04102010 h Pcl 110

7/28/2019 04102010 h Pcl 110

1/6

Equitymaster Agora Research Private LimitedIndependent Investment Research

10 April, 2010

Hindustan Petroleum Corp. Ltd. Page 1 of 6

-

100

200

300

400

Apr-05 Sep-07 Mar-10

HPCL: Rs 97

Sensex: Rs 273

Market data

Current price Rs 309 (BSE)

Market cap Rs 104,585 m

Face value Rs 10.0

FY09 DPS (Rs) 6.3

BSE Code 500104

NSE symbol HINDPETRO

No. of shares 338.6 m

Free float 48.9%

52 week H/L Rs 425 /242.5

Rs 100 invested is now worth

Stock price Performance

HPCL Index*

1-yr 17.7% 66.0%

3-yr 6.6% 10.8%

5-yr -0.9% 22.6%Returns over 1 year are compoundedannual averages (CAGR)* BSE Sensex

Shareholding (Dec-2009)

Category (%)

Promoters 51.1

Banks, FIs, MFs & UTI 26.9

FIIs 11.3

Public 10.7Others -

Total 100.0

Report prepared by

Equitymaster Agora ResearchPrivate [email protected]

Hindustan Petroleum Corp. Ltd.Sell

Investment Concerns The business destroys shareholder wealth: Public sector oil

marketing companies such as Hindustan Petroleum CorporationLimited (HPCL) have unmatched physical assets-in-place.Refineries, pipelines and a vast distribution network. But they incurlosses every single day that they operate. On the one hand, theirinputs costs keep rising with higher crude oil prices. On the otherhand, the government forces them to price their final output - autoand cooking fuels- at subsidised rates. As a result, from ashareholder's perspective, all that the wonderful assets succeed indoing is destroy wealth.

We have all heard of the proverbial white elephant. The animal takesa fortune to maintain. But it earns precious little in return. Anyonelooking at it is amazed by its size. What an asset it must be, theythink. But only the owner knows how difficult it is to maintain thisasset.

Despite the recommendation of several committees, the latest onebeing the Kirit Parikh committee, the government continues to shieldthe consumer from high oil prices through a subsidy sharingmechanism involving downstream oil companies, the governmentand upstream oil companies.

Cash flow problems and interest burden: The rise in the prices ofcrude oil, coupled with the inability to pass on the entire burden tothe consumer, has put an enormous strain on the liquidity position ofthe refining and marketing companies.

Although oil bonds from the government and discounts on crude oilprices by upstream companies have ensured that oil marketingcompanies remained profitable at the bottomline level, their cashflow position has been adversely affected. Consequently, theirborrowing levels have increased, along with the corresponding rise inthe interest outgo. This could pose serious challenges to HPCLwhich has drawn up major investment plans in the areas of refineryupgradation, building new capacities, development of distribution

infrastructure and exploration and production.

Complex refineries at a time when crude spreads narrow: Overthe last few years, heavier and sour crude oils formed a higherproportion of the crude oil basket as the light/heavy crudedifferentials were quite high. Consequently, newer refineries with thelatest facilities were opting for heavier crude oils to take advantage ofthe differentials. There has been a sharp reduction in the differential,with the average spread between Brent and Dubai crude comingdown sharply. These changes are expected to have an impact on therefinery economics.
http://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/[email protected]://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/www.equitymaster.comhttp://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/www.equitymaster.comhttp://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/[email protected]://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/[email protected]://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/[email protected]://localhost/var/www/apps/conversion/tmp/RIYAZ/Application%20Data/Microsoft/Word/www.equitymaster.com

7/28/2019 04102010 h Pcl 110

2/6

10 April, 2010


Comparative

HPCL BPCL

Operating ratios (FY09-FY12E)

Sales CAGR 6.6% 6.0%

Avg. EBDITA margin* -6.0% 3.0%

Net profit CAGR 32.0% 37.7%

Avg. net profit margin 1.0% 1.0%

Other key ratios (FY12E)

Return on equity 12.1% 9.8%

Return on assets 3.2% 2.9%

D/E ratio 1.7 1.7

Valuations (FY12E)

Current market price (Rs) 309 505

Price to earnings 5.9 11.0

Price to sales 0.1 0.1* For HPCL, subsidies excluded from operating results

Investment Rationale

GDP growth to drive off take and topline: Thegrowth in consumption of petroleum products inIndia during FY09 was 3.5% YoY, lower than the7% growth clocked last year. The averagegrowth in the consumption of petroleumproducts over the FY02 to FY07 was 3.4%. Offtake of petroleum products is closely linked toeconomic activity. Even cautious projections forthe Indian GDP growth rate will translate intoincreased volumes for HPCL.

