>HPCL - BPCL (KOTAK SECURITIES)

One is cheap (BPCL), the other cheaper (HPCL). We highlight that the recent strong outperformance of BPCL stock has opened a large valuation gap between BPCL and HPCL. We see similar upside/downside risks to the earnings of both the companies in the current macro-environment and find it hard to justify the valuation gap. Adjusted for value of investments, HPCL is trading at 4.8X FY2011E EPS and BPCL at 9X FY2011E EPS. We maintain our BUY rating on both stocks but prefer HPCL on higher potential upside (45% for HPCL and 11% for BPCL).

BPCL’s strong outperformance makes HPCL look cheaper
BPCL stock (+16.3%) has outperformed the BSE-30 Index by 15% since November 20, 2009
versus a moderate 5.6% rise in HPCL stock price over the same period. We attribute the spurt in
BPCL stock price partly to an announcement of a significant oil discovery in Brazil. However, it is
difficult to justify the valuation gap of US$1.8 bn between EVs of BPCL and HPCL. We note that
HPCL stock offers a significant upside (+45%) to our 12-month target price of Rs525. The recent
strong outperformance of BPCL leaves moderate upside for the stock (+11%) to our target price of Rs675. We maintain our BUY rating on both the stocks and find it difficult to justify the significant gap in valuations given similar operating environment.

HPCL is trading at 4.8X P/E and BPCL is trading at 9X P/E
We believe that the current relative valuations of BPCL and HPCL offer a good trading play. We do not see any justification for such a significant valuation gap as both companies have similar
operating environment and regulatory exposure. HPCL stock is trading at 4.8X FY2011E EPS and BPCL at 9X FY2011E EPS (adjusted for the value of investments and dividends). Exhibit 1 gives our estimated replacement value for R&M companies broken down by various assets. At the current valuations, HPCL is trading at 27% discount to its replacement cost, as compared to BPCL which is trading at a 21% discount. Even on a P/B ratio, HPCL continues to be inexpensive at 0.9X in relation to BPCL which is trading at 1.44X

To read the full report: HPCL-BPCL