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HPCL: Mired by policies

May 28, 2005

Performance summary
HPCL, one of the key refining and marketing oil companies in the country, announced its FY05 results recently. In line with its peer PSU, BPCL, topline growth of HPCL for FY05 is robust at 16%, though a tad lower than BPCL. As expected, the sharp rise in crude prices and inability to pass on the rise in input cost to consumers has impacted margins. Consequently, the bottomline has declined by 33% for FY05.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net sales 145,534 163,835 12.6% 515,177 597,934 16.1%
Expenditure 136,883 159,271 16.4% 482,544 577,411 19.7%
Operating profit (EBDITA) 8,651 4,564 -47.2% 32,633 20,523 -37.1%
EBDITA margin (%) 5.9% 2.8%   6.3% 3.4%  
Other income 1,475 1,169 -20.8% 3,794 3,295 -13.1%
Interest 163 166 2.0% 557 816 46.7%
Depreciation 1,631 1,878 15.1% 6,066 6,596 8.7%
Profit before tax 8,332 3,689 -55.7% 29,804 16,406 -45.0%
Tax 3,062 (1,309) - 10,765 3,633 -66.3%
Profit after tax/(loss) 5,270 4,998 -5.2% 19,039 12,773 -32.9%
Net profit margin (%) 3.6% 3.1%   3.7% 2.1%  
No. of shares (m) 338.9 338.9   338.9 338.9  
Diluted earnings per share (Rs)       56.2 37.7  
Price to earnings ratio (x)         9.0  

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 Visakhapatnam, 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 FY05?
Topline growth robust: Though crude throughput and sales growth of segments of the company are not available now, gauging from BPCL's performance, it has been an eventful year for oil marketing majors. Just to put things in perspective, BPCL's growth numbers for some segments were - LPG sales (11.3% YoY), direct diesel sales (5.6% YoY), lubricants (5.3% YoY) and furnace oil (22.3% YoY). But as is evident from the graph, the topline growth of HPCL has been lower than BPCL in FY05. As compared to the growth in gross sales of 15%, net sales have risen faster on account of the reduction in the excise duty (excise duty as a percentage of sales in FY05 was 8% as compared to 10% in FY04). The performance of the company at the gross sales level is much higher than our estimate of 11%.

Outperforms BPCL on margins: While it is clear that operating margins have reduced on a YoY basis in FY05, the gross refining margins (GRM) have actually improved, reflecting better prices in the international markets on a YoY basis. For instance, the GRM of the Mumbai refinery in FY05 was US$ 5.6 per barrel as compared to US$ 4.3 per barrel in FY04. This is significantly higher than BPCL's GRM at US$ 4.6 per barrel (BPCL's only refinery is in Mumbai). Over the years, the company has reduced its dependence on standalone refineries for its retail requirements and the decline in purchase for resale as a percentage of sales in FY05 is indicative of that. Once the ongoing expansion of capacity is completed, we believe that HPCL will benefit more.

Expenditure table
(%) of sales 4QFY04 4QFY05 FY04 FY05
Consumption of raw materials 23.3% 29.9% 28.3% 34.4%
Purchase for resale 64.7% 58.8% 58.8% 56.3%
Staff cost 0.9% 1.5% 1.1% 1.2%
Other expenditure 5.2% 7.0% 5.4% 4.7%

Higher capex subdues net profits: As compared to a 37% decline in operating margins, PBIT has fallen at a faster rate owing to lower other income and higher interest charges. This could be attributed to the fact that HPCL is investing in its Mumbai and Visakhapatnam refineries so as to comply with the mandatory Euro-III norms and at the same time, enhance combined capacity by nearly 3.3 MMTPA (million tonnes per annum) over a period of next two years (25% of the existing capacity).

What to expect?
The stock currently trades at Rs 338 implying a price to earnings multiple of 9.0 times FY05 earnings (price to cash flow of 5.9 times). We believe that petroleum products sales growth is linked to economic performance (5% to 6% growth). Growth is likely to be faster in the case of LPG and aviation fuel in the medium-term, as the customer base is expanding. However, the key is operating margins. Given the fact that the government has increased prices of gas during the week, there is likely to be lower losses on LPG sales in FY06. If crude prices continue to trade high, taking into account the political compulsions, margins will remain under pressure. These are external factors, which are very difficult to predict. On the internal side, the company's refinery capacity expansion is a step in the right direction and will result in cost savings going forward. We had recommended HPCL in September 2004 at Rs 320 and we continue to maintain our BUY view on the stock from a two to three year perspective. However, the risk profile of the sector is higher and investors have to take count of this factor before making their investment decision.

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