Hindustan Oil Exploration: Access to the black gold
From a trot to a gallop
This 26 year old plodder, after a long somnolence, has suddenly picked up speed. And how! Matters are moving so fast that its principal shareholder, the Italian giant ENI, with an equity stake of a little over 47%, even had to fast forward a mega loan of Rs 5.7 bn during the year, just so as not to upset the good tidings in the making. (Since there are no free lunches, the quid pro quo includes a piece of the action in Hindustan Oil Exploration Company (HOEC's) other drilling ventures). The Indian banking system, of which one of HOEC's own directors, Mr. Deepak Parekh, is a hallowed member of, is so agonizingly slow on the uptick, that the company would have been grossly out of pocket, but for the parent's deep pockets.
The company finally appears to have hit pay dirt or something close to it. (It has found a gusher in a field called the PY-1 field off the Coromandel Coast, from which it extracts both crude oil and gas.) It is primarily in the business of drilling for hydrocarbon deposits, and when it is able to extract the two, it sells the crude to the downstream PSU oil refiners and the gas to GAIL India. (It also appears that it does not have much of a choice in this matter). It has a pan India footprint for exploring hydrocarbon deposits, ranging from Rajasthan in the West, to Assam in the East.
Its basic DNA
From ones understanding of the situation, HOEC does onshore exploration in Rajasthan, Gujarat, and Assam, offshore explorations in Cambay, off the Coromandel Coast, and in the Krishna-Godavari basin. That is a lot of digging alright. Since the land bearing the hydrocarbon deposits are deemed to be the family silver of the Central Government, the hydrocarbon diggers can either and go it alone and pan for the black gold as a proxy of the Sarkar, or they can form what are called unincorporated joint ventures with other such oil farers, and do likewise.
How the barrel is apportioned
The way the shoe pinches is that for every barrel of oil worth US $50 that is gurgled up from below the shifting sands, the contractor gets to keep US $33 (based on an apparently very complex system of apportioning costs and profits) including a 60% share of the oil profit, while the tax hungry government gets to keep the balance, as its share of the loot. As a matter of fact the way the Oil and Gas Exploration and Production Industry is structured, is so bewildering to the uninitiated, (the notes to the accounts alone runs into countless baffling pages), that one wonders what value individuals see in becoming shareholders in oil prospecting companies, in the first place. All the more surprising then, that even such savvy investors as Rakesh Jhunjhunwala and his wife Rekha rank up there amongst the ten biggest shareholders.
It's a jungle out there
The way HOEC has painted the picture, it is a jungle out there. It requires extra large dollops of cash especially when it stumbles on oil deposits. It is capital intensive to the extreme, especially when measured to the turnover that it generates, (depreciable gross block grew from Rs 2.4 bn to Rs 17.9 bn over the year). And naturally, there is no guarantee that you will get to locate any of the precious oil at the end of the tunnel. Further, you don't get to keep what you find due in part to production sharing contracts, while hydrocarbon prices are a global political hot potato. And, in India, oil and gas prices are administered to boot. It is also very dependent on the ENI group for technical support. Besides, it accounts for its oil and gas assets under one of two incomprehensible methods called Successful Efforts Method of accounting or Full Cost Method of accounting-both methods appear subject also to circumstances.
As the directors report states “The preparation of the financial statements requires the company's management to make a number of estimates and assumptions, relating to the reported amounts of assets and liabilities, and disclosures of its contingent assets and liabilities......and the reported amounts of revenues and expenses.” This covers just about every other aspect of the profit and loss account and balance sheet, and besides, the company is not talking about small change here. It also has to provide for depletion of its oil bearing assets after finding the oil, and suffer the effects of assorted other qualifications by its auditor's, including mega income tax demands by the government, and separately, another mega demand by the government for an oilfield abandoned by the company as a part of a consortium. Then there is the treatment of foreign currency fluctuations on a variety of interests, and a slew of litigations and arbitrations in its drilling contracts. Last but not the least is the fact that nine of its other unincorporated joint ventures for hydrocarbon prospecting are audited by as many auditors. Now, that is more than a fistful of complexities.
Hazy about the future?
The company is apparently so scared of the future, that it has omitted dividend payment in a year where sales and service income has risen 65% to Rs 1.4 bn. Post tax profits are lower but that is primarily due to lesser dividends on non trade investments on the one hand, and a substantially higher provision for amortization of assets and provision for tax and deferred tax on the other. The reason given for skipping dividend is that the post tax profits are lower than in the preceding year. But the point is that it omitted dividend payment in the preceding year too! So that cannot be the reason. The reason could well be the large debt that it had contracted by year end. But the company is also lucky to have a low outgo on its interest burden during the year. The interest paid and debited to revenue expenditure averages out to a mere 2%, on its gargantuan outstanding debt of Rs 6.5 bn. This year may well see some fireworks on this score, unless ENI waives the interest liability.
Some figures do not add up
The very interesting feature of this company's operations is that it has an Italian as the managing director since the latter half of 2008. He is given the salary and perks demanding of his office, but sad to say that he does not feature in the 'list of particulars of people' required to be disclosed under the Companies Act. The cash flow presentation is another very interesting story. It generates a humungous cash flow from operations, from investing activities, and from financing activities. By all accounts it represents more than a handful for its finance department. Creditably enough, it was also able to generate surplus funds in a year of heavy capex and other operational demands, and invest the funds by buying and selling debt securities to try and make a quick buck. It bought securities worth Rs 6.5 bn and sold securities worth Rs 6.6 bn. But this dual investment trick does not appear to feature in the 'cash flow from investing activities' as should be the norm. After all this represents cash flow.
And did it make any money from this exercise? It appears to have made more than a few pennies as dividends from non trade investments, though there is no clue on whether it realized any gains on sale. It possibly indulged in dividend stripping and then booked a short term loss on sale post dividend, a time honored sleight of hand. The company also makes do with a fuddy duddy subsidiary, HOEC Bardhal, which appears to be meandering on rather aimlessly.
The lackluster directors' report, followed by a double whammy in the Management Discussion and Analysis report, makes one to wonder about the professionalism of the management.
Disclosure: Please note that I am not a shareholder of this company
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.