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HPCL: The oil bonds kicker! - Views on News from Equitymaster
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HPCL: The oil bonds kicker!
Oct 31, 2006

Introduction to results
HPCL, the refining and marketing major, has declared its results for 2QFY07 and 1HFY07. It has registered a topline growth of 44% YoY. However, with oil bonds issued by the government, the operating margins and consequently the profitability has improved significantly.

Financial snapshot…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 168,649 243,675 44.5% 319,410 450,416 41.0%
Expenditure 167,891 227,212 35.3% 322,586 439,119 36.1%
Operating profit(EBDITA) 759 16,462 N.A (3,176) 11,296 N.A
EBDITA margins(%) 0.4% 6.8%   -1.0% 2.5%  
Other income 789 1,925 144.0% 1,471 2,946 100.2%
Interest expenses 309 983 218.2% 451 1,579 250.5%
Depreciation 1,744 1,742 -0.1% 3,407 3,443 1.1%
Profit before tax (505) 15,663 N.A (5,562) 9,220 N.A
Tax 284 3,443 N.A 261 3,809 N.A
Profit after Tax (221) 12,220 N.A (5,300) 6,143 N.A
Net profit margin(%) -0.1% 5.0%   -1.7% 1.4%  
No.of shares(m) 338.9 338.9   338.9 338.9  
Diluted earnings per share (0.65) 36.05   (15.64) 18.12  
Price to earning ratio.(x)         7.1  

What is company business?
HPCL is the country’s third largest integrated oil marketing company with over 7,500 retail outlets, 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 the performance in 2QFY07?
Realisation drives revenues: HPCL registered a 44% YoY growth in its topline during 2QFY07. It should be remembered that in order to compensate the oil marketing companies for under recoveries, the governments has issued oil bonds. Hence, with the issuance of these oil bonds, the increase in product prices is finally manifesting itself in the form of the robust rise in topline. The same was also driven to a lower extent at the retail level by hikes in price of petrol by 8% and diesel by 6% in June 2006. Moreover, it is not just the rise in prices that has driven the topline, as product offtake has also been stronger. As per reports by its peer, total consumption of diesel in the country, which accounts for one-third of the total sales of petroleum products, increased by 6.7% YoY during the first half of the current fiscal. Demand for LPG increased by 2.3% and that for MS (petrol) increased by 6.4% YoY, whereas naphtha demand witnessed a decline of 13% during the corresponding period.

Business mix and Government saves the day: During 2QFY07, the capacity utilisation was 128%, on account of debottlenecking exercise undertaken. Increased capacity utilisation, led to significant reduction in third party purchases as the same declined to 50% of sales in 2QFY07, compared to 69% of sales in the corresponding period previous year. GRMs during the first half ended September 2006 was US$ 5.97 per barrel for Visakh refinery, while the same for the Mumbai refinery was touch lower at US$ 5.74 per barrel. The lower margins of the Mumbai refinery compared to that of Visakh refinery is due to entry tax on crude imposed by the state. However, the reason for the GRMs significantly above the historical trend can be attributed to improved distillation yield and higher capacity utilisation.

Expenditure break up…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Consumption of raw material 36,832 94,048 155.3% 82,216 181,396 120.6%
as a % of sales 21.8% 38.6%   25.7% 40.3%  
Staff Cost 1,478 2,202 49.0% 3,068 3,859 25.8%
as a % of sales 0.9% 0.9%   1.0% 0.9%  
Purchase of product of resale 116,105 121,223 4.4% 216,246 235,466 8.9%
as a % of sales 68.8% 49.7%   67.7% 52.3%  
Other expenditure 13,476 9,740 -27.7% 21,056 18,398 -12.6%
as a % of sales 8.0% 4.0%   6.6% 4.1%  

Sales for 2QFY07 also include approval receipt from the government for issuance of the oil bond to the tune of Rs 29 bn (11.9% of the net sales). Subsidy sharing from the upstream players was to the extent of Rs 25 bn (10.3% of the net sales).

Working capital squeeze: Subsidized sales of four major petroleum products have adversely affected the working capital position of the company. The same is reflected by the fact that company had to resort to borrowing to meet the requirements. Consequently, the interest expenditure for the quarter increased by as much as 218% YoY. Other income during the quarter increased by 144% YoY, due mainly to the dividend income that it received from its associate companies and this helped it to more than offset the rise in interest costs.

However, the single most important factor that helped the company post robust profits to the tune of Rs 1.2 bn was the infusion of oil bonds, a step taken to ensure that the company gets to reap part of the benefits of a rise in product prices.

Performance over the recent past…
(Rs m) 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Sales growth(YoY) 10.4% 24.7% 12.5% 27.2% 37.1% 44.5%
Operating profit margins -2.6% 0.4% -4.8% 9.4% -2.5% 6.8%
Net profit margins -3.4% -0.1% -5.9% 9.7% -2.9% 5.0%
Net profit growth(YoY) N.A N.A N.A 302.8% N.A. N.A.

What to expect?
At, the current prices of Rs 307, the stock trades at price to earnings ratio of 7.1 times its trailing twelve-month earnings. HPCL has reported superior refining margins in 1HFY07, and it has improved overall performance to an extent. Marketing margins on the sales of petrol and diesel has also improved, with petrol having positive marketing margins and diesel selling almost at the break-even prices. However, the subsidy on the domestic LPG and kerosene is still high as the domestic prices of these products are benchmarked at crude oil prices of US$ 30 and US$ 35 respectively. Profitability outlook for the OMCs has improved to an extent with the approval of issue of oil bonds and decline in crude oil prices. This is positive for the oil marketing companies including HPCL. We are in the process of updating the view on the stock.

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