Bharat Petroleum Corporation: Buy on declines

Recommendation: Buy on declines

Raghuvir Srinivasan

OIL REFINING stocks may not be the flavour of the season.

In fact, if anything, they seem to be getting the rough end of the stick in the market, going by the steep fall in their valuation in the last few weeks. Of course, such treatment meted out to these stocks is not without reason.

Refining companies are going through a rather tough patch, caused as much by the prevailing high global oil prices as by the Government's policy (or the lack of it) for the sector. However, from the investor's point of view, the current down-phase in these stocks can be used to build cheap exposure to what is essentially a critical sector going through a difficult patch.

A fundamentally sound refining stock that can be considered for long-term investment is Bharat Petroleum Corporation Ltd. (BPCL). However, investors have to bear two factors in mind here -- one, such investment has to necessarily be with a medium-to-long-term perspective; and two, there could be risks stemming from the Government's restructuring plans for the oil sector.

Going by the broad contours of the present restructuring plan, it should help BPCL as its capacity is likely to more than double. The risk comes only because the Government is unsure of its approach to the deregulation of the oil sector and it is rather susceptible to manipulation by interest groups.

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BPCL is one of the three major oil companies in the country and operates a 6.5 million tonnes refinery at Mumbai. It has a 20 per cent share of the market and has 4,500-odd outlets across the country. BPCL's core traditional strength has been its marketing activity. Though hamstrung by a low refining capacity, in the past it managed to carve out a good market share with aggressive marketing. Given the attractive marketing margins, this has been a major factor in its growth.

However, its biggest drawback has been the lack of refining capacity. The company's greenfield refinery at Bina, in Madhya Pradesh has been a non-starter due to environmental problems. The tie-up with Chennai Petroleum Corporation now, to market its products, has given BPCL access to higher product volumes just as the previous arrangement with Kochi Refineries did. It also has an agreement to distribute a part of the production from Reliance Petroleum's refinery.

But in the long term, the lack its own capacity is certainly a major worry. This could change if the Government's plan to sell off its stake in Kochi Refineries to BPCL goes through. BPCL's capacity will go up by 7.5 million tonnes in one shot, giving it access to large product volumes. Added to this would be the 3 million tonnes capacity from the Numaligarh refinery, where BPCL holds a 51 per cent stake. Of course, the problems associated with the product evacuation from Assam could prove to be a major factor here. If the transfer of Kochi Refineries does not happen, then BPCL could be in trouble come total deregulation in 2002.

The company is also planning a 9 million tonnes refinery near Allahabad, but given that the proposal is only in the initial stages it could be another four years before it is built. Besides, the investment commitment on any such project, which could be at least Rs. 4,000 crores, needs to be factored in while evaluating the overall risk profile of the company. BPCL has been trying to rope in an overseas partner for project, but has been unsuccessful till now.

On the marketing side, BPCL appears to be well positioned. It already owns about 60 per cent of its total distribution outlets, and is planning to buy or take on long-term lease the rest. This should stand it in good stead in a free-market environment as competitors would not be able to buy out its outlets.

In the near-term, BPCL could face working capital problems due to reimbursements not coming in from the Oil Pool Account. The first quarter numbers, which show an almost 100 per cent rise in interest charges are a clear indicator of the trend for the remaining part of this fiscal. The bottomline has also been hit by higher depreciation as the company had to write off the entire cost of its LPG cylinders.

Earlier, the Government would reimburse a part of the procurement cost of cylinders for new connections. This has been done away with now. Refining margins have also been hit by the prevailing high crude prices and the flat trends in product prices. The BPCL stock is trading at around Rs. 176. Investment can be considered at the current price and/or declines with a long-term perspective.