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HPCL: Divestment Blues

May 14, 2004

Political concerns coupled with increasing crude prices and a freeze on prices of petroleum products has led to a major dip in energy stocks over the past one month. One of the major losers during this period has been HPCL, which has witnessed a dip of 27% during this period. Apart from the aforementioned concerns, doubts over the disinvestment of the PSU navratna have led to such a downfall. The NDA led government had HPCL and BPCL on its divestment radar. However, now that the government has not been able to get a clear mandate, the uncertainty over disinvestment of these companies looms large. The below mentioned graph gives a clear picture of the shredding witnessed by these PSUs along with IOC, IPCL and GAIL.

It should be remembered that since the APM was dismantled, the oil companies have, to a large extent, become more competitive. And in the current scenario, with increasing prices of crude and petroleum products, they are in a better position to maintain their profitability, post elections.

Strengths

  • Although the companies are witnessing a price hike dilemma, with the entrance of Reliance Industries in the retail segment, the pricing shall be more dependent on market forces. Also, since the PSU marketing companies have a vast retail network, they shall be in a better position to cater to the customers.

  • Along with this comes the government's decision to reduce subsidies on LPG and kerosene, which shall to a large extent, help the companies improve their realizations.

  • HPCL plans to become a global integrated oil company with presence across the straddle of the business. The company has recently announced its plans to acquire oil fields through its subsidiary Prize Petroleum and is also in talks to expand its retail network overseas. It is also planning to enter the gas business so as not to lose out on its naphtha customers, which are now switching over to natural gas as a feedstock.

  • In case of divestment, the strategic partner shall be able to manage the company's affairs in a more professional and autonomous manner as compared to the current management. However, disinvestment is just one of the strengths and shall not be looked upon as the only solution.

Weaknesses

  • Compared to its competitors, HPCL has not yet ventured into the natural gas business. Natural gas is fast becoming a main source of feedstock, substituting naphtha and with IOC, BPCL and GAIL, already having stepped on the gas, HPCL shall lose out on its naphtha customer base.

  • Currently, under the government's management, HPCL has not been able to increase prices of petroleum products. Since oil prices are a political issue in the country, HPCL, as a PSU, shall suffer from under-recoveries in case of LPG and kerosene.

HPCL, with 5,056 retail outlets and 19 m customers for LPG is currently trading at a price to earnings multiple of 5.4x FY04E earnings, while its global peer such as Shell is trading at a P/E multiple of 11x FY04 earnings. In a developing economy, whereby per capita oil consumption vis-a-vis other developing economies, is very low, HPCL has vast potential to expand and improve on its realizations. Further, its product pipelines give the company major flexibility. Upgradation of its refinery shall help the company produce much high-yield value added products, thereby giving it a competitive edge over its peers. We, therefore, advise investors not to look at the company from the sole intention of divestment. There is more to it than that!


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