India Oil and Gas Sector - Credit Suisse

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12 October 2011 Asia Pacific/India Equity Research

Oil & Gas Refining & Marketing

India Oil and Gas Sector COMMENT

Little earnings visibility Figure 1: OMC RoEs have been declining steadily

0

5

1015

20

25

3035

40

FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011

IOCL BPCL HPCL

(%)

Source: Company data

■ Continued uncertainty. Unless crude prices collapse, we see little hope of improved returns at the OMCs (oil marketing companies) for FY12. We reiterate UNDERPERFORM on BPCL and HPCL. We believe IOCL (NEUTRAL) offers the best relative value in the space.

■ Reforms critical, but uncertain. Without a material reduction in the scale of industry losses (through c.28% lower crude averages or retail price reform), OMC RoEs are unlikely to improve much. Most funding issues at the OMCs are related to the timing of government payments. Despite historical under-funding, BPCL and IOCL have managed their capex without much increase in net debt (adjusted for receivables); only HPCL has struggled. Given OMCs can manage cash flow with the current level of support, the govt. is unlikely to increase subsidy payments as long as it has to pay large (and increasing) amounts itself. Therefore, OMC RoEs can remain depressed.

A structural reform cannot be ruled out, though the Rs8/litre (18%) increase in diesel prices may be difficult near term (with elections in Uttar Pradesh, the largest state, due in April 2012). With several false starts, the prospect of reform is unlikely to generate excitement soon. The OMCs are likely to remain contra crude ‘trades’ at best. Given the low, uncertain and potentially falling RoEs, buying on perceived valuation may not work either.

■ Little upside. Any strength in crude prices will hurt. Increasing uncertainty on FY12 EPS heading into March can also impact stock prices. The contraction in Asian refiners’ multiples has reduced the upside in case OMC returns were to increase. We update our models for IOCL/ BPCL/ HPCL and revise their TPs to Rs361/ 582/ 303 from Rs388/ 595/ 347, maintaining our NEUTRAL rating on IOCL and UNDERPERFORM on BPCL and HPCL.

Research Analysts

Sanjay Mookim 9122 6777 3806

[email protected]

Saurabh Mishra 91 22 6777 3894

[email protected]

12 October 2011

India Oil and Gas Sector 2

Focus charts and tables Figure 2: BPCL’s cash flow (FY06-11)—BPCL has been

able to manage capex with its cash flow (INR mn)

Figure 3: In terms of cash flow, IOC is best placed among

OMCs

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Source: Company data Source: Company data

Figure 4: India’s FY13 total loss estimates for various crude and exchange rate assumptions Brent (USD/bbl) ▼ / INR/USD ► 45 46 47 48 49 50

90 349 423 500 577 655 732

100 716 802 887 973 1,059 1,144

110 1,087 1,181 1,275 1,369 1,462 1,556

120 1,458 1,560 1,662 1,764 1,866 1,968

130 1,829 1,939 2,050 2,160 2,270 2,380

Source: Credit Suisse estimates

Figure 5: Expected FY13 losses of OMCs under various diesel price increase scenarios Diesel price increase HSD loss LPG loss SKO loss Total loss

INR/lt INR bn INR bn INR bn INR bn

2 498 264 272 1,034

4 351 264 272 887

6 204 264 272 740

8 57 264 272 593

Note: (1) Assuming price increase effective from 1 April 2012, (2) Brent at US$110/bbl and (3) INR/USD exchange rate at 46.


Figure 6: Asian refiners’ historical average EV to 12-

month forward EBITDA multiple

Figure 7: Brent crude historical price and forecast

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Refining avg. EV/12m fwd EBITDA

Source: DataStream, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates

12 October 2011


Little earnings visibility Given the large retail losses and stretched government finances, OMCs’ FY12 earnings are not likely to benefit much from any small correction in crude (especially if the rupee weakens). While sector reform is not impossible, we find it difficult to value it without clarity; the possibility of reforms is also difficult to rely on given the past misses. Near-term strength in crude prices and uncertainty on EPS heading into March 2012 can hurt. We update our models and reiterate UNDERPERFORM on BPCL/HPCL. We believe IOCL (NEUTRAL) offers the best relative value in the sector.

Reconciled to low RoE, in the absence of reform We believe there is little hope OMC RoEs will improve without reforms that lead to a material reduction in the scale of under-recoveries. IOCL/BPCL/HPCL have almost always had to bear ‘net under-recoveries’, consequently, delivering average RoE of 16/12/11% over the last five years. Ceteris paribus, the government is unlikely to improve the level of subsidy support.

We highlight that most of the recent funding difficulties at OMCs have been a result of delays in (and the form of) subsidy support instead of inadequate government payments. Adjusted for receivables, both IOCL and BPCL have managed their capex plans with little increase in net debt from FY06 to FY11. Only HPCL has struggled, with a material net debt increase, especially in FY11. The government is very likely cognizant of this fact and will feel no pressure to increase the level of subsidy support. That OMC RoEs are less than the comparables’ is unlikely to worry the government much, in our view.

Reform dependant on range-bound crude prices A Rs1.6/litre increase in retail diesel prices (4%) will generate Rs120 bn (US$2.4 bn) in revenue (annualised)—equivalent to the government’s revenue target through the sale of ONGC stock. A Rs7.5/litre increase (18%), which equals about four instances of the standard Rs2/litre increase, will eliminate diesel losses completely. If crude (and INR/USD) remains range bound, it should be easier for the government to dramatically reduce industry under-recoveries over time (say in two years). Any remaining LPG/SKO losses (c.Rs536 bn or US$11.8 bn) should be easier to fund.

Given that the market has cried wolf on oil reform many times, we do not think ‘hope and faith’ have much value now. Unless the diesel price reform is implemented (and adhered to), we do not believe the market will pay for much upside upfront.

Meanwhile, a question of valuations Without paying for reform-related upsides (higher EBITDA, EPS), it becomes difficult to get too excited about the OMC. In the short term, the market tends to look at book values for stock price support, but we highlight that falling RoEs at OMCs (as they have been) will lead to erosion of P/B multiples. While Asian refining comparables do not matter yet, they define potential upside—the recent, sharp correction in valuations means OMCs would not have much upside even if the government funded all under-recoveries. Theoretically, an RoE of 11% should imply P/B multiples of 0.7 times (for c.40% payout ratio); though we acknowledge several Indian stocks not strictly adhering to such calculations.

Without reform, we think it is difficult to convincingly build an investment case simply on valuations—the OMC can continue to be perceived as ‘contra-crude’ trades. We are ‘cautiously optimistic’ on crude prices and forecast Brent to average US$120/bbl in 2014.

We update our models for IOCL/BPCL/HPCL and revise their target prices to Rs361/582/303 from Rs388/595/347, maintaining NEUTRAL on IOCL and UNDERPERFORM on BPCL and HPCL. Any near-term strength in crude prices can hurt stock prices. Given the large losses that have already been crystallised in 1H FY12 and tight government finances, there is little hope that FY12 earnings will offer much upside.

We highlight that most recent funding difficulties at OMCs have been a result of delays in (and the form of) subsidy support and not due to inadequate government payments

Given that the market has cried wolf on oil reform many times, we do not believe ‘hope and faith’ have much value now

Without reform, we hold it is difficult to convincingly build an investment case simply on valuations

12 O

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Summary sector valuations Figure 8: Valuation comparison—Global refiners Market Div FCF RoE ROIC D/E

Company Ticker R Fx Price TP +/- cap EV-11E P/E (x) yield yield EV/EBITDA (x) (%) (%) (%) P/B (x)

LC LC % US$ mn US$ mn 10 11E 12E 11E 11E 10 11E 12E 11E 11E 11E 10 11E 12E

BPCL BPCL.BO U INR 674 582 -12 4,986 7,636 9.9 10.1 10.3 3.9 14.7 7.6 7.0 6.6 14 8 71 1.6 1.4 1.3

HPCL HPCL.BO U INR 360 303 -4 2,493 5,853 6.5 6.3 5.5 4.8 21.5 6.8 6.0 5.4 14 7 115 0.9 0.9 0.8

IOC IOC.BO N INR 310 361 25 15,393 19,773 6.5 6.3 6.2 5.5 5.0 5.7 5.5 5.5 18 10 30 1.3 1.1 1.0

RIL RELI.BO O INR 826 1,057 28 55,312 57,006 14.0 11.7 10.0 1.3 7.1 7.3 7.0 7.4 14 12 5 1.8 1.6 1.4

Essar Oil ESRO.BO O INR 79 174 121 2,203 4,374 16.6 11.4 3.5 0.0 -48.5 8.0 7.2 3.9 12 9 138 1.5 1.4 1.1

