Investors with a long-term perspective can buy the stock of public sector oil refiner BPCL. The company’s exploration assets overseas can, in the future, reduce its dependence on the domestic refining business.

The ongoing expansion at its Kochi refinery should help the company increase its gross refining margin, which is already higher than that of peers IndianOil and HPCL.

The rout of the rupee in July and August raised fears of higher under-recoveries (because of selling fuels below cost) and impacted the BPCL stock. While the rupee’s comeback in recent weeks and news of a big oil find in Brazil have helped the stock recoup losses, it is still available at an attractive valuation. At the current price of Rs 361, the BPCL stock trades at around 13 times its estimated FY14 earnings. This is lower than the historical average of around 16 times over the last five years.

BPCL has scored in its overseas exploration and production ventures. Last month, the SEAL-11 block off the Brazil coast, in which BPCL has a 20 per cent stake, reported a huge find, estimated at more than a billion barrels of oil. Also, the Rovuma basin block in Mozambique, in which BPCL has 10 per cent stake, is attracting top dollar investments from new players, indicating the asset’s significant potential.

Based on bids from ONGC and Oil India a couple of months back, BPCL’s stake is worth around $2.5 billion. This works out to Rs 210 a share or almost 60 per cent of the stock’s current price. These assets may take five-six years to produce oil/gas, but they represent a significant diversification away from the domestic refining business which has been impacted by under-recoveries.

If the gradual increase in diesel prices, started earlier this year, continues, the under-recoveries can reduce significantly. But this may take time given the political climate and the inflation situation. Of comfort though is the fact that over the past two years, oil marketing companies have been almost fully compensated for the under-recoveries, even if with a lag. BPCL has higher gross refining margins compared with peers, thanks to better operational efficiencies. This helped it post a profit of Rs 150 crore in the June quarter despite the under-recoveries. The Bina refinery, in which the company has 49 per cent stake, is expected to break-even in FY14. Also, the ongoing expansion at its Kochi refinery will add to its complexity, and aid volumes and margins. The Kochi plant expansion will also enable BPCL enter the petrochemicals business.

(This article was published on October 19, 2013)
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