HPCL: Refinery upgrades to boost GRMs, throughputs by 65%

11 July 2016

Update

| Sector:

Oil & Gas

HPCL

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Motilal Oswal

values your

Refinery upgrades to boost GRMs, throughputs by 65%

Focused on increasing margins; earnings visibility high; valuations attractive

We attended the HPCL analyst meet. Following are the key takeaways:



Brownfield expansion to up refinery capacity by ~65%; expect stable GRM

HPCL plans capex of INR558b over FY16-21, which includes ~INR257b for

refineries, ~INR262b for marketing, and the remaining for renewables, R&D

and JV projects. For the next two years, capex will be funded through internal

accruals; could take loan in later years as refinery capex will be back-ended.

Refinery capex of INR257b includes INR42b for Euro VI upgradation and

brownfield expansions (a) at Vizag from 8.3 to 15mmt (~INR200b, up from

INR170b) along with upgradation, (b) at Mumbai from 6.5 to 9.5mmt (INR42b)

and (c) JV Bhatinda refinery from 9 to 11.3mt (INR24b)

Expects overall GRM to improve by ~USD1.5-2/bbl: (a) Vizag to complete by

April 2020 and expand GRM by USD4-5/bbl, (b) Mumbai to complete in three

years and expand GRM by USD1-1.5/bbl and (c) Bhatinda by Jun-17.

Expects GRM to remain stable in the medium term (FY16 GRM: USD6.7/bbl), at

USD5-7/bbl helped by higher distillate yields.

Bhatinda refinery (HPCL stake 49%) is expected to continue posting profits in

FY17 (FY16 PAT was ~INR18b) even at the current petroleum product cracks,

and expects GRM to be in double-digits.

Updated capex plans place high emphasis on marketing; five-year marketing

capex significantly high at INR262b (~47% of total capex).

Management announced plans to set up 3 new LPG plants, 3 POL depots and

Lube Blending Plants at Mumbai and Kasna (UP).

Mktg. margins remain strong at INR1.7/1.6/ltr for petrol/diesel (v/s regulated

era of INR1.4/ltr). Volumes remain strong with FY16 POL growth at 9.3%.

Dynamic pricing (based on location, demand and competition) is already

underway in some test markets, and could be rolled out on a pan-India basis.

Dynamic/differential pricing will help the company to sweat the marketing

assets better and improve profitability further.

While refining will continue to be cyclical, marketing (including pipelines) gives

earnings stability and lubes business also contributes meaningfully (10-20%).

Of the three OMCs, HPCL’s earnings are more sensitive to a change in the

marketing margin, given its higher ratio of marketing-to-refining volume.

On SA basis, HPCL trades at 7.3x FY18E EPS of INR140.6 and 1.4.x FY18E BV. On

a consol. basis, HPCL trades at 6.1x FY18 EPS of INR169. We value HPCL at 5.5x

for refining and 8x for marketing to arrive at a fair value of INR1,359, implying a

32% upside. Dividend yield is attractive at ~3-4%. Maintain

Buy.



Stock Info

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1, 6, 12 Rel. Per (%)

M.Cap. (INR b)

M.Cap. (USD b)

12M Avg Val (INR M)

Free float (%)

HPCL IN

338.6

1050 / 636

13/7/27

348.6

5.2

1184

48.9



Bhatinda refinery clocking double-digit GRM; to be profitable in FY17



Financials Snapshot (INR b)

Y/E Mar

2016 2017E 2018E

Net Sales

1,792.8 1,825.1 1,926.9

EBITDA

76.2

85.9

94.9

PAT

38.6

43.9

47.7

EPS (INR)

113.9 129.5 140.6

Gr. (%)

41.3

13.7

8.6

BV/Sh (INR)

546.2 638.6 729.8

RoE (%)

22.4

21.9

20.5

RoCE (%)

11.4

12.1

11.9

P/E (x)

9.0

7.9

7.3

P/BV (x)

1.9

1.6

1.4

Shareholding pattern (%)

Mar-16 Dec-15 Mar-15

Promoter

DII

FII

Others

51.1

14.0

19.3

15.6

51.1

14.8

19.4

14.6

51.1

16.4

18.5

14.0

Marketing capex increased significantly; margins above regulated era



Already started dynamic pricing; Marketing, lubes give earnings stability



Valuation and view



FII Includes depository receipts

Investors are advised to refer through important disclosures made at the last page of the Research Report.

