>DOWNSTREAM R&M (CITI)

What Needs To Happen And What Can Happen?

■ Stocks up on de-regulation talk — BPCL, HPCL, and IOCL all spiked up today on a statement by the Oil Minister regarding a fresh proposal for pricing decontrol to be submitted to the Cabinet in six weeks. We think the proposal could contain: (i) petrol/diesel pricing freedom to a limit (say US$75 crude), and (ii) efforts to better direct LPG/SKO subsidy. This is not the first such proposal but implementation has proved to be tricky. Duty cuts may be difficult given fiscal constraints.

■ What are the stocks factoring in? — Our base case factors in “status quo” on LPG/SKO and pricing freedom on auto fuels, which in our view cannot result in a marketing margin beyond normative levels of US$5/bbl (Rs1.5/l). Assuming LPG is completely deregulated (SKO is outside bounds), then the FY10E EPS for BPCL, HPCL, IOC would go to Rs48 (+29%), Rs45 (+45%), and Rs55 (+10%), respectively. On current prices this translates to P/E’s of 9.7x, 8.0x, and 11.0x respectively, implying that the market is already pricing in decent probability of LPG de-regulation.

■ Lower oil prices remain critical — In the above scenario, net under-recovery (post upstream
sharing) comes to Rs100bn (on SKO only). For this to be recovered fully from over-recoveries on petrol/diesel, it is imperative that crude slides to US$50levels. Lower crude therefore remains critical to get constructive on downstream names, notwithstanding the government’s efforts to partially de-regulate.

■ Sell on newsflow — Newsflow on various proposals could remain strong for a few weeks. However, given that the Oil Ministry’s wish list has only been halfway met in the past, we would advice investors to use any strength as an exit opportunity. To see full report: DOWNSTREAM R&M.

To see full report: DOWNSTREAM R&M