FPCC 6505.TW U TWD 93 77 -17 29,211 32,238 21.6 23.9 22.9 3.3 9.2 13.7 14.5 13.2 15 9 38 3.6 3.6 3.5

S-Oil Corp 010950.KS O KRW 102,000 190,000 86 9,871 11,855 14.9 6.2 5.9 3.9 1.8 13.8 6.3 5.4 32 19 39 2.5 1.9 1.6

SK Innovation 096770.KS O KRW 145,500 275,000 89 11,564 15,704 10.5 3.6 5.1 1.5 10.2 6.6 3.4 4.9 30 20 32 1.5 1.1 0.9

GS Holdings 078930.KS O KRW 58,200 72,000 24 4,648 5,103 6.8 5.2 5.0 2.6 19.8 5.1 5.5 5.2 16 13 8 1.0 0.8 0.7

Thai Oil TOP.BK O THB 55 70 28 3,619 4,033 12.4 6.6 7.8 6.9 21.2 6.9 3.7 4.2 21 19 15 1.6 1.4 1.3

AsiaPac avg 11.5 6.4 6.0 3.6 9.7 7.1 6.2 5.4 16 11 35 1.5 1.4 1.2

Japan refiners

Showa Shell 5002 N JPY 580 710 22 2,849 8,015 13.7 4.9 6.2 3.1 -38.2 8.7 5.2 6.7 15 6 131 0.9 0.7 0.7

Idemitsu 5019 O JPY 7,380 9,500 29 3,850 16,316 4.9 3.8 5.6 2.0 -28.1 6.0 5.4 6.4 13 5 156 0.5 0.5 0.4

JX Holdings 5020 O JPY 438 680 55 14,209 42,464 3.5 4.1 5.7 3.7 1.6 6.0 5.2 6.5 14 6 103 0.7 0.6 0.5

Japan average 4.9 4.1 5.7 3.1 -28.1 6.0 5.2 6.5 14 6 131 0.7 0.6 0.5

US refiners

Delek Holdings. DK N USD 14 17 24 792 854 (27.1) 3.7 3.5 1.1 12.0 13.7 1.9 1.8 30 31 9 1.7 1.1 0.9

Tesoro Corp. TSO O USD 24 36 48 3,508 4,239 (84.7) 4.6 4.8 0.0 13.1 7.5 2.3 2.3 24 17 17 1.4 1.1 0.9

Valero Energy VLO O USD 21 41 95 12,038 17,501 13.3 4.7 3.6 1.0 11.0 5.2 2.8 2.4 16 13 31 0.9 0.8 0.6

Western Refining. WNR N USD 15 24 56 1,396 1,747 (14.6) 4.4 3.6 0.0 27.2 6.2 1.8 1.6 75 32 28 12.2 3.3 1.8

US average (20.8) 4.5 3.6 0.5 12.5 6.9 2.1 2.1 27 24 22 1.5 1.1 0.9

Europe refiners

Galp Energia GALP.LS O EUR 15 18 26 16,437 21,141 39.4 35.6 17.9 1.4 -4.9 14.7 17.1 10.4 12 6 118 4.5 4.2 3.6

Neste NES1V.HE N EUR 7 12 65 2,436 5,294 11.1 16.7 5.0 3.0 -10.2 7.8 8.1 4.9 4 2 84 0.7 0.7 0.6

Petroplus PPHN.VX O USD 6 18 198 564 2,099 21.3 (9.9) 4.1 0.0 4.8 3.8 4.8 3.4 -4 4 101 0.3 0.4 0.3

Saras SRS.MI U EUR 1 2 54 724 1,101 30.8 25.1 7.7 1.6 -7.8 10.1 4.7 3.5 3 5 39 0.8 0.7 0.7

PKN Orlen PKNA.WA O PLN 37 59 60 5,001 6,910 6.7 6.7 9.0 2.5 5.7 3.9 4.0 4.4 10 8 23 0.7 0.7 0.6

Tupras TUPRS.IS O TRY 40 58 46 5,434 5,014 11.2 8.7 9.8 8.0 -11.5 6.7 5.8 5.5 27 31 no debt 2.6 2.3 2.2

Europe average 16.3 12.7 8.3 2.0 -6.3 7.2 5.3 4.7 7 6 84 0.8 0.7 0.7

Source: Company data, Credit Suisse estimates

12 October 2011


Reconciled to low RoE, in the absence of reform We believe there is little hope OMC RoEs will improve without reforms that lead to a material reduction in the scale of under-recoveries. IOCL/BPCL/HPCL have almost always had to bear ‘net under-recoveries’, consequently, delivering average RoE of 16/12/11% over the last five years. Ceteris paribus, the government is unlikely to improve the level of subsidy support.

We highlight that most recent funding difficulties at the OMCs have been because of delays in (and the form of) subsidy support, instead of inadequate government payments. Adjusted for receivables, both IOCL and BPCL have managed their capex plans with little increase in net debt from FY06 to FY11. Only HPCL has struggled, with a material net debt increase, especially in FY11. The government is very likely cognizant of this fact and will therefore feel no pressure to increase the level of subsidy support. That OMC RoEs are less than the comparables’ is unlikely to worry the government much, in our view.

Returns not the best, but not yet distressed Downstream companies have retained between 0% and 21% of gross under-recoveries over the last five years and have reported average RoE of 16/12/11% (IOCL/BPCL/HPCL). Excluding the stresses in FY09, RoE would have averaged higher, at 18/14/13%. Global refiners’ RoEs have averaged at 12% over the same period. Similarly, IOCL/ BPCL/ HPCL have reported ROIC of 13/ 12/ 7% over the last five years, compared to a global sector average of 8%. Downstream companies’ returns are arguably low (and on a declining trend for each of the three companies), but are perhaps still not at levels that may be considered distressed or that may force the government to materially increase subsidy support. The fact that OMC returns are lower than the comparables’ is unlikely to lead to greater subsidy support and higher returns, in our view.

Figure 9: Historical RoEs of OMCs

0%

5%

10%

15%

20%

25%

FY06 FY07 FY08 FY09 FY10 FY11

BPCL HPCL IOC

RoE (%)

Source: Company data

Companies have managed capex without much net debt Anecdotes of funding issues at the OMC are frequent and lead to a sense of crisis in relation to the companies. Most funding troubles are related to delays in cash payments by

Downstream companies’ returns are arguably low, but are perhaps still not at levels that may be considered distressed

12 October 2011


the government—while the companies account for government’s support each quarter (based on a letter), the actual cash payment happens after a significant delay. Working capital requirements at the OMC shoot in the interim, causing them to scramble for funds.

If the reported cash flow statements for these companies are adjusted for receivables from the government, the picture does not appear bad. Both IOCL and BPCL have managed their capital expenditure with little increase in net debt between FY06 and FY11. Only HPCL has had to resort to large borrowings to fund its capex.

The government is likely to see through the shorter-term pressures and argue that the companies do not need additional ‘cash’ support.

Figure 10: BPCL’s cash flow, FY06–11 (INR mn) Figure 11: BPCL’s cash flow, FY11 (INR mn)

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Figure 12: HPCL’s cash flow, FY06–11 (INR mn) Figure 13: HPCL’s cash flow, FY11 (INR mn)

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Both IOCL and BPCL have managed their capital expenditure with little increase in net debt between FY06 and FY11

12 October 2011


Figure 14: IOC’s cash flow, FY06–11 (INR mn) Figure 15: IOC’s cash flow FY11 (INR mn)

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Figure 16: Return ratios for OMCs With under-recoveries Without under-recoveries

ROIC (%) ROGIC (%) ROIC (%) ROGIC (%)

BPCL 11.6 8.7 17.5 12.6

HPCL 7.1 7.2 11.8 10.3

IOC 12.7 10.2 17.7 13.4


Figure 17: Credit Suisse oil price forecast (calendar year) 1Q11 2Q11 3Q11 4Q11E 2011E 1Q12E 2Q12E 3Q12E 4Q12E 2012E 2013E 2014E LT

Brent USD/bbl 101.27 116.99 112.09 100 107.8 100 100 110 110 105 115 120 90

WTI USD/bbl 94.6 102.34 89.54 75 90.7 80 86 90 88 86 106.8 115.5 84

Brent-WTI USD/bbl 6.67 14.65 22.55 25 17.1 20 14 20 22 19 8.2 4.5 6

Source: Bloomberg, Credit Suisse estimates

12 October 2011


Reform dependant on range-bound crude prices A Rs1.6 per litre increase in retail diesel prices (4%) will generate Rs120 bn (US$2.4 bn) in revenue (annualised) – equivalent to the government’s revenue target through its sale of ONGC stock. Even an increase of Rs7.5 per litre (18%) can eliminate diesel losses – which calls for about four instances of the standard Rs2/litre increase. If crude (and INRUSD) remain range bound, it should be relatively easy for the government to dramatically reduce industry under-recoveries over time. Any remaining LPG/SKO losses (c.Rs536 bn, US$11.8 bn) should be relatively easy to fund.