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Harshad Borawake

(HarshadBorawake@MotilalOswal.com); +91 22 3982 5432

Rajat Agarwal

(Rajat.Agarwal@MotilalOswal.com); +91 22 3982 5558

HPCL

Exhibit 1: FY15-20 capex plans of INR450b were focused

towards Refining and JV projects

JV projects

31%

Refining

47%

Renewables

& RD

Marketing

20%

Source: Company, MOSL

Exhibit 2: FY16-21 capex plans of ~INR560b places increased

focus on marketing projects

Renewables

& RD

JV projects

Refining

46%

Marketing

47%

Source: Company, MOSL

Exhibit 3: Summary of Profitability improvement measures by HPCL

Recent addition of

secondary processing units

and improvement in crude

mix have added USD1.2/bbl

to Mumbai refinery GRM

and single point mooring

system has added

USD0.5/bbl to Vizag GRM.

Initiative

Optimized MS block operations

LOUP project at Mumbai refinery

Robust LP model

FCC with Cat Cooler at Mumbai refinery

Encon measures

CDU II Revamp at Mumbai refinery

Flare gas recovery systems

Power purchrase through open access

Impact Area

Increased MS production in lieu of Naphtha

Increased production of valued added lubricants

Optimizing Crude selection

Conversion of Low value Fuel Oil to value added products

Reduced fuel consumption

Increased crude processing

Reduced hydrocarbon losses

Reduced operating expenditure

Source: Company, MOSL

Exhibit 4: BS IV and BS VI coverage plans on track

Source: Company, MOSL

11 July 2016

HPCL

Exhibit 5: High volume highway location contributes to 51% of HPCL’s retail outlet

locations

HPCL’s market share

amongst PSUs is gradually

increasing in marketing and

retail aspects; at 25.8% in

Mar’16 from 25.2% in

Dec’15

Lubricants market share has

increased by 2.6% in FY16

Source: Company, MOSL

Exhibit 6: Well prepared for private competition with Loyalty programs and fleet

management solutions for auto fuel customers – Already automated 2,731 outlets

Source: Company, MOSL

11 July 2016

HPCL

Exhibit 7: High margin automotive segment contributes 32% to lube volumes sales; has

diversified OEM partnerships with automotives and industrial players

Source: Company, MOSL

Exhibit 8: Brent prices on a recovery post declining to their monthly lowest since Feb-04 in Feb016

WTI

150

120

Brent (USD/bbl)

Source: Bloomberg, MOSL

11 July 2016

HPCL

Exhibit 9: HPCL GRM trend – 4QFY16 GRM was equivalent to benchmark Singapore GRM; GRM supported by benign crude

prices

(In USD/bbl)

9.1

6.7

6.3

8.7

6.6

5.4

3.8

HPCL GRM

6.2

4.7

2.4

2.0

2.1

(1.0)

Singapore GRM

5.8

4.8

6.3

7.5

8.6

8.0

8.6

8.0

7.9

2.7

4.3

6.3

7.7

7.5

4.4

1.9

(2.1)

3.7

2.6

Source: Company, MOSL

Exhibit 10: Industry level gross under recoveries have come down sharply; LPG shifted to DBTL (INRb)

Gross under recoveries: HPCL + BPCL + IOCL (INRb)

478

436

406

393

362

115 378

325

110

105

215

299

290

241

236 207

187

182

Petrol

398

127

185

393

159

152

287

224

121

125

159

103

(7)

