28 July 2017
Update
| Sector:
Oil & Gas
BSE SENSEX
32,383
S&P CNX
10,021
HPCL
Buy
CMP: INR374
TP: INR427 (+14%)
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ONGC-HPCL merger
Finding the right value for HPCL
The Department of Investment and Public Asset Management (DIPAM) has invited bids
for appointing an advisor for strategic sale of the government’s 51.11% stake in HPCL to
ONGC. The bid document mentions the following methodologies for achieving the best
valuation for HPCL: (1) discounted cash flow, (2) relative valuation, (3) asset-based
valuation, and (4) market valuation. We study the four possibilities to estimate what the
reserve price could be. We also take a look at the possibility of a control premium.
However, for this report, we leave aside the issue of open offer. While theoretically, an
open offer is likely, legal interpretations may be complex and contradictory.
Stock Info
Bloomberg
Equity Shares (m)
52-Week Range (INR)
1, 6, 12 Rel. Per (%)
M.Cap. (INR b)
M.Cap. (USD b)
Avg Val, INRm
Free float (%)
HPCL IN
1,524
393/254
7/-11/23
559.3
8.7
1893.0
48.9
2019E
2,085
100.6
49.7
32.6
10.4
173.6
20.0
12.0
11.5
2.2
Discounted cash flow method
Using a GRM of USD5.1/bbl, net marketing margin of INR1.1/liter, stretched till
2038, but taking nil terminal value, we arrive at a DCF valuation of INR470/share
for HPCL. Our valuation uses a WACC of 11%. Nil terminal growth beyond 2038
suggests the possibility of disruptive technologies like electric vehicles having an
adverse impact on refineries. We have only taken imminent capex like expansion of
Vizag refinery, and ignored larger ones like petrochemicals complex in Andhra
Pradesh and participation in 60mmtpa West Coast refinery.
Financials Snapshot (INR m)
2017 2018E
Y/E Mar
1,870 1,855
Net Sales
105.8
91.4
EBITDA
62.1
45.0
PAT
40.7
29.5
EPS (INR)
66.6 (27.5)
Gr. (%)
133.4 152.5
BV/Sh (INR)
32.4
20.6
RoE (%)
18.8
12.3
RoCE (%)
9.2
12.7
P/E (x)
2.8
2.5
P/BV (x)
Relative valuation
Global peers are trading at 6.9x FY19E EV/EBITDA and 10x FY19E P/E. Indian peers
are also trading at 6.9x FY19E EV/EBITDA and a little lower 9.5x FY19E P/E. Though
there aren’t many comparables for pure marketing plays, Caltex Australia, Z
Energy, New Zealand and Petron Corp are trading at an average 7.5x FY19E
EV/EBITDA and 12.3x FY19E PE. Our SOTP valuation of HPCL implies 7.8x FY19E
EV/EBITDA and 11.5x FY19E EPS.
Shareholding pattern (%)
As On
Jun-17 Mar-17 Jun-16
Promoter
51.1
51.1
51.1
DII
10.1
9.6
14.5
FII
16.9
16.9
19.4
Others
21.9
22.4
15.0
FII Includes depository receipts
Stock Performance (1-year)
HPCL
Sensex - Rebased
400
350
300
250
Asset valuation models
HPCL’s consolidated FY18E book value is INR164. It is not correct to look at long-
term average P/BV due to regulations prior to deregulation of diesel in 2014. Since
2015, the stock has traded at average P/BV of 1.7x. For the last one year, due to
better GRMs, the stock has traded at 2.2x. At 2.2x, the stock is valued at INR361.
We also use replacement method (Exhibit 4) to value the assets. Our replacement
cost methodology suggests a value of INR350/share.
Market valuation
The stock declined 10% after 4QFY17 results, partly on account of cloud over
merger, and partly on account of expected inventory losses in 1QFY18 and
expected market share loss to private players. However, with expected premium
valuation for sale to ONGC, it has appreciated. Using the last 60 days’ average, the
valuation of the company stands at INR356/share.
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Swarnendu Bhushan- Research Analyst
(Swarnendu.Bhushan@MotilalOswal.com); +91 22 6129 1529
Abhinil Dahiwale- Research Analyst
(Abhinil.Dahiwale@motilaloswal.com); +91 22 3980 4309

HPCL
Valuation of HPCL
Our base case valuation using SOTP and EV/EBITDA for segments stands at
INR427/share.
