GoI invites EoI for BPCL

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 The Government of India (GoI) has invited an expression of interest (EoI) for the strategic divestment of its entire stake (~53%) in BPCL.  The stake sale will transfer management control of the company to a strategic buyer, except for BPCL’s 61.65% stake in Numaligarh Refinery Limited (NRL), which will be transferred to a Central Public Sector Enterprise (CPSE).  The last date for submission of EoIs is 2nd May’20. Other key details from preliminary information memorandum  Eligibility: CPSEs and central government owned cooperative societies are not eligible to bid for the proposed transaction.  Financial Criteria: The net worth criterion for any Interested Party (IP) is a minimum of USD10b. Also, the maximum number of members in case of a consortium is four (with minimum net worth of USD1b for each member).  Reserve Price: The GoI will set up a reserve price for the transaction before the bids open; however, it will not be disclosed to the bidders.  Open Offer: The confirmed selected bidder (CSB) will have to make an open offer to acquire minimum 26% shares (or voting rights) of BPCL (according to SEBI guidelines), and deposit equivalent cash into an escrow account. Stake sale offers lucrative entry into fast growing Indian market  A stake in any of the oil marketing companies (OMCs) will provide a buyer ready access to the third largest and one of the fastest growing petroleum markets globally. OMCs together account for 92%/91%/90% of petroleum product pipelines/marketing depots/fuel retail outlets, with BPCL’s share at 18%/25%/23%.  Thus, BPCL with ~25% market share in Indian petrol and diesel sales provides a lucrative entry point for a prospective buyer to capture the Indian growth story.  We analyzed various valuation methodologies that suggest BPCL’s estimated value at INR520-629/share (refer exhibit 2), which offers incremental premium of 30-57% to the current market price.  Even using the recent BP-RIL deal, our replacement cost for BPCL’s retail outlets stand at INR251. To this, we add another INR73 for its pipeline, terminals/depot and LPG bottling plants. Total valuation of INR324 implies EV/EBITDA of 8.5x for BPCL’s marketing/pipeline segment.  The announcement has come after recent bold moves in the political and economic arena of the country, igniting hopes of further boost to the sector and the economy. However, challenges remain on BPCL’s privatization, such as (a)guarantee of non-interference in pricing of auto fuels even if oil surges, (b)complexities involved in dealing with subsidiaries and JVs, and (c)high employee cost. None of the above mentioned challenges are addressed in the preliminary information memorandum.

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Valuation and recommendation

 In the current benign crude price environment (our estimate of USD65/bbl for FY20/FY21), we expect to see structural changes in the pricing of LPG and kerosene, bidding farewell to all under-recoveries in the petroleum sector.  Further, deregulating LPG would boost the working capital of the OMCs. At endFY19, OMCs had total government receivables of INR349b on account of compensation for LPG/kerosene under-recoveries.  During Jul’19-Jan’20, OMCs appear to have increased the price of subsidized LPG by INR63/cylinder. At the rate of INR10/cylinder/month, it would hardly take 15 months for the subsidy to become nil. Raising prices of subsidized LPG cylinder augurs well for the OMCs, especially keeping in mind the intended privatization of BPCL. However, the government’s resolve would be tested if oil prices spike.  In our view, stabilization of the Kochi refinery would also support its GRMs. Also, deregulation of LPG would aid privatization, although there are other bottlenecks that need to be cleared before the stake sale.  Thus, we maintain Neutral on the stock and value it at 1.9x (10% discount to FY15-18) FY22 PBV to arrive at a target price of INR520.

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