Diesel

PDS Kerosene

Domestic LPG

Total

354

254

105

186

FY12

FY13

FY14

FY15

FY16

Source: PPAC, Industry, MoPNG

Exhibit 11: Petrol and Diesel are expected to grow at 8.4%/6.9% CAGR till FY22 (mmt)

76.9

HSD

81.6

86.8

92.1

97.9

104.1

110.8

64.8

69.1

68.4

69.4

15.0

15.7

17.1

19.1

20.8

22.6

24.5

26.6

28.8

31.1

33.7

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

FY20

FY21

FY22

Source: PPAC, MOSL

11 July 2016

HPCL

Other key takeaways



Management expects GRMs to be range bound within USD5-7/bbl in FY17

(excluding GRM movements).

FY17 capex plans stand at INR68.6b (five year capex at INR558b). This includes

INR14b for refining, INR46b for marketing, INR2.9b for renewables, INR4.8b for

Joint ventures (refining, gas including LNG and E&P) and remaining for R&D.

Capex financing:

Management guided that for the next 1-2 years, the capex

plans of ~INR550b will funded through internal accruals and eventually

borrowings could be increased

Mega refinery plans:

Currently, the mega refinery is being planned in two

phases with Phase I capacity of 40MMT and remaining 20MMT capacity in Phase

II. Management highlighted that land acquisition remains the biggest challenge

for the refinery and OMCs are currently scouting for locations.

Management reiterated that Rajasthan refinery plans haven’t been shelved and

are under review. Management also highlighted that its subsidiary Prize

Petroleum is currently screening E&P opportunities.

DBT in Kerosene is expected to lead to reduction of Kerosene subsidies, as

usually DBT leads to reduction in bogus accounts.

HPCL has upgraded its lubes production capacity to produce better grade Group

III base oils.

Management re-emphasized focus on R&D as a long-term business driver. Post

six years of formulation, HPCL started supply of winter diesel to the Indian army.

Five years R&D spend are planned at ~INR5b.

The PSU pay revision is currently expected in December 2016, and post that the

employee expenses could increase

FII limit currently stands at 24% and will be increased shortly to 40%.

HPCL’s standalone debt stands at INR212b (vs INR203b in March-15) and subsidy

receivables at INR40b.

Valuation and view



Widening Moat:

OMCs’ economic moat is widening, led by (1) scope for

meaningful increase in marketing margins and profitability, (2) slower ramp-up

by private marketers, (3) high volume growth, aided by expected GDP boost,

and (4) improving balance sheet with increasing cash flow.

OMCs profit normalization was delayed for a decade:

OMC’s deregulation and

in turn their profit normalization had been derailed for a decade after an earlier

brief de-regulation period in 2004-06. However, this time around we believe

government will stay put with its deregulation decision given the hard lessons of

financial stress of last decade. Increased excise duties offer some flexibility to

moderate prices in event of spike in oil prices, but huge and growing India

consumption volumes will make it practically impossible to again revisit the

price control model.

Marketing division to drive profitability:

Post de-regulation, we expect

marketing division profitability to grow rapidly, hence should also command a

higher valuation. An INR0.5/ltr increase in petrol and diesel marketing margins

increases HPCL’s FY18E EPS by 27%. We model gross per liter diesel margin of

1.6/2.0 in FY17/FY18.

11 July 2016

HPCL



Pure play marketing companies trade at higher valuations:



Pure play petroleum marketing companies - US based CST Brands (CST US;

M Cap: USD2.4b) and New Zealand based Z Energy (ZEL NZ; M Cap:

USD1.5b) trade (1 year forward basis) at ~10x EV/EBITDA.



These valuations (in-line with the underlying business dynamics) are more

similar to consumer business than refining or oil & gas.

Of the three OMCs, HPCL's earnings are more sensitive to a change in the

marketing margin-given its higher ratio of marketing-to-refining volume. Hence,

it would be the largest beneficiary of higher auto fuel margins.