Given the market’s penchant for crying wolf on oil reforms, we do not believe ‘hope and faith’ retain much value now. Unless diesel price reform is implemented (and adhered to), we do not expect the market to pay for much upside upfront. Though under-recoveries remain high (FY11 is likely to witness the largest losses despite much government effort), estimates have now become very sensitive to small changes, given increasing diesel consumption volumes. A Rs5.3 per litre increase in retail diesel (13%) will generate Rs400 bn (US$8.8 bn) in revenue (annualised) – equivalent to the government’s total FY12 disinvestment revenue target. A Rs7.5 per litre increase (18%) will eliminate diesel losses. Irrespective of a change in the official pricing policy, range bound crude/ INRUSD would mean under-recoveries peak in FY12, as diesel losses are slowly obliterated. The remaining LPG/SKO losses should be relatively easy to fund. We are ‘cautiously optimistic’ on crude prices, and forecast Brent averaging US$120/bbl in CY2014.

While the possibility exists, it is difficult to assume the government will act to reduce the problem, given the multiple political considerations. Given recent policy disappointments, until such ‘reform’ is affected (and adhered to), we believe the OMCs can remain ‘trades’ at best, and move inversely to crude prices.

Losses at an all-time high Industry under-recoveries totalled Rs1,033 bn (US$23 bn) in FY09, when crude averaged US$85/bbl (INR-USD of 45.85). Since then, the government has taken material steps – by decontrolling petrol pricing, increasing diesel/LPG/SKO prices 32/ 31/ 54%, and by reducing taxation for the oil business. Yet FY12 under-recoveries are expected to be higher – at Rs1,197 bn, due to (1) higher crude, (2) INRUSD and (3) larger HSD consumption.

Figure 18: Historical net under-recoveries to OMCs (INR bn) FY07 FY08 FY09 FY10 FY11

Petrol 20 73 52 52 22

Diesel 188 352 523 93 347

Domestic LPG 107 155 176 143 218

PDS kerosene 179 191 282 174 195

Total losses 494 771 1,033 461 782

Government oil subsidy 241 353 713 260 410

Upstream share of subsidy 205 257 329 144 303

Net under-recoveries 48 161 - 56 69

Source: PPAC

FY12 under-recoveries are expected to be higher – at Rs1,197 bn, due to (1) higher crude, (2) INRUSD and (3) larger HSD consumption

12 October 2011


Figure 19: Historical consumption volume of controlled products

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120,000

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

HSD MS LPG SKO

'000 MT

Source: PPAC

Potentially at a peak? We believe it may be possible to affect small, periodical increases in retail diesel prices without raising too many political issues. Diesel is currently only Rs7.5 (18%) ‘out of the money’ – and needs only four standard Rs2/litre increases to break even – assuming crude / INR/USD remain range bound.

Inflation is high, and political pressures can surprise (especially heading into election years), but it may be possible for the government to ensure that FY12 under-recoveries are the highest the industry ever faces.

Figure 20: Price increase required for controlled products to break even (for US$105/bbl

Brent and INRUSD rate of 47) Product Out of the money

HSD INR/lt 7.5

SKO INR/lt 26

LPG INR/cylinder 260


Figure 21: India FY13 total loss estimates for various crude and exchange rate assumptions Brent (USD/bbl) ▼ / INR/USD ► 45 46 47 48 49 50

70 184 199 214 229 244 259

80 267 283 300 317 333 350

90 349 423 500 577 655 732

100 716 802 887 973 1,059 1,144

110 1,087 1,181 1,275 1,369 1,462 1,556

120 1,458 1,560 1,662 1,764 1,866 1,968

130 1,829 1,939 2,050 2,160 2,270 2,380


It may be possible for the government to ensure that FY12 under-recoveries are the highest the industry ever faces.

12 October 2011


Figure 22: Expected FY13 OMC losses under various diesel price increase scenarios Diesel price increase HSD loss LPG loss SKO loss Total loss

INR/lt (INR bn) (INR bn) (INR bn) (INR bn)

- 646 264 272 1,181

2 498 264 272 1,034

4 351 264 272 887

6 204 264 272 740

8 57 264 272 593

Note: (1) Assuming price increase effective from 1 April 2012, (2) Brent at US$110/bbl and (3) INR/USD

exchange rate at 46.


LPG subsidy reforms can help as well While there is longer term hope that the government will be able to direct subsidies based on the ‘Aadhar’ identity system, a limiting of subsidised LPG cylinders per household (as is being proposed) can also materially reduce total under-recoveries.

We estimate that limiting subsidies to four cylinders per household can save c.Rs122 bn (US$2.7 bn) in FY13 (at US$110/bbl Brent), which could be 10% of the total estimated losses for the year.

Figure 23: Implementation of four LPG cylinders per connection cap can reduce total

FY13 estimated losses by c.10% for crude at US$110/bbl LPG loss LPG loss under Current FY13 Savings

under current proposed Savings estimated as % of

Crude mechanism mechanism on LPG losses total

(USD/bbl) (INR bn) (INR bn) (INR bn) (INR bn) %

70 69 37 32 199 16%

80 118 63 55 283 19%

90 166 89 77 423 18%

100 215 115 100 802 12%

110 264 141 122 1,181 10%

120 312 167 145 1,560 9%

130 361 193 168 1,939 9%


Figure 24: India’s subsidised LPG consumption can be reduced materially LPG Domestic Number of Subsidised Subsidised

connections consumption cylinders cylinders LPG

(mn) (TMT) (mn) (mn) (TMT)

FY13 139 14,745 1,038 556 7,895

FY14 146 15,335 1,080 584 8,293

Source: UIDAI, Credit Suisse estimates

A limiting of subsidised LPG cylinders per household (as is being proposed) can also materially reduce total under-recoveries

12 October 2011


Figure 25: India’s LPG consumption profile

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<=4 5 6 8 10 12 14 >=15

Cumulative % of customers

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Proposed cap @ 4 cylinders per year

Median consumption at 6.7 cylinders/yr

Source: UIDAI

12 October 2011


Meanwhile, a question of valuations Without paying for reform-related upsides (higher EBITDA, EPS), it becomes difficult to get too excited about the OMCs. In the short term, the market tends to look at book values for stock price support, but we highlight that falling RoE at the OMCs (as they have been) will lead to erosion of P/B multiples. While Asian refining comparables do not matter yet, they define potential upside – the recent, sharp correction in valuations means OMCs would not have much upside even if the government funded all under-recoveries. Theoretically, an RoE of 11% should imply P/B multiples of 0.7x; though we note there are several stocks in India that do not strictly adhere to such calculations.

Without reforms, we believe it is difficult to convincingly build an investment case simply on valuations. The OMC can continue to be perceived as ‘contra-crude’ trades. We are ‘cautiously optimistic’ on crude prices, and forecast Brent averaging US$120/bbl in 2014.

Are book values a support? Due to the lack of earnings visibility, the market has tended to consider book value multiples for these stocks. Given the long-term declining trend in RoEs, P/B multiples for these companies have also fallen on trend. Multiples for IOCL/HPCL are at end 2006 levels, though ROEs now are lower than those delivered in FY07/FY08. Multiples for BPCL are higher than those at end 2006 (despite lower headline ROE), perhaps reflecting the valuation of the E&P portfolio of the company.

BPCL used to deliver ROE greater than HPCL in the early 2000’s – this difference has been closed (HPCL delivered better returns in FY11) by the subsidy-related uncertainties in the sector, we estimate. The relative expansion in BPCL’s P/B multiple, however, is indicative of excitement on its E&P portfolio (Brazil, Mozambique). If BPCL’s core businesses were to be valued at P/B multiples similar to those of HPCL, we believe the market is paying c.US$1.9 bn for BPCL’s upsides.

Figure 26: ROEs delivered by OMCs Figure 27: Historical price to 12-month forward book

valuations of OMCs

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY20

02

FY20

03

FY20

04

FY20

05

FY20

06

FY2

007

FY2

008

FY20

09

FY20

10

FY20

11

IOCL BPCL HPCL

0.50

0.70

0.90

1.10

1.30

1.50

1.70

1.90

2.10

2.30

2.50

1-Ja

n-04

1-Ja

n-05

1-Ja

n-06

1-Ja

n-07

1-Ja

n-08

1-Ja

n-09

1-Ja

n-10

1-Ja

n-11

IOCL BPCL HPCL

Source: Company data Source: DataStream, Credit Suisse estimates

If the government continues to provide companies with bare minimum amounts of cash flow (on an absolute basis), RoE will continue to decline. The P/B multiples for the OMC should then continue to deteriorate as well – buying these stocks when they hit perceived ‘lows’ on a P/B chart may not work in such a situation.

