Citigroup - HPCL, BPCL, IOC

Citigroup on BPCL

Our target price for BPCL of Rs385 based on an FY08E EV/EBITDA of 5.5x for core earnings and 2.0x to contribution from oil bonds. We use FY08E as a base considering a normalized earnings scenario along with improved marketing profitability (in line with lower crude) but continued policy ambiguity. While valuing the Indian oil refining and marketing companies, we prefer to use EV/EBITDA to compare companies across the region to avoid differences in accounting policies in depreciation and taxation. Our target price is also based on an FY06E P/BV of 1.4x, between the value we ascribe to HPCL and IOC, justified given the better mix of refining and marketing BPCL as compared to HPCL, but a lower proportion of high-yielding pipeline assets vis-a-vis IOC.

Citigroup on HPCL

We assign a Medium Risk rating to the stock, even though our quantitative rating system rates the stock Low Risk, as we believe volatility in international oil prices will continue to impact earnings given the linkage to marketing margins. Sentiment towards the sector and HPCL is closely linked to crude price fluctuations, sector deregulation, subsidy losses, and auto fuel price hikes. Upside risks to our target price include: a further decline in crude prices (to US$50-55/bbl) and stronger-than-expected recovery in the company's marketing profitability leading to higher-than-estimated returns; if the government took concrete pricing action on retail products to bring them in line with international prices, it would put our earnings forecasts at risk; and on the macro front, if the government were to adopt the Downstream Regulatory Bill, appoint an independent regulator, and give pricing freedom to the oil-marketing companies, it would likely give a fillip to the stock price.

Citigroup on IOC

Our target price for IOC of Rs450 is based on an FY08E EV/EBITDA of 6.0x—at a premium to BPCL and HPCL and 2.0x the contribution from oil bonds. We are maintaining a valuation premium (for core earnings) to BPCL and HPCL considering IOC's superior revenue mix and sustainable competitive advantage. The target price includes the value of IOC's holdings in ONGC and GAIL at current market prices worth Rs103/share at a 20% discount to the current market prices. IOC has stated its intention to liquidate a part of the crossholdings in ONGC and GAIL in installments, the first tranche of which was completed earlier this year. While valuing the Indian oil refining and marketing companies, we prefer to use EV/EBITDA to compare companies across the regions to avoid the differences in accounting policies on depreciation and taxation. Our target price is also based on an FY06E P/BV of 1.6x, at a premium to BPCL/HPCL given IOC's lower proportion of marketing assets as a proportion of total assets.