Upswing in refining margins aids thebeleaguered marketing side: Whenever thereis buoyancy in refining margins, it contributessignificantly in improving the bottom lines of theoil companies, thereby mitigating to someextent, the under-recoveries on the marketingside. Better margins are also the result of therefineries no longer having to contribute towardssharing the under recoveries of the marketing

companies on the recommendation of theRangarajan Committee. However, with the lightheavy crude oil price differentials narrowingsignificantly in the recent past, the advantagesarising out of the ability to process heavier crudecould diminish.

Background

Hindustan Petroleum Corporation Limited (HPCL) isthe third largest oil refining and marketing companyin India. Apart from the 13 MTPA (million tonnes per

annum) of refining capacity, it has strong retailpresence with over 8,500 retail outlets spreadacross the country. The refineries at Mumbai andVisakhapatnam achieved a combined throughput of15.8 MT during FY09.The company achieved marketsales of 25.4 MT during the year. Further, thecompany has nearly 27 m customers in the fastgrowing LPG business. Going forward, the companyplans to increase its refining capacity from thecurrent 13.0 MTPA to nearly 16.2 MTPA.

Industry Prospects

India continues to be dependent on imports formeeting a major portion of its crude oil requirements.128.16 m tonnes (MT) of crude oil were importedduring the FY09, an increase of 6.49 MT over FY08.US$ 75.7 bn were spent on these imports ascompared to US$ 68 bn in the previous year. Theconsumption of petroleum products in India stood at133.4 MT in FY09, as compared to 128.95 MT inFY08, a YoY growth rate of 3.5%. However, thecurrent pricing regime is shifting the energy usepattern in favour of transport fuels as seen in theirgrowth rates. While consumption of petrol grew by9% YoY, the consumption of diesel increased by

8.4% YoY in FY09. India's state owned oil marketingcompanies Indian Oil, BPCL and HPCL plan toinvest over Rs 775 bn in adding 44.2 m tonnes ofrefining capacity by 2012.

Key management personnel

Mr. Arun Balakrishnan- Chairman & MD, is aChemical Engineer from the Government College ofEngineering, Trichur and a Post GraduateManagement from the Indian Institute ofManagement, Bangalore. He has handled variousportfolios in marketing, corporate and human

resources of HPCL and possesses a rich experiencein the oil sector. Prior to taking charge of his currentresponsibility on April 01, 2007, he held the positionof director - human resources. He also had a 5 yearstint with the erstwhile Oil Coordination Committee inthe Petroleum Ministry as director - planning.

Mr. S. Roy Choudhury- Director Marketing, is aMechanical Engineer from the University ofAssam.Prior to taking charge of his current responsibility inMay 2004, he was executive director, the direct

7/28/2019 04102010 h Pcl 110

3/6

10 April, 2010


sales SBU of the company. Mr. Roy joined HPCL on21st June, 1982 as a Construction Engineer. Hebegan his career with the Assam Oil Company,Digboi.

Risk AnalysisPlease see Risk Matrix table on page 5 of this report

Sector: The Indian petroleum sector is heavilydependent on imports for meeting a major portion ofits crude oil requirements. The state-owned oilmarketing companies do not have the freedom to setthe prices of petroleum products independently. As aresult, they cannot recover their input costs. Theseunder recoveries are only partly subsidised byupstream companies and the government. Hence,we assign a high risk rating to the company on thisparameter.

Companys standing: While HPCL is a largecompany in the overall scheme of things, in itsindustry it comes after Indian Oil and BPCL in termsof market share in most of the segments that it ispresent in. Hence, we assign a medium rating to thecompany on this parameter.

Sales: HPCL generated average revenues to thetune of nearly Rs 878 bn (US$ 19.5 bn) each yearover the last five years. Further, in the latest financialyear (FY09), the company has generated over Rs1.1 trillion. We, thus, assign a low-risk rating of 10 tothe stock.

Operating margin: Operating margin is ameasurement of what proportion of a company'srevenue is left over after paying for variable costs ofproduction such as raw materials, wages, and salesand marketing costs. A healthy operating margin isrequired for a company to be able to pay for its fixedcosts, such as interest on debt. The higher themargin, the better it is for the company as it indicatesits operating efficiency. HPCLs average operatingmargins, on excluding subsidies, for the past threeyears have been -7% on a consolidated basis, whichwe do not expect to improve drastically during the

next three, due to the governments policy tosubsidise prices. As such, we assign a high riskrating of 1 to the stock on this parameter.

