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HPCL: The scars remain

Jan 27, 2005

Performance summary
Hindustan Petroleum Corporation, the country's third largest refining and marketing company in terms of market share, announced mixed 3QFY05 results. While the company witnessed strong topline growth of over 25% YoY, the bottomline dipped sharply by nearly 70% YoY on the back of political ramifications.

What is the company's business?
HPCL is the country's third largest integrated oil marketing company with over 6,000 retail outlets (nearly 27% of the total number of retail outlets) spread across the length and breadth of the country. The company has just over 20% of the market share in the diesel business, while a 25% market share in the retail petrol sales. Also, HPCL has a strong presence in the LPG business accounting for a quarter of the industry volumes and catering to over 19 m customers. The company operates two refineries, one at Visakhapatnam, with a rated capacity of 7.5 million metric tonnes (MMT) and the other at Mumbai, having capacity of 5.5 MMT.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 129,390 162,271 25.4% 369,642 434,099 17.4%
Expenditure 116,202 157,624 35.6% 345,661 418,140 21.0%
Operating profit (EBDITA) 13,188 4,647 -64.8% 23,981 15,959 -33.5%
EBDITA margin (%) 10.2% 2.9%   6.5% 3.7%  
Other income 566 1,012 78.8% 2,319 2,127 -8.3%
Interest 166 319 92.6% 394 650 65.2%
Depreciation 1,492 1,623 8.8% 4,435 4,718 6.4%
Profit before tax 12,097 3,717 -69.3% 21,472 12,717 -40.8%
Tax 4,340 1,357 -68.7% 7,703 4,942 -35.8%
Profit after tax/(loss) 7,757 2,359 -69.6% 13,769 7,775 -43.5%
Net profit margin (%) 6.0% 1.5%   3.7% 1.8%  
No. of shares (m) 338.9 338.9   338.9 338.9  
Diluted earnings per share (Rs)* 91.6 27.8   54.2 30.6  
Price to earnings ratio (x)   12.1     11.0  
(* annualised)            

What went wrong during 9mFY05?
Robust volumes help realisations:  During 9mFY05, the topline has improved by a decent 17%. This growth could largely be attributed to higher volumes witnessed in the domestic markets. To put things in perspective, while diesel (constituting 40% of petro products sale) sales grew by 6.5% during 9mFY05, LPG sales continued with the double-digit growth, witnessing a jump of over 11% YoY. Further, price hikes during the 3QFY05 also helped boost topline.

Expenditure Table
(%) of sales 3QFY04 3QFY05 9mFY04 9mFY05
Consumption of raw materials 26.8% 43.1% 30.3% 36.0%
Purchase for resale 55.3% 49.8% 57.5% 55.4%
Staff cost 1.1% 0.9% 1.2% 1.1%
Other expenditure 6.6% 3.2% 4.6% 3.8%

Its ‘crude' politics:  HPCL witnessed a sharp decline of over 7% in operating margins during 3QFY05 on the back of rising raw material (read crude oil) costs and inventory losses. To put things in perspective, crude oil prices touched record high of over US$ 55 per barrel. Following the trend, product prices at the refinery gate peaked with petrol touching US$ 55 per barrel and diesel at US$ 54 per barrel. Also, product prices at the retail level were not allowed to increase in line with costs, thereby impacting margins.

Other income fails to boost bottomline:  HPCL witnessed a significant dip of nearly 70% in the bottomline during 3QFY05 despite a strong growth of nearly 79% in other income. High interest cost, which rose by 93% YoY (could be largely due to high working capital costs) also created a significant dent in the bottomline.

What to expect?
At Rs 336, the stock is trading at a price to earnings multiple of 11 times annualized 9mFY05 earnings (price to cash flow multiple of 9.1 times). The current fiscal been a turbulent one for the oil marketing companies on the back of elections, populist measures and rise in raw material prices. However, we believe that the companies are likely to witness some deregulation going forward as private participation increases. Further, HPCL is expanding refining capacity to over 16 MMT over the next couple of years, which would help the company capture refining margins on its balance sheet, while reducing external dependence.

As per our estimates, at Rs 336, the company trades at a price to cash flow multiple of 3.9 times our FY07E earnings. We believe that the company's focus towards production of higher yield products and the growing retail demand are likely to help margins improve going forward. As a result, we reiterate our view and maintain our ‘BUY' recommendation on the stock.

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