Due to the lack of earnings visibility, the market has tended to look at book value multiples for these stocks

12 October 2011


Valuations for comparables have fallen materially Asian refiners’ valuations have fallen materially over the last few months, and are now approaching levels seen during the financial crisis. Average P/E is now 8.5x, EV/EBITDA is now 5.5x—a reflection of market concerns on earnings/ refining margins, we believe. We agree that the Indian OMCs do not have this commodity leverage to earnings—their EBITDA is more controlled by government policies; and to that extent, their valuations need not mimic those of Asian refiners.

Comparable valuations however, should define the upside for the OMC – in the scenario (1) that the government either deregulates the sector (allowing free pricing of all products), or (2) that the government is willing to reimburse all the under-recoveries incurred by OMCs. While free pricing of products may allow marketing margins to expand, the recent decline in regional P/E or EV/EBITDA multiples limits stock price upside in the second case.

Figure 28: Asian refiners’ historical average/median price

to 12-month forward earnings

Figure 29: Asian refiners’ historical average EV to 12-

month forward EBITDA multiples

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

Jan-

04A

pr-0

4Ju

l-04

Oct

-04

Jan-

05A

pr-0

5Ju

l-05

Oct

-05

Jan-

06A

pr-0

6Ju

l-06

Oct

-06

Jan-

07A

pr-0

7Ju

l-07

Oct

-07

Jan-

08Ap

r-08

Jul-0

8O

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8Ja

n-09

Apr

-09

Jul-0

9O

ct-0

9Ja

n-10

Apr

-10

Jul-1

0O

ct-1

0Ja

n-11

Apr-

11Ju

l-11

Oct

-11

Asian refiners' avg. Price to 12m fwd EPSAsian refiners' median Price to 12m fwd EPS

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Refining avg. EV/12m fwd EBITDA

Source: DataStream, Credit Suisse estimates Source: DataStream, Credit Suisse estimates

Little upside then We estimate ‘normalised’ EPS for IOCL/ BPCL/ HPCL assuming all the net under-recoveries were reimbursed, and eliminating one-off costs/ gains. Using the current Asian P/E average on these normalised EPS estimates, IOCL/ BPCL/ HPCL would be worth Rs415/ 700/ 692 per share, respectively. On a similar EV/EBITDA comparison, these stocks would be worth Rs362/ 624/ 415 per share, respectively.

Figure 30: Valuations of OMCs under normalised earnings and regional multiples BPCL - FY12 HPCL - FY12 IOC - FY12

Normalised EPS (INR/share) 82 81 49

Normalised EBITDA (INR mn) 69,510 60,060 228,297

FY12 net debt 156,825 189,706 375,771

Implied price at 8.5x P/E 700 692 415

Implied price at 5.5x P/B 624 415 362

Shares (mn) 362 339 2,428


Asian refiners’ valuations have fallen materially over the last few months. They are now approaching levels seen during the financial crisis

12 October 2011


On a theoretical framework, 0.7x book While CAPM has been questioned lately, we use it anyway to estimate a ‘theoretical’ P/B multiple for the OMCs. We calculate Beta for each of the three OMCs (IOCL/BPCL/HPCL) at between 0.7-0.72; using weekly returns for the last ten years. With risk free rates at 8.6% (ten-year G-Sec) and market premium of 5%, the cost of equity for the OMCs works out to c.12.1%.

On a dividend discount model, a stock’s price-to-book multiple is linked to (1) its expected RoE, (2) the dividend payout ratio and (3) its cost of equity (see formula below).

Figure 31: Price-to-book multiple is a function of ROE, cost of equity and payout ratio

)1(;

)(

)1()(

)(

)1(

)(

)1()1(

)(

1

0

1

0

00

10

opayoutratiRoEgwhere

gR

tgRoE

B

P

gR

topayoutratiRoE

B

P

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tgopayoutratiRoEBP

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e

d

e

d

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d

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−×=−

−×−==>

−−××==>

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−=

Source: Aswath Damodaran, http://people.stern.nyu.edu/adamodar/pdfiles/pbv.pdf

As the OMCs are public sector ‘Navratna’ companies, they pay c.30-35% of annual PAT as dividend – for a total payout of c.35-40% including dividend taxes. If BPCL/ HPCL continue to deliver 11% RoE in perpetuity, they should then trade at P/B multiples of c.0.7x (using the formula above). IOCL, with a higher RoE, should trade at c.1.1x.

Figure 32: Price-to fwd book ratio under various CoE and payout ratio scenarios

(assuming RoE 11%) Cost of equity ▼ / Payout ratio ► 25% 30% 35% 40% 45% 50% 55%

10% 1.30 1.19 1.12 1.07 1.04 1.01 0.99

11% 0.83 0.83 0.83 0.83 0.83 0.83 0.83

12% 0.61 0.64 0.66 0.68 0.69 0.70 0.71

13% 0.48 0.52 0.55 0.57 0.59 0.61 0.62

14% 0.40 0.43 0.47 0.49 0.52 0.54 0.55

15% 0.34 0.38 0.41 0.43 0.46 0.48 0.50


Figure 33: Price-to-fwd book ratio under various CoE and payout ratio scenarios

(assuming RoE 13%) Cost of equity ▼ / Payout ratio ► 25% 30% 35% 40% 45% 50% 55%

10% 10.79 3.60 2.44 1.96 1.70 1.54 1.43

11% 2.16 1.70 1.48 1.35 1.26 1.20 1.15

12% 1.20 1.12 1.06 1.03 1.00 0.98 0.96

13% 0.83 0.83 0.83 0.83 0.83 0.83 0.83

14% 0.63 0.66 0.68 0.70 0.71 0.72 0.73

15% 0.51 0.55 0.58 0.60 0.62 0.63 0.65


Cross checking on a DDM

We cross check the above inference using Dividend Discount Models for each of the three companies – their implied P/B multiples turn out similar to those calculated above.

If BPCL / HPCL continue to deliver 11% RoE in perpetuity, they should trade at P/B multiples of c.0.7x.

12 October 2011


Figure 34: BPCL dividend discount model Stage I Stage II Stage III

11 12E 13E 14E 15E 16E 17E 18E 19E E 21E 22E 23E 24E 25E 26E Bharat Petroleum

BVPS (Rs./share) 425 452 481 513 546 582 620 661 704 750 800 852 852 852 852 852 RoE (%) 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% EPS (Rs./share) 45 50 53 56 60 64 68 73 77 83 88 94 94 94 94 94 Payout (%) 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 100% 100% 100% 100% 100% Dividend(Rs./share) 21 20 21 23 24 26 28 29 31 33 36 94 94 94 94 94 Retained earnings(Rs./sh) 27 30 32 34 36 38 41 43 46 49 52 - - - - - Dividend post tax(Rs./sh) 18 17 18 20 21 22 24 25 27 29 30 80 80 80 80 80 CMP(Rs./share) 674 DDM (Rs./share) 373 399 427 457 489 524 561 601 644 690 740 740 740 740 740


Figure 35: HPCL dividend discount model Stage I Stage II Stage III

11 12E 13E 14E 15E 16E 17E 18E 19E E 21E 22E 23E 24E 25E 26E Hindustan Petroleum



Figure 36: IOC dividend discount model Stage I Stage II Stage III

11 12E 13E 14E 15E 16E 17E 18E 19E E 21E 22E 23E 24E 25E 26E Indian Oil



Valuations on HOLT We use Credit Suisse HOLT to further assess the question of OMC valuations. On a consensus EPS scenarios, HOLT suggests downsides for both BPCL and HPCL, but recommends an approximately 60% upside on IOCL. Largely, we believe this is reflective of the fact that BPCL/ HPCL have CFROI forecasts less than HOLT’s discount rate, while IOCL is forecast to return more. Additionally, HOLT treats the oil bonds that each of these companies carries as ‘assets’; which suppresses returns. Any ‘deleveraging’ through the

12 October 2011


sale of these oil bonds would help reduce the asset base and consequently improve the CFROI.

Despite complications, we look at OMC valuations on HOLT. In order to work around the oil bonds issue, we assume zero asset growth for the next three years – essentially implying all incremental capex is funded by the sale of oil bonds. If we then assume CFROI remains at the FY11 levels (FY10 in the case of HPCL), HOLT implies a 58% upside for IOCL, but a 32/ 72% downside for BPCL and HPCL, respectively.

