The prevailing high oil price (Brent over US$90/bbl) is likely to deter diesel deregulation. Given the rising risk to reforms, we have cut R&M companies? PO (Price Objective) by 8-18%.
Revised PO implies 25-26% potential upside in the case of HPCL and IOC, and 8% potential upside for BPCL. The cuts in the POs are mainly due to cuts in FY12E EPS and using a lower earnings multiple. We have cut BPCL and HPCL?s FY12E EPS by 8-10%, assuming a higher subsidy and lower inventory gain. IOC?s EPS is flat, as higher petrochemical margins make up for the higher assumed subsidy. We keep our ratings unchanged at Buy on IOC and HPCL and Neutral on BPCL.
There was only one state election in FY11, making it easier to implement reforms. Every year in the next 4 years (FY12-FY15E), there are at least 5 state elections. Brent may also touch US$100/bbl in 2011E . Thus, the outlook for reforms is worsening due to high oil prices and state elections in May 2011.
However, diesel deregulation is not completely ruled out. Diesel may be deregulated by way of price hikes before and after May 2011 elections. After May 2011, there are no elections until February 2012. Diesel deregulation appears very unlikely when the oil price is over US$90/bbl. However, some hike in the diesel price cannot be ruled out. In fact, press reports suggest that the diesel price may be hiked by Rs2/litre in the current week. This could boost R&M companies? share prices, which have corrected over the last few weeks as the oil price has risen. However, what would be crucial is whether there is a further price hike to deregulate diesel even after the May 2011 elections.
Other share price drivers in the next few months could be oil price movements and government compensation of the FY11E subsidy.
? Bank of America Merrill Lynch