The four methodologies mentioned in DIPAM’s bid result in a minimum
valuation of INR350 and a maximum valuation of INR470.
Control premium could add to the confusion; theory suggests no control
premium.
Valuation methodologies suggest INR350-470/share
The stock declined 10% after 4QFY17 results, partly on account of cloud over
merger, and partly on account of expected inventory losses in 1QFY18 and expected
market share loss to private players. Then vibes on higher valuation for sale to
ONGC lifted the stock to INR370, almost where it was three months ago. Our DCF
calculations (Exhibit 1) suggest a valuation of INR470/share, using a GRM of
USD5.1/bbl. However, average GRM (including inventory gain/loss) was USD4/bbl,
using which the valuation works out to INR417/share. Our DCF valuation is till 2038.
We assume nil terminal growth due to the threat of disruptive technologies like
electric vehicles in the long run.
28 July 2017
2

HPCL
Exhibit 1: DCF valuation of HPCL
Exchange rate (INR/USD)
Refining-standalone
Throughput (mmt)
GRM (USD/bbl)
Refining EBITDA (INRm)
Marketing
Direct sales (mmt)
Net marketing margin (INR/lit)
Marketing EBIDTA (INRm)
Pipeline
Throughput (mmt)
EBITDA (INR/mt)
EBITDA (INRm)
Core EBITDA (INRm)
Other operating income (INRm)
Total standalone EBITDA (INRm)
MRPL
Throughput (mmt)
GRM (USD/bbl)
Refining EBITDA (INRm)
HMEL
Throughput (mmt)
GRM (USD/bbl)
Refining EBITDA (INRm)
Conso EBITDA (INRm)
Depreciation
WC Changes
Capex
FCFF
WACC (%)
NPV (INRm)
Terminal growth rate (%)
NPV of Terminal growth (INRm)
EV (INRm)
Net debt (INRm)
Market cap target (INRm)
Target price (INR/share)
FY18E
65.6
17.8
5.0
28,277
36.5
1.0
42,484
17.9
757
13,547
84,308
3,047
87,355
FY19E
67.0
17.8
5.1
29,755
37.9
1.0
44,183
17.9
772
13,818
87,757
3,169
90,926
FY20E
67.0
18.8
5.1
31,425
39.4
1.0
45,950
17.9
787
14,095
91,470
3,296
94,766
FY21E
67.0
20.1
5.1
33,487
41.0
1.0
47,788
17.9
803
14,377
95,652
3,427
99,080
FY22E
67.0
25.7
5.1
42,972
42.6
1.0
49,700
17.9
819
14,664
107,336
3,565
110,900
FY23E
67.0
27.5
5.1
45,977
44.3
1.0
51,688
17.9
836
14,957
112,623
3,707
116,330
FY24E
67.0
27.5
5.1
45,977
46.1
1.0
53,755
17.9
852
15,257
114,989
3,855
118,845
FY25E
67.0
27.5
5.1
45,977
48.0
1.0
55,906
17.9
869
15,562
117,445
4,010
121,454
16.3
6.6
35,675
16.3
6.5
35,557
16.3
6.5
35,557
16.3
6.5
35,557
16.3
6.5
35,557
16.3
6.5
35,557
16.3
6.5
35,557
16.3
6.5
35,557
10.0
10.0
33,659
121,329
29,764
34,282
(100,000)
25,395
11.1%
733,886
0
161,544
895,430
178,047
717,383
470
10.0
10.0
34,378
125,194
31,970
1,368
(100,000)
(4,202)
10.0
10.0
34,378
129,034
33,321
2,169
(50,000)
49,618
10.0
10.0
34,378
133,348
33,845
9,899
(50,000)
60,410
10.0
10.0
34,378
145,168
34,352
9,899
(50,000)
68,498
10.0
10.0
34,378
150,598
34,137
9,899
(5,000)
117,064
10.0
10.0
34,378
153,113
33,222
9,899
(5,000)
118,447
10.0
10.0
34,378
155,722
32,336
9,899
(5,000)
119,903
Source: Company, MOSL
28 July 2017
3

HPCL
Exhibit 2: Peer valuation
RoE (%)
FY18/
FY19/
CY17
CY18
18.5
16.9
12.7
8.4
13.2
13.5
20.0
17.0
9.9
9.6
13.9
13.4
18.5
19.4
12.6
11.5
10.9
10.8
12.9
13.3
9.7
7.7
11.6
10.8
23.0
64.8
18.5
17.5
