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HPCL: Tough times! - Views on News from Equitymaster
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HPCL: Tough times!
May 26, 2006

Introduction to results
Refining and marketing major, HPCL has announced mixed results for the fourth quarter and fiscal ended March 2006. For FY06, while the topline has grown by 19% YoY, operating margins and bottomline have borne the brunt of the inability to pass on the rise in input costs to consumers. The expansion in operating margins and consequent rise in net profits during 4QFY06 was a result of discounts that the company received from refiners.

Financial snapshot…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 163,835 208,359 27.2% 597,934 710,379 18.8%
Expenditure 159,271 188,832 18.6% 577,411 702,323 21.6%
Operating profit (EBDITA) 4,564 19,528 327.8% 20,523 8,056 -60.7%
EBDITA margin (%) 2.8% 9.4%   3.4% 1.1%  
Other income 1,169 1,810 54.9% 3,295 3,285 -0.3%
Interest 166 578 248.2% 816 1,587 94.4%
Depreciation 1,878 1,745 -7.1% 6,596 6,902 4.6%
Profit before tax 3,689 19,014 415.4% 16,406 2,851 -82.6%
Tax (1,309) (1,120) -14.4% 3,633 (1,205) -133.2%
Profit after tax/(loss) 4,998 20,134 302.8% 12,773 4,056 -68.2%
Net profit margin (%) 3.1% 9.7%   2.1% 0.6%  
No. of shares (m) 338.9 338.9   338.9 338.9  
Diluted earnings per share (Rs) 14.7 59.4   37.7 11.97  
Price to earnings ratio (x)         26.2  

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) spread across the length and breadth of the country. The company has just over 20% market share in the diesel business and a 25% market share in 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 Vishakhapatnam, with a rated capacity of 7.5 million metric tonnes (MMT) and the other at Mumbai, having capacity of 5.5 MMT.

What has driven performance in FY06?
Topline growth robust: HPCL’s topline growth during the fiscal can be attributed to the 18% YoY improvement in realisations (volumes have declined by 3% YoY). This is after excluding the effect of oil bonds (Rs 23 bn) that have been considered as part of sales during FY06. As a matter of fact, during the fiscal, the government had issued oil bonds to domestic oil marketing companies in lieu of the under-recoveries on sale of sensitive products like petrol and diesel. The capacity utilisation for the fiscal stood at 106% as compared to 107% in FY05.

Political issue dictates margins: Spiraling prices of raw material (crude oil) aided with inability of the company to pass on the price rise to consumers has eroded margins during FY06. Operating margins, which stood at 3.4% during FY05, contracted to 1.1% during the fiscal. Gross refining margins (GRM’s) for the Mumbai refinery during the fiscal was US$ 3.22 per barrel against US$ 5.60 per barrel in FY05. Visakh refinery has reported GRM’s of US$ 2.56 per barrel as against US$ 5.06 in FY05. In 4QFY06, operating margins have increased to 9.4% from the 2.8% recorded over the corresponding quarter previous fiscal. The reason for this increase is availability of greater discount from refineries, which is visible in the considerable reduction witnessed in ‘purchase of products for resale’ (see table below). The total discount received by the company in FY06 from government, upstream oil companies and refineries is Rs. 60 bn (8.4% of net sales).

Expenditure break-up
(%) of sales 4QFY05 4QFY06 FY05 FY06
Consumption of raw materials 29.9% 37.0% 34.4% 34.0%
Purchase for resale 58.8% 48.0% 56.3% 59%
Staff cost 1.5% 1.0% 1.2% 1.0%
Other expenditure 7.0% 4.5% 4.7% 4.5%
Total expenditure as % of sales 97.2% 90.6% 96.6% 98.9%

Bottomline: Weak operating performance (owing to the subsidy burden) had an impact on the cash flows of the firm. Thus, the company had to borrow for meeting its working capital requirements, which can be gauged from fact that interest expenditure has increased by a whopping 95% YoY during FY06. Though HPCL has posted a positive bottomline growth in the fourth quarter, the poor performance of the past three quarters has weighed heavy on the company’s full year performance.

What to expect?
At the current price of Rs 313, the stock is trading at a price to earnings multiple of 26.2 times its FY06 earnings. The board has recommended a divided of Rs. 3 per share (dividend yield of 1%). The reluctance on the part of government to hike prices of subsidised products coupled with crude and petroleum products scaling newer highs has raised concerns about the future profitability of oil marketing companies, including HPCL. Lack of clear policy issues, coupled with political compulsions has impaired the investment prospects. Currently, we believe that there are no signals of crude prices softening and thus, only regulatory policy changes can help resolve the issues related to pricing of petroleum products.

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