Figure 37: IOC on CS HOLT Price: 311.45 (September 30, 2011)

Warranted Price : 497.16 INR (60%)Price: 311.45 (September 30, 2011)Warranted Price : 497.16 INR (60%)

Source: CS HOLT

Figure 38: BPCL on CS HOLT Price: 669.25 (October 7, 2011)Warranted Price : 425.54 INR (-36%)Price: 669.25 (October 7, 2011)Warranted Price : 425.54 INR (-36%)

Source: CS HOLT

12 October 2011


Figure 39: HPCL on CS HOLT

Source: CS HOLT

Crude: Macro risks, bullish fundamentals This is an excerpt from our note, A Dangerous New Phase, published on 4 October 2011. For more details on the note, please click here.

Ironically, for a commodity that has held up better than most, we see more downside than upside in the next six months or so for Brent crude oil. An extreme lack of confidence adds downside pressure to what currently is at best only sluggish oil demand growth, at least at a global level. Combined with seasonal weakness in 4Q and 1Q, we expect Brent average prices to continue to deflate slowly in this quarter, with no meaningful recovery in 1Q12, in our view.

However, once the macro dust settles, strong underlying oil demand growth trends and any of a number of issues on the supply side should become more apparent. From 2Q12, we expect oil prices to resume an upward trend, peaking at what we consider maximum sustainable levels of around $120 per barrel for Brent in early 2013.

Although our base-case scenario is for the global economy to stabilise over the coming months, the full impact of the damage already done this summer is probably still playing out in the oil markets. That said, aside from a severe crisis scenario, strong trend growth in emerging market oil consumption should continue to flow to the bottom line. Capacity utilisation all along the oil supply chain, including its refining system, remains historically high. If this year did anything in the world of oil, it underscored supply side risk among the entire range of MENA oil producers. In addition, an emerging trend of robust non-OPEC supply growth suddenly also appears vulnerable.

Aside from a severe crisis scenario, a strong trend growth in emerging market oil consumption should continue to flow to the bottom line

12 October 2011


Figure 40: OECD oil use reset in 2008–09 Figure 41: Global demand growth by product shows the

strength of diesel and jet

Source: IEA, Credit Suisse estimates Source: JODI, IEA, Credit Suisse research

Figure 42: US mid-distillate use recovery Figure 43: China middle-distillate demand is robust

Source: EIA, Credit Suisse research Source: EIA, Credit Suisse research

Figure 44: Brent crude historical price and forecast Figure 45: WTI crude historical price and forecast

Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates

12 October 2011


Asia Pacific / India Oil & Gas Exploration & Production

Indian Oil Corp Limited (IOC.BO / IOCL IN)

The behemoth ■ Update TP. We update our target price for IOCL from Rs388 to Rs361 but

maintain our NEUTRAL rating. IOCL offers the best value among the OMCs, in our opinion.

■ Greater inherent profitability. IOCL is the Indian behemoth of the petroleum retail business: its FY11 gross assets are 1.45x that of BPCL and HPCL combined. IOCL’s earnings also benefit from large inland refineries (it has consistently delivered GRM better than BPCL/HPCL) and extensive pipeline infrastructure. Despite vagaries of the subsidy system, IOCL has reported only nine loss-making quarters in the last five years (compared to 12 for HPCL). This higher profitability means it is better off on cash flows, and can continue to invest for growth—the new Paradip refinery, for example (following the Panipat naphtha cracker). In partnership with OILI, IOCL also has access to potentially large E&P assets overseas.

■ Catalysts. Any structural reform, reducing the levels of net under-recoveries for IOCL will be an obvious positive. A turnaround at the Panipat cracker (which we understand is still struggling with operating rates; and which has likely affected FY11 EBITDA), can help core EBITDA. Expansion of refining capacity at Paradip (15 mn tpa) would similarly help, but we understand the project is delayed into end-2013. The proposed government stock sale can remain an overhang, while lower government support (to be known only at year end), can hurt near-term earnings and cash flow materially.

■ Valuation. IOC trades at 1.3x FY11 book, on 14% FY11 RoE, and at 9.6x FY11 EPS. We estimate FY11 normalised EPS for IOC at Rs38, less than that for FY10 (Rs49), perhaps due to start-up losses at Panipat. While our EPS estimates continue to price in zero net under-recoveries (for lack of any insight, and to highlight earnings potential of the company), our TP is now based on FY12 EBITDA estimates assuming Rs100 bn net under-recovery for the OMC.

Share price performance

200300400500600

Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11

80

100

120

140Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the BSE SENSEX IDX which closed at 16536.47 on 11/10/11 On 11/10/11 the spot exchange rate was Rs49.34/US$1.

Performance over 1M 3M 12M Absolute (%) -1.9 -8.1 -25.4 Relative (%) -2.2 3.1 -7.3

Financial and valuation metrics

Year 3/11A 3/12E 3/13E 3/14E Revenue (Rs mn) 3,090,767.5 3,662,393.1 3,694,046.4 3,951,917.0 EBITDAX (Rs mn) 126,013.4 228,297.3 252,145.4 262,539.1 EBIT (Rs mn) 76,687.4 163,403.8 182,250.3 187,086.8 Net income (Rs mn) 78,307.2 118,490.0 131,382.3 134,087.1 EPS (CS adj.) (Rs) 32.25 48.80 54.11 55.23 Change from previous EPS (%) n.a. -1.1 8.2 -7.8 Consensus EPS (Rs) n.a. 35.5 40.8 41.5 EPS growth (%) -26.9 51.3 10.9 2.1 P/E (x) 9.6 6.4 5.7 5.6 Dividend yield (%) 3.7 5.5 6.1 6.3 EV/EBITDAX (x) 9.3 4.9 4.3 3.9 P/B (x) 1.3 1.2 1.0 0.9 ROE (%) 14.2 19.3 18.9 17.2 Net debt/equity (%) 69.6 55.5 43.3 33.0

Source: Company data, Thomson Reuters, Credit Suisse estimates.

* Stock ratings are relative to the relevant country benchmark. ¹ Target price is for 12 months.

Research Analysts


[email protected]

Rating NEUTRAL* Price (11 Oct 11, Rs) 309.95 Target price (Rs) (from 388.00) 361.00¹ Chg to TP (%) 16.5 Market cap. (Rs mn) 752,544 Enterprise value (Rs mn) 1,128,315 Number of shares (mn) 2,427.95 Free float (%) 10.0 52-week price range 430.2 - 293.3

12 October 2011


Figure 46: IOC normalised earnings estimates Year-end 31 Mar (INR mn) FY09 normalised FY10 normalised FY11 normalised

Gross sales 3,273,699 2,878,686 3,530,258

Excise paid (including duties) 226,829 218,023 257,899

Net sales 3,046,870 2,660,663 3,272,359

Total expenses 2,979,252 2,538,303 3,155,077

Raw material costs 2,732,929 2,396,299 2,986,484

Consumption of raw materials 1,370,472 1,175,458 1,430,003

Purchase of products 1,362,457 1,220,842 1,556,481

(Increase)/ decrease in inventory 16,746 (50,443) (49,729)

Staff costs 56,945 57,411 64,356

Other expenditure 172,633 135,035 153,967

EBITDA 67,619 122,360 117,282

Adjust for MTM loss on bond portfolio 6,703 14,995 -

Adjust for net under-recovery - 31,588 38,032

Adjust for inventory loss 16,746 - -

Adjust for employee benefit provisions - 6,870

Adjusted EBITDA 136,996 168,943 162,183

Depreciation 28,817 32,271 45,467

Adjusted EBIT 108,179 136,672 116,717

Adjusted interest 7,904 5,088 8,899

Adjusted other income 33,783 49,806 32,767

Of which forex gains 17,945 6,956

PBT 134,058 181,389 140,585

Tax 46,920 63,486 49,205

Net profit 87,138 117,903 91,380

Number of shares (mn) 2,428 2,428 2,428

Normalised EPS (Rs) 36 49 38


Figure 47: IOC SOTP valuation INR mn Valuation Comments

FY13 EBITDA 196,724 Assuming Rs100 bn losses for OMCs

Multiple 5.50 Asian EV/EBITDA multiple

EV 1,081,980

Less: FY12 net debt (412,904)

Indian Oil treasury stock 17,484 At Rs300 per share

ONGC 164,481 At Rs250 per share

GAIL 12,252 At Rs400 per share

OIL India 13,375 At Rs1,250 per share

Equity value 876,668

Share count (mn) 2,428

Share price (Rs) 361


12 October 2011


Figure 48: IOC summary financials Year-end 31 Mar (INR mn) FY10 FY11 FY12E FY13E FY14E