Long term EPS growth: Given the wafer thinmargins (after including subsidies) for HPCL, anyimprovement will lead to a strong growth rate due tothe low base effect. We expect profit growth be 32%CAGR over the next three years. As such we assigna low risk rating of 9 to the stock on this parameter.

Return on capital invested (ROIC): ROIC is animportant tool to assess a company's potential to bea quality investment by determining how well themanagement is able to allocate capital to itsoperations for future growth. A ROIC of above 15%

is considered decent for companies that are in anexpansionary phase. Considering HPCLs last threeyears average ROIC of 14%, we have assigned ahigh-risk rating of 2 to the stock on this parameter.

Dividend payout: A stable dividend history inspiresconfidence in the management's intentions ofrewarding shareholders. HPCLs average payoutratio has been a decent 28% over the past 3 fiscals.Thus, we have assigned a low-risk rating of 7.

Promoter holding: A larger share of promoterholding indicates the confidence of the people who

run it. We believe that a greater than 40% promoterholding indicates safety for retail investors. Promotershareholding in HPCL at the end of December 2009stood at 51%. As such, we assign a low risk rating of8 to the stock on this parameter.

FII holding: We believe that FII holding of greaterthan 14% can lead to high volatility in the stockprice. The FII holding in HPCL at the end ofDecember 2009 stood at 11%. Based on ourparameters, the rating assigned is 5.

Liquidity: The average daily trading volumes ofHPCLs stock over the past 52 weeks stand atnearly 318,000 shares. This level of liquidity level isa matter of comfort, as this might protect the stockfrom undue volatility in case of exchange of largeholdings among market participants/investors. Therating assigned is 9.

Current ratio: HPCLs average current ratio duringthe period FY05 to FY09 has been 1.4 times. Thisindicates that the company is comfortably placed topay off its short-term obligations, which givescomfort to its lenders. We assign a medium-riskrating of 5.

Debt to equity ratio: A highly leveraged business isthe first to get hit during times of economicdownturn, as companies have to consistently payinterest costs, despite lower profitability. AlthoughHPCLs average debt to equity ratio has been 1.4over the past five fiscals, it is set to increase over thenext three in order to fund its aggressive capitalexpenditure plan. We have assigned a high-riskrating of 1 to the stock.

7/28/2019 04102010 h Pcl 110

4/6

10 April, 2010


Interest coverage ratio: It is used to determine howcomfortably a company is placed in terms ofpayment of interest on outstanding debt. Theinterest coverage ratio is calculated by dividing acompany's earnings before interest and taxes (EBIT)

by its interest expense for a given period. The lowerthe ratio, the greater are the risks. HPCLs averageinterest coverage ratio has been 3 over the pastthree years and is expected to be 2 over the nextthree. We assign a high risk rating of 1 to the stockon this parameter.

P/E Ratio: The P/E ratio (price-to-earnings ratio) ofa stock is a measure of the price paid for a sharerelative to the per share income or profit earned bythe company. This is one of the important metrics tojudge the attractiveness of a stock and thus gets thehighest weightage in our risk matrix. HPCLs

consolidated P/E on earnings of FY09 stands at 14times at a price of Rs 309 per share. As such, wehave assigned a medium risk rating of 5 to the stockon this parameter.

Considering the above analysis, the total rankingassigned to the company is 63 that, on aweighted basis, stands at 5.4. This makes thestock a medium-risk investment from a long-term perspective.

Valuations

The stock currently trades at Rs 309, implying amultiple of 0.7 times our estimated FY12 book valueper share. We value HPCL on a book value basis.

The key variables impacting the company's valuationare the volume of petroleum products sold,realisation rates (under recoveries, oil bonds &subsidy), capex and debt plans. It is important tonote that, given the current lack of freedom onpricing, the performance of the company isextremely sensitive to its cost structure. So much so,that an increase of 1% in input costs (as a % ofsales) from current levels can swing the bottomlineinto the red. In fact, much of the net profit isaccounted by subsides which are unpredictable andcan often leave investors on tenterhooks.

On a book value multiple of 1x, HPCL should trade

at Rs 452 from an FY12 perspective. This translatesinto a CAGR of 14%. However, there is a strongpossibility that the price would remain at currentlevels or even fall from here if the companycontinues to bleed on account of unreasonablegovernment policies. In light of this, we recommenda SELL on the stock. It should be noted that thestock presents a good buying opportunity for thosewho hope that the government will eventually takesome rational decision. However, as far as we areconcerned, we continue to remain negative andreiterate our SELL view on the stock.

