Privatisation could result in more gains for Bharat Petroleum's investors

New asset-based valuation method indicates strong upside for OMCs

Even after significantly outperforming with returns of over 30 per cent in the last one month, the Bharat Petroleum Corporation (BPCL) stock continues to outdo its close peers.

On Tuesday, it hit a 21-month high of Rs 511.5, before closing with gains of 5.5 per cent. Clearance of the government’s divestment in the downstream oil and gas major, by the Group of Secretaries, cheered the Street.

Some analysts believe that in light of the expected privatisation of BPCL, a different valuation approach (asset-based as compared to the existing one based on earnings) for all three public sector oil-marketing companies, or OMCs (other two being IndianOil and Hindustan Petroleum), seems more relevant. The same indicates strong upside in OMC stocks, even from present levels. 

According to Elara Capital, the stocks are trading at a sharp discount of 57-73 per cent, based on the replacement/acquisition costs of OMCs’ marketing and refining assets. 

If the government’s plan to privatise BPCL succeeds, the stocks may achieve higher valuations. The new asset-based valuation approach implies 122-273 per cent upside in these stocks from current levels, estimate the analysts.

The recent deal struck by Reliance Industries, to sell 49 per cent stake in its retail fuel business to UK-based BP Plc (British Petroleum), also highlights the undervaluation of OMCs’ marketing assets, says Elara Capital.

Beyond valuation gains, there are benefits on the fundamental aspect, too. 

BPCL’s potential privatisation will also help OMCs earn higher gross margin in their fuel retailing businesses.

OMCs’ average gross margin was close to Rs 3.5 per litre for FY19, lower than many of its global peers. Moreover, on a sequential basis, the benchmark Singapore refining margins are already up.

Further margin support to OMCs could stem from the ban on use of high-sulphur marine fuels, placed by the International Maritime Organization (shipping regulatory agency of the United Nations). 

For BPCL, the ramp-up of its Kochi refinery should further add to profitability.

However, the higher earnings-based valuation of BPCL cannot be completely ignored. 

Given the strong 40 per cent surge (compared to 19-22 per cent in HPCL and IOC), BPCL’s current earnings-based valuation of over 9x its FY21 enterprise value/Ebitda is 23 per cent higher than its long-term historical 1-year  forward valuation, and also 50-56 per cent higher than the other two OMCs. 

Ebitda is earnings before interest, tax, depreciation and amortisation.

Some analysts, though, believe that the potential benefits from privatisation may take a while to fructify. Thus, investors with some risk appetite may consider the stock on corrections.