Net sales 2,333,103 2,838,500 3,289,474 3,301,154 3,536,446

Government subsidy 167,949 242,815 363,321 383,291 405,165

Operating expenses 1,372,811 1,697,376 2,123,440 2,130,637 2,281,942

RM consumed 1,211,932 1,501,207 1,919,709 1,920,352 2,061,363

Transportation 61,569 68,980 69,670 70,366 71,070

Employee cost 60,651 67,358 72,073 77,118 82,516

Resale of products 1,007,775 1,275,911 1,258,024 1,258,445 1,350,853

SG&A 55,934 47,603 52,632 52,818 56,583

Inventory (gain)/ loss (53,869) (56,136) - - -

EBITDA 129,614 126,013 228,297 252,145 262,539

Depreciation 35,552 49,326 64,894 69,895 75,452

EBIT 94,063 76,687 163,404 182,250 187,087

PBT 150,486 101,140 185,646 206,156 210,637

PAT 109,987 80,856 122,526 136,063 139,020

Profit after tax 107,132 78,307 118,490 131,382 134,087

Balance sheet

Gross fixed assets 788,467 1,008,422 1,089,422 1,179,422 1,269,422

Depreciation 333,751 382,229 448,407 518,302 593,754

CWIP 227,678 142,842 151,842 161,842 171,842

Cash 15,984 15,374 15,374 15,374 15,374

Inventories 410,765 549,171 696,817 726,739 814,381

Advances and deposits 208,131 310,120 331,590 354,690 379,543

Business advances 152,070 233,573 251,091 269,923 290,168

Sundry debtors 56,062 76,546 80,498 84,766 89,376

Other current assets 15,079 14,906 14,906 14,906 14,906

Investments 214,298 186,469 114,133 78,994 62,505

Total assets 1,547,119 1,845,735 1,965,978 2,013,966 2,134,520

Current liabilities 351,658 532,103 675,161 704,153 789,071

Provisions 103,612 69,291 69,291 69,291 69,291

Total borrowings 494,726 578,376 465,351 384,101 317,258

Deferred tax 54,170 70,282 79,564 89,872 100,404

Equity share capital 24,280 24,280 24,280 24,280 24,280

Reserves and surplus 500,344 551,473 628,364 713,623 800,636

Total shareholder's funds 524,623 575,752 652,644 737,902 824,915

Minority interest 18,330 19,930 23,966 28,647 33,580

Total liabilities 1,547,119 1,845,735 1,965,978 2,013,966 2,134,520

Cash flow

PBT 150,486 101,140 185,646 206,156 210,637

Interest 17,262 29,803 24,562 22,535 24,177

Depreciation 35,552 49,326 64,894 69,895 75,452

Other income (74,547) (54,964) (46,804) (46,441) (47,726)

Working capital changes (74,620) (94,097) (26,059) (24,030) (27,577)

Cash from operations 54,132 31,208 202,239 228,116 234,962

Tax (40,499) (20,284) (63,119) (70,093) (71,616)

Cash from operating activities 13,633 10,924 139,119 158,023 163,345

Purchase of assets (141,991) (136,471) (88,356) (100,000) (100,000)

Change in investments 98,941 27,829 72,336 35,139 16,489

Other income 74,547 54,964 46,804 46,441 47,726

Cash from investing activities 31,644 (53,658) 30,784 (18,420) (35,784)

Change in debt 21,257 83,650 (113,025) (81,251) (66,842)

Interest (17,262) (29,803) (24,562) (22,535) (24,177)

Dividend (37,278) (27,491) (41,598) (46,124) (47,074)

Cash from financing (26,364) 42,469 (169,903) (139,603) (127,561)


12 October 2011


Asia Pacific / India Oil & Gas Refining & Marketing

Bharat Petroleum (BPCL.BO / BPCL IN)

E&P a differentiator ■ Update TP. We update our TP for BPCL from Rs595 to Rs582, and maintain

our UNDERPERFORM rating on the stock.

■ Brazil, Mozambique to the rescue. BPCL derives a larger proportion of income from refining than HPCL does, and to that extent, it is seen as less sensitive to the retail marketing business fortunes. BPCL has outperformed HPCL in a falling crude environment, we believe principally due to positive news flow at its E&P business. On 22 September, Petrobras announced an oil discovery in the Sergipe-Alagoas basin (Brazil), which adds to BPCL’s earlier success at Wahoo. Anadarko also recently increased its recoverable resource estimates at the Rovuma basin in Mozambique to 10 TCF, and is reportedly looking at two five MTPA LNG trains for the project. Assuming the core businesses trade at similar P/B multiples, we estimate the market is paying Rs90 bn (US$1.9 bn) for the E&P portfolio.

■ Catalysts. Any reduction in net under-recoveries for BPCL will be a positive, helping the company get closer to its earnings potential. While the E&P business can continue to deliver positive news flow on resources for some time (especially on recent Brazilian success), we believe incremental news flow on Wahoo and Mozambique will tend to be development led; with focus shifting to project timelines and capex. While BPCL can possibly monetise its stake in these E&P assets earlier, we think the probability is low.

■ Valuation. BPCL trades at 1.6x FY11 book, on 11% FY11 RoE, and at 14.9x FY11 EPS. Our normalised FY11 EPS estimate for BPCL is at Rs87; a gain from that in FY10 likely due to higher refining margins. While our EPS estimates continue to price in zero net under-recoveries (for lack of any insight, and to highlight BPCL’s earnings potential), our TP is now based on FY12 EBITDA estimates assuming Rs100 bn net under-recovery for the OMC.


400500600700800


80100120140160

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the BSE SENSEX IDX which closed at 16536.47 on 11/10/11 On 11/10/11 the spot exchange rate was Rs49.34/US$1.

Performance over 1M 3M 12M Absolute (%) 2.5 1.1 -9.3 Relative (%) 2.3 12.3 8.8


Year 3/11A 3/12E 3/13E 3/14E Revenue (Rs mn) 1,556,744.3 1,777,392.1 1,790,286.1 1,920,649.9 EBITDAX (Rs mn) 42,762.2 69,510.2 75,022.2 79,386.4 EBIT (Rs mn) 23,848.5 55,652.4 60,686.5 65,111.0 Net income (Rs mn) 16,349.6 29,754.2 31,666.7 34,376.0 EPS (CS adj.) (Rs) 45.22 82.30 87.59 95.08 Change from previous EPS (%) n.a. 23.1 34.0 16.4 Consensus EPS (Rs) n.a. 51.8 61.4 63.2 EPS growth (%) 0.2 82.0 6.4 8.6 P/E (x) 14.9 8.2 7.7 7.1 Dividend yield (%) 2.7 4.9 5.2 5.7 EV/EBITDAX (x) 9.7 5.8 5.6 5.3 P/B (x) 1.6 1.4 1.3 1.2 ROE (%) 11.1 18.3 17.5 17.2 Net debt/equity (%) 105.4 85.7 85.7 78.5



Research Analysts


[email protected]

Rating UNDERPERFORM* Price (11 Oct 11, Rs) 674.20 Target price (Rs) (from 595.00) 582.00¹ Chg to TP (%) -13.7 Market cap. (Rs mn) 243,752 Enterprise value (Rs mn) 400,576 Number of shares (mn) 361.54 Free float (%) 35.7 52-week price range 771.6 - 538.6

12 October 2011


Figure 49: BPCL normalised earnings Year-end 31 Mar (INR mn) FY09 normalised FY10 normalised FY11 normalised

Gross sales 1,428,475 1,315,213 1,632,182

Excise paid (including duties) 76,098 92,238 116,732

Net sales 1,352,377 1,222,975 1,515,451

Total expenses 1,325,004 1,198,969 1,481,211


Consumption of raw materials 539,369 505,925 627,304

Purchase of products 678,678 630,789 781,051

(Increase)/ decrease in inventory 15,759 (39,898) (20,561)

Staff costs 18,849 21,411 28,029


EBITDA 27,373 24,007 34,240

Adjust for MTM loss on bond portfolio - 10,865 -



Adjust for employee benefit provisions - - 11,460

Adjusted EBITDA 56,160 47,249 61,200

Depreciation 10,756 12,423 16,554

Adjusted EBIT 45,404 34,825 44,646



of which forex gains - 5,563 (310)

PBT 47,957 44,972 48,606

Tax 16,785 15,740 17,012

Net profit 31,172 29,232 31,594

Number of shares (mn) 362 362 362



Figure 50: BPCL SOTP valuation INR mn Valuation Comments



EV 288,386


BPCL Trust for Investments in Shares 21,924 At Rs650 per share

Oil India Ltd 6,688 At Rs1,250 per share

Bina refinery 30,000 At 1.5x expected equity investment

Wahoo 15,185 @ 400 mmbbl recoverable estimate

Mozambique 7,833 10% stake in 10 TCF reserve @ US$1/boe

Petrobras 12,292 @ 400 mmbbl recoverable estimate


Share count (mn) 362



12 October 2011


Figure 51: Summary of BPCL E&P discoveries Discovery Basin Country Reserves Comments

Wahoo Santos Brazil 400 mn bbl (12.5% BPCL)

In Sep-08 BPCL, in a 50:50 JV with Videocon, bought stake in ten Brazilian blocks from Encana for US$283 mn (BPCL share US$142 mn). The block BM-C-30 in the Santos Basin is operated by Anadarko (BPCL effective share of 12.5%) where two wells have successfully tested for oil (the Wahoo 1 and 2 discoveries).We currently use an estimate of 400 mn barrels recoverable as base case. The production from the Wahoo is expected around 2014. We model the field concession at US$6.8/bbl. With BPCL owning 50 mn barrels net, this would add US$340 mn (Rs42/share) to valuation.

