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HPCL: Bruised but not battered

Jul 12, 2004

Oil stocks tumbled after the budget session, as the much-anticipated duty cuts and pricing autonomy was not granted to the oil marketing companies. At the same time came the statement that oil companies cannot be granted freedom on pricing, which actually was a dampener of sorts on the future of these companies' operations.The lack of such announcements has led to around 12% erosion in HPCL's share prices. Let us now have a look at the impact on HPCL in the long term.

With no change in custom duty cuts, HPCL's gross refining margins (GRMs) shall remain strong, as international product prices remain firm in the foreseeable future. At the same time, HPCL is expanding capacity of its two refineries by approximately 5 MMTPA, which would further help the company leverage its strengths and reduce dependence on external refineries for products. To put things in perspective, post FY04, the company reduced its product offtake from Reliance Industries and the latter is now offering discounts to the PSU marketing companies for product offtakes. We believe high GRMs would help compensate for the squeeze in marketing margins.

The pricing autonomy has not been granted to the companies but the government has clearly indicated that prices could be revised upwards as and when the case for such hikes is warranted. It should also be remembered that with private players entering into the markets, it is a known fact that the companies would penetrate the markets on the pricing strategy and would result in a price war. Since the government controls pricing at this point in time, going forward, we feel the prices would be completely market determined, until and unless, the private players are bound by any future government policies.

Although the above chart shows that HPCL has under performed the Sensex in the current fiscal, it should be remembered the energy sector has historically grown in line with the GDP growth rates and with the private participants already pricing products at much lower rates, the consumer is likely to benefit with lower prices resulting in higher volumes. In such a scenario, the government is likely to let prices be market determined and HPCL is in a very strong position with more that 5,000 retail outlets to capitalize on any such opportunity.

At Rs 289, the stock is trading at a price to cash flow multiple of 4.2x FY05E earnings (P/E multiple of 6x FY05E earnings). Although companies witness pressure on the pricing front from the political quarters, we believe that private competition is likely to change the situation going forward, as the country cannot have two parallel pricing strategies, one for private players while to other one for the PSUs. These factors could keep the sentiment subdued in the near-term.

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