Valuations

FY09 FY10E FY11E FY12E

Revenue (Rs m) 1,136,797 1,211,638 1,291,791 1,377,706

PAT (Rs m) 7,573 13,601 15,429 17,605

EPS (Rs) 22.4 40.2 45.6 52.0

Price to earnings (x) 13.8 7.7 6.8 5.9

Price to sales (x) 0.1 0.1 0.1 0.1

7/28/2019 04102010 h Pcl 110

5/6

10 April, 2010


Risk Matrix

Rating accorded

Rating Weightage* (A) Rating# (B) Weighted (A*B)

Sector risk - High NA

Company's standing - Medium NAPerformance parameters

Sales (US$ m) 5.0% 10 0.5

Operating margins (%) 5.0% 1 0.1

Long term EPS growth (%) 10.0% 9 0.9

Return on invested capital (%) 10.0% 2 0.2

Technical parameters

Dividend payout (%) 5.0% 7 0.4

Promoter holding (%) 10.0% 8 0.8

FII holding (%) 5.0% 5 0.3

Liquidity (Nos. '000) 10.0% 9 0.9

Safety parameters

Current ratio (x) 5.0% 5 0.3

Debt to equity ratio (x) 10.0% 1 0.1

Interest coverage ratio (x) 5.0% 1 0.1

P/E ratio (x) 20.0% 5 1.0

Final Rating** 63 5.4

# Rating has been assigned on the basis of the company's performance over the past five years and expected performance over the next 3 to5 years. Rating is on a scale of 1 to 10, with 1 indicating highest risk and 10 indicating lowest risk. * 'Weightage' indicates the relativeimportance in percentage terms of the parameter. For instance, for an investor, given all the performance metrics, Return on Equity should bethe foremost criteria for buying/not buying stocks. ** The final rating has been arrived at by multiplying the rating/points given on eachparameter with the respective weightage

Financials at a glance

Consolidated (Rs m) FY09 FY10E FY11E FY12E

Sales 1,136,797 1,211,638 1,291,791 1,377,706

Sales growth (%) 11.3% 6.6% 6.6% 6.7%

Operating profit* (121,033) (49,391) (52,611) (56,062)

Operating profit margin (%) -10.6% -4.1% -4.1% -4.1%

Net profit 7,573 13,601 15,429 17,605

Net profit margin (%) 0.7% 1.1% 1.2% 1.3%

No. of shares (m) 338.6 338.6 338.6 338.6

EPS 22.4 40.2 45.6 52.0

Balance Sheet

Current assets 174,155 182,013 193,354 208,499Fixed assets 191,180 203,782 215,349 225,966

Investments 128,274 128,274 128,274 128,274

Total Assets 493,609 514,068 536,976 562,738

Current liabilities 124,665 132,872 141,662 151,084

Net worth 111,441 123,409 137,204 153,175

Loan funds 240,612 240,612 240,612 240,612

Total liabilities 493,609 514,068 536,976 562,738

* Subsidies excluded from operating results

7/28/2019 04102010 h Pcl 110

6/6

10 April, 2010


Equitymaster Agora Research Private Limited. All rights reserved.

Disclosure:

Equitymaster Agora Research Private Limited (hereinafter referred as Equitymaster) is an independent equity research

Company. Neither Equitymaster nor the Author holds any share in the company/ies discussed in this document.

Disclaimer:

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) bereproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without theconsent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by,any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where suchdistribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subjectEquitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent orhas reached any individual in such country, especially, USA, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives,financial situations, or needs of individual investors. Before acting on any advice or recommendation in this document,

investors should consider whether it is suitable for their particular circumstances and, if necessary, seek professionaladvice. The price and value of the investments referred to in this material and the income from them may go down as wellas up, and investors may realize losses on any investments. Past performance is not a guide for future performance,future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable butEquitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our currentopinions as of the date appearing in the material and may be subject to change from time to time without notice. Thisdocument should not be construed as an offer to sell or solicitation of an offer to buy any security in any jurisdiction.Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurredto any person as a consequence of his or any other person on his behalf taking any investment decisions based on thisdocument.

Important Message from Equitymaster:

We request you to sign up for the following to ensure that you make the most of your Equitymaster Subscription:

RSS feed for StockSelect Get intimated about a new report as soon as it is released

RSS feed for Views on News and Subscriber Features Do not miss out on any new investment idea/updatethat we have posted on Equitymaster for our subscribers.
http://feeds.equitymaster.com/stockselect?format=HTMLhttp://feeds.equitymaster.com/stockselect?format=HTMLhttp://feeds.equitymaster.com/EQTM?format=HTMLhttp://feeds.equitymaster.com/EQTM?format=HTMLhttp://feeds.equitymaster.com/EQTM?format=HTMLhttp://feeds.equitymaster.com/stockselect?format=HTML

Documents

04102010 h Pcl 110