Barra Sergipe - Alagoas

Brazil 400 mn bbl (10% BPCL)

The consortium of Petrobras (60%), Videocon and BPCL (20% each) recently successfully discovered oil in the Sergipe-Alagoas Basin in Brazil. No hard reserve numbers are available yet, but we value the discovery at 400 mn bbl recoverable reserve, which adds Rs34/share (for US$6.8/bbl field concession) in our SOTP valuation.

Mozambique Rovuma Mozambique 10 tcf (10% BPCL)

A consortium led by Anadarko Petroleum (BPCL 10% stake) has made four discoveries so far in offshore Mozambique. The consortium recently upgraded its reserve estimate to 10 tcf for this discovery. With production still 6-7 years away, we value this discovery at US$1/boe and it adds Rs22/share to our SOTP valuation.


Figure 52: BPCL E&P portfolio

Source: BPCL

12 October 2011


Figure 53: BPCL—Summary financials Year-end 31 Mar (INR mn) FY10 FY11 FY12E FY13E FY14E

Profit and loss

Gross sales 1,388,522 1,680,683 2,008,453 2,023,023 2,170,334

Duties and taxes 99,324 123,938 231,061 232,737 249,684

Net sales 1,289,198 1,556,744 1,777,392 1,790,286 1,920,650

Crude costs 583,200 712,770 795,569 795,836 854,274

Resale of products 567,667 701,497 804,010 804,279 863,338

Operating costs 85,924 91,520 98,946 105,724 113,541

Total costs 1,258,660 1,513,982 1,707,882 1,715,264 1,841,264

EBITDA 30,539 42,762 69,510 75,022 79,386

Depreciation 14,446 18,914 13,858 14,336 14,275

EBIT 16,093 23,849 55,652 60,686 65,111

Interest 11,247 12,468 17,978 17,774 17,492

Other income 23,652 17,252 11,223 6,799 6,018

PBT 27,721 28,483 48,898 49,711 53,636

PAT 16,324 16,350 29,754 31,667 34,376

Balance sheet

Gross fixed assets 302,023 344,850 346,850 372,733 374,733

Depreciation 134,524 152,581 166,439 180,775 195,050

Net fixed assets 167,499 192,269 180,411 191,958 179,683

Cash 7,284 7,971 5,000 5,000 5,000

Inventories 141,092 182,135 235,451 250,181 285,623

Receivables 26,009 28,779 37,203 39,530 45,130

Advances 72,645 60,366 63,497 66,976 70,716

Current assets 248,865 305,305 371,206 396,184 439,095

Investments 119,323 84,600 49,024 31,336 22,592

Oil bonds 101,237 71,552 35,776 17,888 8,944

Other investments 18,086 13,048 13,248 13,448 13,648

Total assets 617,791 668,925 706,949 749,316 815,207


Short-term debt 188,196 180,699 200,341 217,082 235,521

Long-term debt 78,725 71,156 (2,741) (19,700) (44,184)


Shareholder funds 141,429 153,508 171,249 190,130 210,627

Total liabilities 617,791 668,925 706,949 749,316 815,207

Cash flow statement

PBT 27,721 28,483 48,898 49,711 53,636

Interest 11,247 12,468 17,978 17,774 17,492

Depreciation 14,446 18,914 13,858 14,336 14,275

Other income (23,652) (17,252) (11,223) (6,799) (6,018)

WC changes (39,399) (3,809) 1,533 (5,526) 3,890

Cash from operations (9,638) 38,804 71,043 69,496 83,276

Tax (13,248) (8,645) (14,131) (14,367) (15,501)

Cash from operating activities (22,885) 30,159 56,912 55,130 67,775


Change in investments 44,677 34,723 35,576 17,688 8,744

Other income 23,652 17,252 11,223 6,799 6,018

Cash from investing activities 12,956 3,645 21,388 (24,925) (31,238)

Change in debt 24,529 (15,066) (54,254) (219) (6,045)

Interest (11,247) (12,468) (17,978) (17,774) (17,492)

Dividend (6,450) (6,601) (12,013) (12,786) (13,879)

Cash from financing activities 6,833 (34,136) (84,245) (30,779) (37,417)


12 October 2011


Asia Pacific / India Oil & Gas Refining & Marketing

Hindustan Petroleum (HPCL.BO / HPCL IN)

The canary in the mine ■ Downgrading target price. We reduce our target price for BPCL from

Rs347 to Rs303, and maintain our UNDERPERFORM rating on the stock.

■ Operating on the margin. HPCL has historically reported the least returns among OMCs, and has struggled the most for profitability. Our cash flow analysis indicates that it has faced a material increase in net debt over the last five years, as capex outstripped operating cash flows. We believe that when the government examines pro forma results at year end (with the intention of calculating amounts that need to be paid), keeping HPCL’s EPS positive represents the constraint. HPCL continues to have large capex plans, on paper adding up to a large Rs450 bn (US$10 bn) over the next six years. Unless the government increases subsidy support, this will imply large further increases in net debt. We believe this is unlikely, and therefore model much lower capital expenditure for HPCL.

■ Catalysts. HPCL is the most leveraged to changes in the petroleum retail sector, and can have large improvement in returns should the government act on policy reforms. To that extent, HPCL will be the stock to own in case such reforms become visible—which unfortunately is not the case. Start-up of the nine MTPA Bhatinda refinery in Q3/4 FY12 (of which HPCL owns 49%), should help, though we expect the subsidiary to initially be loss making.

■ Valuation. HPCL trades 1.0x FY11 book, on 13% FY11 RoE, and at 8.1x FY11 EPS. Our normalised FY11 EPS estimate for HPCL is at Rs80; a gain from that in FY10, likely due to higher refining margins. While our EPS estimates continue to price in zero net under-recoveries (for lack of any insight, and to highlight the earnings potential of the company), our target price is now based on FY12 EBITDA estimates assuming a Rs100 bn net under-recovery for the OMC.


200300400500600


80100120140160

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the BSE SENSEX IDX which closed at 16536.47 on 11/10/11 On 11/10/11 the spot exchange rate was Rs49.34/US$1

Performance over 1M 3M 12M Absolute (%) -1.5 -9.4 -29.9 Relative (%) -1.7 1.8 -11.8


Year 3/11A 3/12E 3/13E 3/14E Revenue (Rs mn) 1,334,989.4 1,731,099.5 1,744,347.2 1,870,512.8 EBITDAX (Rs mn) 33,087.9 60,059.6 66,457.5 68,698.8 EBIT (Rs mn) 19,018.4 42,734.5 48,816.7 50,901.1 Net income (Rs mn) 15,390.1 27,641.6 28,595.0 33,054.3 EPS (CS adj.) (Rs) 45.35 81.46 84.27 97.41 Change from previous EPS (%) n.a. 41.6 29.8 27.9 Consensus EPS (Rs) n.a. 43.1 52.3 53.6 EPS growth (%) 18.3 79.6 3.4 15.6 P/E (x) 7.9 4.4 4.3 3.7 Dividend yield (%) 3.9 7.0 7.2 8.3 EV/EBITDAX (x) 11.2 5.2 4.1 3.3 P/B (x) 0.97 0.84 0.74 0.65 ROE (%) 12.8 20.5 18.5 18.8 Net debt/equity (%) 198.8 131.2 89.6 57.7



Research Analysts


[email protected]