On SA basis, HPCL trades at 7.3x FY18E EPS of INR140.6 and 1.4.x FY18E BV. We

value HPCL at 5.5x for refining and 8x for marketing to arrive at a fair value of

INR1,359 implying a 32% upside. Dividend yield is attractive at ~3-4%. Maintain

Buy. HPCL had a payout of ~30% of standalone profits last year and the same is

likely to continue.

Maintain Buy.

Exhibit 12: HPCL – Key Assumptions

Exchange Rate (INR/USD)

Brent Crude (USD/bbl)

Market Sales (MMT)

YoY (%)

GRM (USD/bbl)

HPCL Blended GRM

Reuters Singapore GRM

Prem/(disc)

Refining capacity utilization (%)

Refinery throughput (mmt)

Total Refinery throughput (MMT)

Under recoveries Sharing (INRb)

Net sharing

Net sharing (%)

FY09

45.8

84.8

25.4

3.8%

5.17

5.75

(0.58)

118%

16.5

(0.0)

FY10

47.5

69.6

26.3

3.5%

2.97

3.55

(0.58)

116%

16.3

12.3

12%

FY11

45.7

86.5

27.0

2.9%

4.47

5.18

(0.70)

106%

15.8

15.1

FY12

47.9

114.5

29.5

9.1%

5.20

8.17

(2.96)

99%

16.1

0.1

FY13

54.5

110.6

30.3

2.8%

2.08

7.70

(5.62)

98%

15.8

2.3

FY14

60.6

107.8

31.0

2.1%

3.43

5.62

(2.19)

95%

15.4

4.8

FY15

61.1

86.0

32.0

3.2%

2.84

6.36

(3.52)

101%

16.4

5.0

FY16

65.5

47.6

34.2

7.1%

6.67

7.49

(0.82)

106%

17.2

0.1

FY17E

68.0

50.0

36.3

6.0%

5.50

6.25

(0.75)

109%

17.7

FY18E

70.0

55.0

38.3

5.5%

6.00

7.00

(1.00)

109%

17.7

Source: Company, MOSL

11 July 2016

HPCL

Story in charts

Exhibit 13: HPCL’s GRMs have underperformed Singapore

GRM (USD/bbl)

Prem/(Disc) to Singapore

Singapore GRM

7.7

8.2

3.6

3.0

(0.6)

5.2

4.5

(0.7)

5.2

2.1

(3.0)

FY12

(5.6)

FY13

FY14

3.4

(2.2)

5.6

HPCL Blended GRM

6.4

7.5

6.7

2.8

(3.5)

FY15

(0.8)

6.3

5.5

(0.8)

7.0

6.0

(1.0)

Exhibit 14: While refining capacity has been largely flat,

marketing sales have shown steady increase

Marketing Sales (mmt)

Refinery Throughput (mmt)

FY10

FY11

FY12

FY13

FY14

FY15

FY10

FY11

FY16 FY17E FY18E

Source: Company, MOSL

FY16 FY17E FY18E

Source: Company, MOSL

Exhibit 15: HPCL FY16 EBITDA and PAT boosted by GRM and

marketing margins; despite inventory loss

EBITDA (INRb)

PAT (INRb)

FY10

FY11

FY12

FY13

FY14

Exhibit 16: Expect D/E ratio to decline with increasing

profitability (x)

D/E Ratio

1.8

2.0

2.3

2.4

2.1

1.1

0.8

0.6

FY15

FY16 FY17E FY18E

FY10

FY12

FY14

FY16

FY18E

Source: Company, MOSL

Exhibit 17: Diesel deregulation to reduce working capital

leading to lower interest costs

Total Debt (INRb)

Interest Cost (INRb)

Exhibit 18: HPCL: 1 Year Forward P/E Chart – Currently

trading at 12% discount to its historical 10 year average

PE (x)

Median(x)

Peak(x)

Min(x)

Avg(x)

24.6

145

140

9.1

8.0

2.6

8.2

213

FY10

250

FY11

298

FY12

325

FY13

319

FY14

171

FY15

FY16 FY17E FY18E

Source: Company, MOSL

11 July 2016

HPCL

Financials and Valuations

Income Statement

Y/E Mar

Net Sales

Change (%)