22.7
22.7
21.8
21.0
10.8
10.9
24.4
22.3
23.1
24.4
14.4
16.7
EV/EBITDA
FY18/
FY19/
CY17
CY18
7.8
7.5
6.3
6.4
7.4
7.3
6.3
6.6
8.0
7.6
6.2
6.2
8.1
7.0
9.3
8.7
4.6
4.5
8.5
8.2
7.9
8.1
5.8
5.8
6.3
6.0
6.4
6.0
9.9
8.7
6.9
6.7
10.9
9.6
5.5
5.2
5.8
5.1
7.1
6.9
PBV (x)
FY18/
FY19/
CY17
CY18
2.4
2.2
1.2
0.8
1.7
1.6
1.2
1.1
0.7
0.7
1.4
1.3
1.8
1.7
0.7
0.6
0.8
0.8
2.0
1.7
1.9
1.3
1.5
1.5
1.9
1.5
1.8
1.6
2.7
2.3
2.3
2.1
1.6
1.5
1.8
1.5
1.2
1.0
1.5
1.3
PE (x)
FY18/
CY17
13.9
9.0
11.9
6.2
7.8
10.4
10.3
5.1
7.8
14.9
16.6
12.1
14.0
9.4
12.4
10.5
15.7
8.3
6.4
10.8
FY19/
CY18
13.3
10.3
11.6
6.6
7.3
10.2
9.0
4.9
7.4
13.1
14.6
11.3
11.0
9.0
10.9
10.3
13.9
7.5
5.4
10.0
Caltex Australia Ltd
Petron Corp
Showa Shell Sekiyu KK
Esso Thailand PCL
JXTG Holdings Inc
Thai Oil PCL
S-Oil Corp
Idemitsu Kosan Co Ltd
SK Innovation Co Ltd
Phillips 66
Marathon Petroleum Corp
Valero Energy Corp
Tesoro Corp
Indian Oil Corp
Bharat Petroleum Corp
Hindustan Petroleum Corp
Reliance Industries
Mangalore Refinery & Petrochemicals
Chennai Petroleum Corp Ltd
Average excluding Indian companies
Exhibit 3: Pure marketing plays
ROE (%)
FY18/CY17
FY19/CY18
18.5
16.9
28.8
27.9
12.7
8.4
EV/EBITDA
FY18/CY17
FY19/CY18
7.8
7.5
8.9
8.7
6.3
6.4
PBV (x)
FY18/CY17
FY19/CY18
2.4
2.2
4.3
4.0
1.2
0.8
PE (x)
FY18/CY17
FY19/CY18
13.9
13.3
14.2
13.4
9.0
10.3
Source: Bloomberg, MOSL
Caltex Australia Ltd
Z Energy Ltd
Petron Corp
Exhibit 4: Replacement cost valuation
Asset
Refineries
Marketing terminals- large formats
Marketing terminals- depots
Retail outlets
Pipelines
LPG bottling plants
LPG unloading facility at Mangalore
Stake in Bhatinda
Stake in MRPL
Others
Total valuation (INRb)
Current net debt (INRb)
Equity valuation (INRb)
Value per share (INR)
Capacity/
number
14.8mmtpa
12
70
14412
15510km-
mmtpa
47
1
49% of
9mmtpa
17% of
15mmtpa
Valuation
metric
INR20b/mt
INR5b/unit
INR1.5b/unit
INR10m/unit
INR3.2/km-
mmtpa
INR250m/unit
INR10b
INR20b/mt
INR20b/mt
Valuation
(INR b)
166
42
74
144
35
8
7
88
41
100
704
170
534
350
Rationale
Recent capacities at Bina, Bhatinda, Paradip came at
~INR20b/mmt
Discount of 20% for lower complexity
30% discount for the lower useful life left
30% discount for the lower useful life left
30% discount for the lower useful life left
3,000-4,000 have owned land, rest are mostly on
long term lease
Recent acquisition suggests a cost of INR20m for
each unit
Using the cost of Paradip-Raipur-Ranchi pipeline
Using 30% discount due to lower useful life left
Using 30% discount due to lower useful life left
Using 30% discount due to lower useful life left
No discount as this is a new plant
Using 20% discount due to lower useful life left
Stake in SAGPL, Hindustan Colas, land bank etc
Source: Industry, MOSL
28 July 2017
4

HPCL
Exhibit 5: Valuation methodologies
Valuation
methodology
DCF
Key assumptions
Valuation Remarks
470
GRM of USD5.1/bbl for HPCL, 6.5/bbl for
MRPL, 10/bbl for HMEL
Net marketing margin of INR1.1/lit
WACC of 11%
Nil terminal growth
Refining at 5.5x
Marketing at 8x
Implied valuation of 7x FY19 EV/EBITDA &
11x FY19 PE (conso)
2.2x PBV
Refining is a cyclical industry and avg GRM during last
