HPCL

Despite the strong rally on the bourses, one group of companies has strictly remained non-participative, the public sector oil marketing companies (OMCs) IndianOil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL).

Thanks to cheaper valuations, we believe an investment opportunity exists in this sector. Comparing these three companies on various parameters, HPCL appears to be the most undervalued. It is trading at around its book value and offers over 6% dividend yield at current price.

Those looking for a value buy and dividend yield can consider investing in this scrip. HPCL is an integrated refining and marketing company operating two refineries (Mumbai and Visakhapatnam) with a total capacity of 16.2 million tonnes per annum (mtpa).

It ranks below IOC and BPCL in retail market share, which is around 17%. HPCL, in a joint venture with Mittal Energy, is setting up a 9-mtpa refinery at Bhatinda in Punjab by ’10. Currently, HPCL sells four petroleum products, petrol, diesel, LPG for domestic consumption and kerosene through the public distribution system, at administered prices determined by the government, which leads to under-recoveries.

The government shares a part of these under-recoveries by way of oil bonds, while public sector upstream companies such as ONGC and Gail share a part of the burden through discounts offered to OMCs.

BUSINESS: HPCL owns or operates 8,000 retail outlets across the country, selling auto fuels, out of which over 3,500 supported with non-fuel offerings are branded ‘Club HP’. For rural India, HPCL has launched the ‘Hamara Pump’ format, wherein farm inputs such as seeds, pesticides and fertilisers are sold along with fuel.

It also caters to the LPG requirements of over 25 million households. HPCL is one of the leading players in the domestic lubricants market and is also expanding its aviation turbine fuel (ATF) business. It has floated a number of JVs in the energy value chain to diversify risks and augment its cash flows.

Prize Petroleum, in which HPCL holds a 50% stake, is into petroleum exploration and production. It has signed a service contract for an offshore field cluster comprising three oilfields and has also been awarded an onshore block under NELP VI. These initiatives are expected to aid future growth.

Bhagyanagar Gas has commenced CNG operations in Vijayavada and Hyderabad. Similarly, Aavantika Gas is in process of launching CNG operations in Indore, with plans to extend to other major cities in Madhya Pradesh. HPCL holds 22.5% stake in each of these JVs.

HPCL has also established JVs for bitumen products, LPG storage and pipelines. It is investing in alternate energy sources and has entered into contract farming for cultivation of Jatropha in Chhattisgarh. It has set up a 10-mw windmill electricity generation capacity, which will be expanded to 100 mw in a phased manner.

VALUE DRIVERS: HPCL is progressing well in its core business of refining and marketing of petroleum products and has lined up several projects. Its major projects include lube oil base stock upgradation at Mumbai refinery, upgradation for production of Euro IV-compliant fuels, facilities for mixed xylene and propylene production at Mumbai and Vizag refineries and delayed coker unit for bottoms upgradation at Visakhapatnam.

These projects will improve product quality, resulting in better margins. It is also planning to develop a special economic zone (SEZ) near its Vizag refinery by setting up a petrochemical and petroleum investment region to produce petrochemicals and other high-value products.

FINANCIALS: HPCL’s crude throughput witnessed a compounded annual growth rate (CAGR) of 6.6% over the past five years, thanks to capacity expansion and utilisation. This helped HPCL to produce 77% of the petroleum products that it sold during FY07, compared to 68% during FY03, thereby reducing dependence on traded goods.

For H1 ended September ’07, sales grew 4% to Rs 43,761 crore, but the value of special oil bonds received from the government came down by 19% to Rs 2,356 crore. Its operating profit margins remained unchanged at last year’s level. A 155% jump in other income helped it register 25% PAT growth at Rs 766 crore.

VALUATIONS: HPCL appears undervalued compared to its peers, IOC and BPCL, on three main counts. Firstly, HPCL’s price to book value ratio (P/BV) is the lowest at just 1.01. Secondly, its market capitalisation (m-cap) to refining capacity ratio is also the lowest at Rs 5,914 per tpa.

And most importantly, its dividend yield is over 6.2%, which is substantially higher than that of its peers. At the same time, nearly one-third of its m-cap is represented by value of its quoted investments, which again, indicates its undervaluation.

While high crude oil prices in the international market and excessive dependence on government policies remain the key risks, a softening of prices or the government’s decision to hike domestic fuel prices will lead to a dramatic improvement in HPCL’s finances and may trigger a sharp rise in its stock price.