechanism and inability to forecast earnings confidently. However, the government’s decision to bear the entire subsidy on cooking fuels and some portion of subsidy on auto fuels addresses the street’s previous concerns.
The FY2010E, FY2011E and FY2012E EPS estimates for BPCL work out to Rs80(+109%), Rs65(+56%) and Rs74(+29%) and for HPCL Rs73(+77%), Rs58(+52%) and Rs70(+8%). The large upward revision over the current year estimates reflects (1) the new subsidy-sharing mechanism and (2) information contained in FY2009 annual report. Key downside risks to earnings and fair valuations stem from (1) unfavorable changes to subsidy-sharing system and (2) lower-than-expected refining margins.