10yrs stood at USD4/bbl, which results in valuation of
INR420/share
WACC of 12% results in valuation of INR412/share
Methodology is very subjective and is open to challenge
This is our base case and is least debatable
Relative
valuation
427
Asset
valuation
Replacement
cost valuation
361
Doesn’t provide for possible ROE expansion in the future
which could increase target PBV
Hugely debatable method. Calculation of useful life,
valuation of land etc might add to confusion.
Source: MOSL
Refer to exhibit 4 for details
350
Control premium – no case theoretically
Theoretically, a control premium is applied only when the acquirer (1) can change
the way the company operates, thereby improving the profitability of the existing
assets, (2) could benefit from the synergies that the acquisition throws, and (3)
reduce the cost of capital, thereby improving interest cost and return ratios of the
future capex. In the acquisition of HPCL by ONGC, the first scenario is completely
ruled out, since ONGC has no better experience in running a refinery and no
experience at all in marketing of petroleum products. Yet, the acquisition does
provide some cushion to volatility in oil prices. Moody’s rating for ONGC is Baa1 and
that for HPCL is Baa3. There might be some improvement in cost of capital for HPCL
due to stronger balance sheet. However, ONGC’s credit rating itself may change due
to the debt it would take to fund the acquisition. In a nutshell, we do not see a
reason for ONGC to pay a control premium.
28 July 2017
5

HPCL
Exhibit 6: Control premium scenarios
Acquirer can
improve the way the
company is
operating, thereby
its valuation
Possible
synergies: 1+1
is more than 2
Reduce the cost of
capital
Control
premium
Source: MOSL
What else could affect valuation?
HPCL presents an opportunity to acquire ~23% of domestic market share of
petroleum products. India is one of the fastest growing countries in terms of
petroleum consumption growth. This provides an immense opportunity for larger
players like British Petroleum, Shell or Reliance Industries that have a large refining
presence and are looking for markets for their products. Replicating this kind of
presence in India would take years of efforts and investments. If a bid were invited
from such private parties, they may also bring operational efficiencies both in
marketing and in refining assets of HPCL, justifying higher valuation.
Confusion could keep stock price under pressure
The best way forward for the government would be to invite bids for partial sell-off
and then ask ONGC to match the valuation. This would be least controversial and
would not attract undue attention/dissent. However, till the time there is clarity on
the way forward, we believe the stock price would remain hostage to news flows
rather than fundamentals.
28 July 2017
6

HPCL
Financials and Valuations
Standalone - Income Statement
Y/E March
Net Sales
Change (%)
Finished Goods
Raw Materials Cons
Other Exp
Total Expenditure
% of Sales
EBITDA
Margin (%)
Depreciation
EBIT
Int. and Finance Charges
Other Income
PBT bef. EO Exp.
EO Items
PBT after EO Exp.
