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HPCL: A matter of risk and return

Nov 7, 2005

Performance summary
HPCL announced its 2QFY06 results recently. While it is not surprising that the company has posted losses during the quarter, but as compared to BPCL's operating loss, the company has posted an operating profit in the same period on the back of stronger gross refinery margins. Even at the topline level, HPCL has outpaced BPCL in 2QFY06, even as it has lagged the latter's for the first half of the fiscal year.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 135,227 168,649 24.7% 271,827 319,410 17.5%
Expenditure 129,098 167,891 30.0% 260,515 322,586 23.8%
Operating profit (EBDITA) 6,129 759 - 11,312 (3,176) -
EBDITA margin (%) 4.5% 0.4%   4.2% -1.0%  
Other income 700 789 12.7% 1,115 1,471 32.0%
Interest 214 309 44.5% 331 451 36.1%
Depreciation 1,515 1,744 15.1% 3,096 3,407 10.0%
Profit before tax 5,100 (505) - 9,000 (5,562) -
Tax 2,157 (284) - 3,584 (261) -
Profit after tax/(loss) 2,943 (221) - 5,416 (5,300) -
Net profit margin (%) 2.2% -0.1%   2.0% -1.7%  
No. of shares (m) 338.9 338.9   338.9 338.9  
Diluted earnings per share (Rs)* 34.7 (2.6)   63.9 (62.6)  
(*annualised)            

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 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 2QFY06?
Volumes down: Market sales during the quarter and in the first half are lower by 5% each, which we believe is largely on account of lower diesel sales. At the same time, gauging from the performance of BPCL, demand for aviation fuel, LPG and naphtha were higher during the quarter. While the topline growth is robust, it is also on account of the reduction in excise duty, which has resulted in net sales growing faster than gross sales. As compared to our FY06 estimates, the topline growth of HPCL is on the higher side and to that extent, we have to revise our sales projections upwards.

Expenditure table
(%) of sales 2QFY05 2QFY06
Consumption of raw materials 32.6% 21.8%
Purchase for resale 57.2% 68.8%
Staff cost 1.2% 0.9%
Other expenditure 4.5% 8.0%
EBDITA margin in the positive: As is evident from the EBDITA margin comparison graph, as compared to BPCL, HPCL has posted a positive operating profit in 2QFY06. This was on account of higher inventory gains and discounts received from refineries on LPG, kerosene, diesel and gasoline, which helped reduce subsidy losses. This is reflected in raw material cost to sales falling from 33% in 2QFY05 to 22% in 2QFY06. At the same time, purchase of petroleum products increased sharply on account of the shutdown in the Mumbai refinery. While HPCL's performance has been better, the fact that oil marketing companies have taken a huge hit on behalf of the consumers is clearly visible.

It all boils down at the net level: Even as other income increased during the quarter, higher interest and depreciation charges (in light of the ongoing expansion) has pushed the company into losses. We have to revise our earnings projections significantly lower, given the lack of visibility in government policy. However, considering the fact that the government is looking at compensating oil marketing companies through oil bonds, it remains to be seen how this pans out. If successful, the entire losses could be wiped out.

What to expect?
At Rs 301, the stock is trading at a price to book value of 1.2 times (FY05). As we mentioned earlier, it is a given fact that oil marketing companies are being subjected to political compulsions and to that extent, the losses are a reality. However, if one considers the strong distribution reach of the PSU major combined with their refining prowess, we believe that the underlying value is higher than the current market price. We had recommended the stock last year at Rs 310 as a BUY. Though we have downgraded our projections, the fact that there is value is a comforting factor and therefore, the limited downside. Having said that, this is a very risky strategy for a retail investor.

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