Have The Bulls Gone Overboard On Bharat Petroleum?

The government is considering selling its entire stake in the nation’s second-largest fuel retailer to a global oil company, Bloomberg reported on Sept. 13. That could help the Modi administration meet its disinvestment target, besides increasing competition in a sector dominated by state-run firms. And it will also reduce the risk of government intervention in pricing, a key overhang for oil marketers.

Shares of BPCL have since surged nearly 50 percent. And the spike was so steep that, according to Bloomberg data, the average of 12-month price target is 16 percent lower than the refiner’s prevailing Rs 531 apiece.

While 61.5 percent of the analysts tracking the stock suggest a ‘Buy’, BPCL is expensive. According to data compiled by BloombergQuint, BPCL’s 12-month forward enterprise -to-Ebitda stands at 10.1 times, a 33 percent premium to its five-year average and 58 percent premium to the global average.

It’s even costlier than the valuations of the last two deals in the sector. Oil & Natural Gas Corporation Ltd. acquired the government’s stake in Hindustan Petroleum Corporation Ltd., India’s third-largest oil retailer, last year at 9.4 times one-year forward earnings. Saudi Arabian Oil Co. will buy a fifth of Reliance Industries Ltd.’s refining and petrochemicals business at 7-8 times.

How Much Will BPCL Privatisation Help?

A potential BPCL privatisation will reduce state interference in increasing retail prices of fuels, a reason that kept valuations depressed in the past. Despite deregulation of petrol and diesel, the government has controlled prices, especially during elections.

During state and general elections, oil marketers refrain from increasing prices if crude surges, impacting their earnings. Last year, the government had asked fuel retailers to bear Re 1 impact to cushion consumers, lowering gross marketing margins earned on sale of every litre of petrol and diesel.

In the last two financial years, payouts to shareholders rose for fuel retailers, helping the government—the largest shareholder—to meet its disinvestment target. And subsidy for LPG and kerosene was also delayed.

High dividend payouts, delayed subsidy and higher capital expenditure pushed the combined debt of Indian Oil Corporation Ltd., BPCL and HPCL to its highest in a decade. Privatisation takes away these risks.

Still, a potential privatisation doesn’t necessarily mean complete pricing freedom. Even if BPCL is sold, private players would control only 33 percent of the retail fuel market, with the state-run Indian Oil and HPCL having a 67 percent share. The dominant position gives the government enough room to indirectly control prices.

Meanwhile, Moody’s Investor Service warned that it will downgrade BPCL if the government goes ahead with its BPCL privatisation plans as that would remove the company’s sovereign links and trigger bond redemption—a credit negative. “BPCL’s Baa2 rating incorporate our expectation of the high likelihood of extraordinary support from the government, which results in two notches of uplift in the ratings.”