Total Tax
Tax Rate (%)
Reported PAT
Adjusted PAT
Change (%)
Margin (%)
FY13
2,065,293
15.9
1,281,786
639,921
104,163
2,025,869
98.1
39,424
1.9
19,315
20,109
18,377
12,300
14,032
714
14,746
5,699
38.6
9,047
8,334
-8.6
0.4
FY14
2,231,454
8.0
1,451,380
613,881
114,112
2,179,372
97.7
52,081
2.3
21,884
30,197
15,046
11,004
26,155
0
26,155
8,817
33.7
17,338
17,338
108.0
0.8
FY15
FY16
2,063,804 1,777,006
-7.5
-13.9
1,292,784 1,159,484
599,079
409,025
117,765
129,104
2,009,627 1,697,613
97.4
95.5
54,176
79,393
2.6
4.5
19,712
26,532
34,465
52,861
7,066
6,536
14,142
11,442
41,541
57,766
0
0
41,541
57,766
14,209
20,505
34.2
35.5
27,333
37,262
27,333
37,262
57.6
36.3
1.3
2.1
FY17
1,870,237
5.2
1,227,317
406,836
130,313
1,764,467
94.3
105,771
5.7
25,353
80,418
5,357
15,147
90,208
0
90,208
28,120
31.2
62,088
62,088
66.6
3.3
FY18E
FY19E
1,854,501 2,084,728
-0.8
12.4
1,218,694 1,383,491
415,409
466,948
129,034
133,685
1,763,137 1,984,124
95.1
95.2
91,364
100,604
4.9
4.8
29,087
31,087
62,276
69,517
5,276
5,925
10,518
10,974
67,518
74,566
0
0
67,518
74,566
22,504
24,853
33.3
33.3
45,015
49,713
45,015
49,713
-27.5
10.4
2.4
2.4
(INR Million)
FY20E
2,115,704
1.5
1,406,670
466,948
138,219
2,011,837
95.1
103,866
4.9
33,087
70,779
7,500
11,475
74,754
0
74,754
24,916
33.3
49,839
49,839
0.3
2.4
Standalone - Balance Sheet
Y/E March
Equity Share Capital
Total Reserves
Net Worth
Total Loans
Deferred Tax Liabilities
Capital Employed
Gross Block
Less: Accum. Deprn.
Net Fixed Assets
Capital WIP
Total Investments
Curr. Assets, Loans&Adv.
Inventory
Account Receivables
Cash and Bank Balance
Loans and Advances
Curr. Liability & Prov.
Account Payables
Provisions
Net Current Assets
Appl. of Funds
E: MOSL Estimates
FY13
3,390
133,874
137,264
324,583
35,984
497,830
370,062
144,575
225,487
51,729
106,269
378,962
164,387
49,350
1,471
163,754
264,617
241,622
22,995
114,345
497,830
FY14
3,390
146,732
150,122
319,301
39,084
508,506
424,668
165,545
259,122
45,856
108,599
362,204
187,754
54,660
347
119,444
267,275
243,978
23,296
94,930
508,506
FY15
3,390
156,831
160,221
170,556
41,036
371,813
481,749
191,121
290,628
34,744
112,415
237,719
129,723
36,031
171
71,796
303,693
273,903
29,790
-65,974
371,813
FY16
3,390
176,308
179,698
143,950
52,814
376,461
547,104
216,028
331,076
18,528
105,786
240,404
132,114
37,580
238
70,472
319,332
301,228
18,104
-78,928
376,461
FY17
10,170
193,311
203,482
171,706
59,682
434,869
604,615
243,296
361,319
18,105
109,186
296,037
185,763
40,642
337
69,296
349,777
323,869
25,908
-53,740
434,869
FY18E
15,255
217,408
232,663
180,000
59,682
472,345
601,749
272,383
329,366
120,970
109,186
221,678
106,271
20,323
1,182
93,901
308,855
289,831
19,024
-87,177
472,345
FY19E
15,255
249,635
264,891
215,000
59,682
539,573
641,749
303,471
338,278
180,970
109,186
257,270
130,463
22,846
865
103,096
346,132
326,157
19,975
-88,862
539,573
(INR Million)
FY20E
15,255
281,944
297,199
