Buy Bharat Petroleum Corp (BPCL) with target price of R887. We use use a 7x target EV/ebitda multiple on an FY16E basis, at a slight discount to the 7.5x multiple we accord to RIL’s cyclical refining and petchem earnings, though there could potentially be upside to these multiples if the marketing business continues to grow structurally driven by deregulation, minimal government intervention, and stable oil demand growth in India, and the companies are successful in establishing a good track record.
While BPCL’s margins are slightly lower now, they are still well above past levels of R1.5 per litre, aided by the R3 per litre price hike taken over the weekend. A sustainable level of margins is difficult to predict at this stage given changing market dynamics, but the trend should almost definitely be upwards in the long run.
The way forward on fuel retailing, now that both petrol and diesel are deregulated, is differential pricing for the fuels across markets, depending on strategic strengths of the various OMCs. Also, with pvt operators entering the retail space, pricing could become more nimble. BPCL expects competition to increase going forward, but competitive intensity will be more gradual this time around. Differential pricing should happen in a big way now as we progressively more towards a mature deregulated scenario. Only then can sustainable mktg margins be accurately forecasted according to mgmt. But the belief remains that markets can quite easily absorb higher margins in the long run.