Rating UNDERPERFORM* Price (11 Oct 11, Rs) 360.00 Target price (Rs) (from 347.00) 303.00¹ Chg to TP (%) -15.8 Market cap. (Rs mn) 121,906 Enterprise value (Rs mn) 311,612 Number of shares (mn) 338.63 Free float (%) 48.9 52-week price range 517.9 - 309.0

12 October 2011


Figure 54: HPCL normalised earnings Year-end 31 Mar (INR mn) FY09 normalised FY10 normalised FY11 normalised

Gross sales 1,151,272 1,423,965

Excise paid (including duties) 72,512 88,976

Net sales 1,248,123 1,078,760 1,334,989

Total expenses 1,218,573 1,050,943 1,301,902


Consumption of raw materials 476,968 377,276 403,620

Purchase of products 666,930 626,778 853,969

(Increase)/decrease in inventory 18,368 (32,500) (34,388)

Staff costs 11,372 16,173 20,172


EBITDA 29,550 27,817 33,088

Adjust for MTM loss on bond portfolio - 7,569 -



Adjust for employee benefit provisions - - 2,930

Adjusted EBITDA 52,748 47,636 51,107

Depreciation 9,813 11,644 14,070

Adjusted EBIT 42,935 35,992 37,038



of which forex gains 2,030 5,333 2,799

PBT 40,137 40,200 41,668

Tax 14,048 14,070 14,584

Net profit 26,089 26,130 27,084

Number of shares (mn) 339 339 339



Figure 55: HPCL SOTP valuation INR mn Valuation Comments



EV 244,572


Oil India shares 6,688 At Rs1,250 per share

HMEL 18,397 At 1.5x expected equity investment


Share count (mn) 339



12 October 2011


Figure 56: HPCL summary financials Year-end 31 Mar (INR mn) FY10 FY11 FY12E FY13E FY14E

Profit and loss

Gross sales 1,076,374 1,334,989 1,731,099 1,744,347 1,870,513

Total costs 1,050,943 1,301,902 1,671,040 1,677,890 1,801,814

Operating costs 76,018 75,849 85,386 91,671 99,117

Crude costs 375,266 403,232 519,889 520,063 558,251

Purchase of products for resale 626,778 853,969 1,065,346 1,065,703 1,143,958

EBITDA 25,432 33,088 60,060 66,458 68,699

Depreciation 11,644 14,070 17,325 17,641 17,798

Interest 9,038 8,840 11,023 11,867 9,008

Other income 16,462 13,435 10,965 10,136 5,616

Income on bonds 5,693 4,882 2,441 1,220 610

PBT 21,250 23,461 42,676 47,086 47,509

PAT 13,014 15,390 27,642 28,595 33,054

Balance sheet

Gross fixed assets 249,884 296,484 368,213 373,943 379,672

Capex 36,661 45,711 28,229 20,729 20,729

Net fixed assets 153,067 186,445 239,586 227,674 215,606

Receivables 24,373 26,544 28,264 30,144 32,200

Advances 105,169 142,716 142,716 142,716 142,716

Current assets 206,419 265,910 315,163 329,071 361,648

Investments 113,872 113,350 77,709 60,940 53,660

Oil bonds 87,584 75,107 37,553 18,777 9,388

Total assets 512,234 603,692 626,944 627,172 655,400



Shareholder funds 115,580 125,458 144,589 164,380 187,257

Total liabilities 512,234 603,692 626,944 627,172 655,400

Cash flow statement

PBT 21,250 23,461 42,676 47,086 47,509

Interest 9,038 8,840 11,023 11,867 9,008

Depreciation 11,644 14,070 17,325 17,641 17,798

Other income (16,462) (13,435) (10,965) (10,136) (5,616)

Working capital changes (2,151) (30,607) 6,778 279 3,423

Cash from operations 23,319 2,328 66,837 66,737 72,122

Tax (6,190) (4,162) (7,141) (7,879) (7,949)

Cash from operating activities 17,129 (1,833) 59,697 58,858 64,173


Change in investments 28,093 522 35,641 16,769 7,280

Interest received (other income) 16,462 13,435 10,965 10,136 5,616

Cash from investing activities 7,526 (32,602) 19,641 6,176 (7,833)

Change in debt (14,528) 37,188 (59,506) (42,352) (39,328)

Share subscription - - - - -

Interest (9,038) (8,840) (11,023) (11,867) (9,008)

Dividend (3,904) (4,738) (8,510) (8,804) (10,177)

Cash from financing activities (27,470) 23,610 (79,039) (63,023) (58,513)


12 October 2011


Companies Mentioned (Price as of 11 Oct 11) Anadarko Petroleum (APC.N, $66.37) Bharat Petroleum (BPCL.BO, Rs674.20, UNDERPERFORM, TP Rs582.00) GAIL (India) Ltd (GAIL.BO, OUTPERFORM, TP Rs521.00) Hindustan Petroleum (HPCL.BO, Rs360.00, UNDERPERFORM, TP Rs303.00) Indian Oil Corp Limited (IOC.BO, Rs309.95, NEUTRAL, TP Rs361.00) Oil & Natural Gas Corporation Limited (ONGC.BO, NEUTRAL, TP Rs337.00) Oil India Ltd. (OILI.BO, Rs1299.10, OUTPERFORM, TP Rs1496.00) Petrobras (PBR, $23.56, NEUTRAL, TP $38.00) (For other companies mentioned, please see Figure 8 on page 4.)

Disclosure Appendix Important Global Disclosures Sanjay Mookim & Saurabh Mishra each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

See the Companies Mentioned section for full company names. 3-Year Price, Target Price and Rating Change History Chart for BPCL.BO BPCL.BO Closing

Price Target

Price

Initiation/ Date (Rs) (Rs) Rating Assumption 18-Nov-08 317.7 408 19-May-09 415 608 13-Jan-10 627.65 500 U 31-May-10 587.45 492 16-Nov-10 731 595

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O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered

3-Year Price, Target Price and Rating Change History Chart for HPCL.BO HPCL.BO Closing

Price Target

Price

Initiation/ Date (Rs) (Rs) Rating Assumption 18-Nov-08 230.65 259 29-Jan-09 278.25 255 21-Apr-09 269 259 19-May-09 280.05 385 O 13-Aug-09 355 409 13-Jan-10 387 337 N 27-May-10 350.5 314 26-Jul-10 430 U 16-Nov-10 460.2 347

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12 October 2011


3-Year Price, Target Price and Rating Change History Chart for IOC.BO IOC.BO Closing

Price Target

Price

Initiation/ Date (Rs) (Rs) Rating Assumption 10-Nov-10 413.5 388 N X

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The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

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12 October 2011


Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

See the Companies Mentioned section for full company names. Price Target: (12 months) for (BPCL.BO) Method: Our target price of Rs.582 per share of BPCL (BPCL.BO) is based on a sum of parts using 5.5 times EBITDA estimates (assuming Rs.100 bn OMC's under-recovery) and adding holdings of Oil India stock, BPCL treasury stock, E&P upsides and the new Bina refinery. Risks: Risks to our target price of Rs.582 per share of BPCL are: non-delivery of the normalised EBITDA - if the government continues to leave portions of calculated under recoveries unfunded, and declines in other income. Higher interest rates can also lead to mark to market losses on oil bond holdings Price Target: (12 months) for (HPCL.BO) Method: Our target price of Rs.303 per share of HPCL (HPCL.BO) is based on a sum of parts using 5.5 times EBITDA estimates (assuming Rs.100 bn OMC's under-recovery) and adding holdings of Oil India stock. Risks: Risks to our target price of Rs.303 per share of HPCL are: non-delivery of the normalised EBITDA - if the government continues to leave portions of calculated under recoveries unfunded, and declines in other income. Higher interest rates can also lead to mark to market losses on oil bond holdings Price Target: (12 months) for (IOC.BO) Method: Our target price of Rs.361 per share of IOCL (IOC.BO) is based on a sum of parts using 5.5 times EBITDA estimates (assuming Rs.100 bn OMC's under-recovery) and adding holdings of ONGC, OIL India, GAIL and IOCL treasury stock Risks: Risks to our target price of Rs.361 per share of IOCL are: non-delivery of the normalised EBITDA - if the government continues to leave portions of calculated under recoveries unfunded, and declines in other income. Higher interest rates can also lead to mark to market losses on oil bond holdings Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names. The subject company (BPCL.BO) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (BPCL.BO) within the past 12 months. Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (BPCL.BO, IOC.BO) within the next 3 months. Important Regional Disclosures Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report.

The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (BPCL.BO, HPCL.BO, IOC.BO) within the past 12 months.

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12 October 2011


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12 October 2011 Asia Pacific / India Equity Research

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India Oil and Gas Sector - Credit Suisse

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