285,000
59,682
641,881
681,749
336,558
345,191
190,970
109,186
348,221
132,285
23,186
88,431
104,319
351,687
330,713
20,974
-3,466
641,881
28 July 2017
7

HPCL
Financials and Valuations
Ratios
Y/E March
Basic (INR)
EPS
Cash EPS
BV/Share
DPS
Payout (%)
Valuation (x)
P/E
Cash P/E
P/BV
EV/Sales
EV/EBITDA
Dividend Yield (%)
FCF per share
Return Ratios (%)
RoE
RoCE
RoIC
Working Capital Ratios
Asset Turnover (x)
Debtor (Days)
Leverage Ratio (x)
Net Debt/Equity
FY13
5.5
18.1
90.0
1.9
37.2
FY14
11.4
25.7
98.4
3.4
35.4
FY15
17.9
30.8
105.0
5.4
36.5
FY16
24.4
41.8
117.8
7.7
37.7
15.3
9.0
3.2
0.4
9.0
2.0
24.8
6.2
4.6
3.9
4.1
9
1.6
12.1
5.9
5.8
4.4
9
1.4
17.6
8.0
7.8
5.6
6
0.4
21.9
12.7
14.3
4.7
8
0.2
FY17
40.7
57.3
133.4
20.0
57.5
9.2
6.5
2.8
0.4
7.0
5.3
9.2
32.4
18.8
19.8
4.3
8
0.3
FY18E
29.5
48.6
152.5
8.9
35.2
12.7
7.7
2.5
0.4
8.2
2.4
5.5
20.6
12.3
15.1
3.9
4
0.3
FY19E
32.6
53.0
173.6
9.8
35.2
11.5
7.1
2.2
0.4
7.8
2.6
-11.7
20.0
12.0
18.9
3.9
4
0.4
FY20E
32.7
54.4
194.8
9.8
35.2
11.5
6.9
1.9
0.4
7.4
2.6
23.0
17.7
10.3
18.8
3.3
4
0.3
Standalone - Cash Flow Statement
Y/E March
OP/(Loss) before Tax
Depreciation
Direct Taxes Paid
(Inc)/Dec in WC
CF from Operations
Others
CF from Operating incl EO
(Inc)/Dec in FA
Free Cash Flow
(Pur)/Sale of Investments
CF from Investments
Inc/(Dec) in Debt
Dividend Paid
Others
CF from Fin. Activity
Inc/Dec of Cash
Opening Balance
Closing Balance
FY13
14,746
19,344
-5,699
-34,913
-6,522
5,131
-1,391
-43,619
-45,010
-2,564
-46,183
49,790
-3,368
359
46,782
-792
2,264
1,471
FY14
26,155
21,884
-8,817
18,291
57,513
3,101
60,614
-49,647
10,968
-2,329
-51,976
-5,282
-6,141
1,661
-9,762
-1,124
1,471
347
FY15
39,921
19,712
-14,209
160,727
206,151
1,952
208,103
-40,106
167,997
-3,816
-43,922
-148,744
-9,985
-5,628
-164,357
-176
347
171
FY16
57,766
26,532
-20,505
13,021
76,815
11,778
88,592
-50,763
37,829
6,629
-44,134
-26,607
-14,061
-3,724
-44,391
67
171
238
FY17
90,208
25,353
-28,120
-25,088
62,352
6,868
69,221
-55,173
14,048
-3,400
-58,573
27,756
-35,702
-2,602
-10,548
99
238
337
FY18E
67,518
29,087
-22,504
34,282
108,384
0
108,384
-100,000
8,384
0
-100,000
8,294
-15,833
0
-7,539
846
337
1,182
(INR Million)
FY19E
74,566
31,087
-24,853
1,368
82,168
0
82,168
-100,000
-17,832
0
-100,000
35,000
-17,486
0
17,514
-317
1,182
865
FY20E
74,754
33,087
-24,916
2,169
85,095
0
85,095
-50,000
35,095
0
-50,000
70,000
-17,530
0
52,470
87,565
865
88,431
28 July 2017
8

HPCL
NOTES
28 July 2017
9

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HPCL
Disclosure of Interest Statement
Analyst ownership of the stock
HPCL
No
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Registration details of group entities.: MOSL: NSE (Cash): INB231041238; NSE (F&O): INF231041238; NSE (CD): INE231041238; BSE (Cash): INB011041257; BSE(F&O): INF011041257; BSE(CD); MSE(Cash): INB261041231;
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28 July 2017
10