EBITDA

EBITDA Margin (%)

Depreciation

EBIT

Interest

Other Income

Extraordinary items

PBT

Tax

Tax Rate (%)

Min. Int. & Assoc. Share

Reported PAT

Adjusted PAT

Change (%)

2011

1,309,342

19.9

33,088

2.5

14,070

19,018

8,840

13,435

-152

23,461

8,071

34.4

15,390

18.3

2012

1,781,392

36.1

34,082

1.9

17,129

16,953

16,977

12,222

-5

12,192

3,077

25.2

9,115

-40.8

2013

2,065,293

15.9

39,424

1.9

19,315

20,109

18,377

12,300

714

14,746

5,699

38.6

9,047

-0.7

2014

2,231,454

8.0

52,081

2.3

21,884

30,197

15,046

11,004

26,155

8,817

33.7

17,338

91.6

2015

2,063,804

-7.5

54,176

2.6

19,712

34,465

7,066

14,142

41,541

14,209

34.2

27,333

57.6

2016

1,792,811

-13.1

76,168

4.2

26,668

49,500

6,401

14,282

57,381

18,753

32.7

38,627

41.3

2017E

1,825,129

1.8

85,916

4.7

28,925

56,992

5,536

14,069

65,525

21,623

33.0

43,902

13.7

(INR Million)

2018E

1,926,920

5.6

94,929

4.9

31,525

63,404

5,320

13,045

71,129

23,473

33.0

47,657

8.6

Balance Sheet

Y/E Mar

Share Capital

Reserves

Net Worth

Debt

Deferred Tax

Total Capital Employed

Gross Fixed Assets

Less: Acc Depreciation

Net Fixed Assets

Capital WIP

Investments

Current Assets

Inventory

Debtors

Cash & Bank

Loans & Adv, Others

Curr Liabs & Provns

Curr. Liabilities

Provisions

Net Current Assets

Total Assets

2011

3,390

122,068

125,458

250,212

31,956

407,626

296,484

110,039

186,445

37,987

113,350

265,910

166,223

26,544

800

72,343

196,066

178,018

18,048

69,844

407,626

2012

3,390

127,835

131,225

298,312

30,853

460,390

334,590

126,094

208,496

44,445

103,705

354,427

194,545

35,652

2,264

121,967

250,683

230,847

19,836

103,744

460,390

2013

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

2014

3,390

146,732

150,122

319,301

39,084

508,506

424,668

165,545

259,122

45,856

108,598

362,204

187,754

54,660

347

119,444

267,275

243,978

23,296

94,930

508,506

2015

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

2016

3,390

181,775

185,165

145,220

48,105

378,490

541,493

217,789

323,705

30,000

109,947

241,865

127,091

42,296

1,483

70,995

327,027

305,459

21,568

-85,162

378,490

(INR Million)

2017E

3,390

213,103

216,493

140,000

54,657

411,151

615,493

246,713

368,780

8,000

115,694

253,891

135,664

43,058

11,473

63,695

335,214

311,490

23,725

-81,324

411,151

2018E

3,390

244,022

247,412

140,000

61,770

449,182

645,493

278,238

367,255

58,000

115,694

251,486

141,582

45,459

750

63,695

343,253

317,156

26,097

-91,767

449,182

11 July 2016

HPCL

Financials and Valuations

Ratios

Y/E Mar

Basic (INR)

EPS

Cash EPS

Book Value

DPS

Payout (incl. Div. Tax.)

Valuation(x)

P/E

Cash P/E

Price / Book Value

EV/Sales

EV/EBITDA

Dividend Yield (%)

Profitability Ratios (%)

RoE

RoCE

RoIC

Turnover Ratios (%)

Asset Turnover (x)

Debtors (No. of Days)

Leverage Ratios (%)

Net Debt/Equity (x)

2.0

2.3

2.4

2.1

1.1

0.8

0.6

4.8

5.6

5.9

5.6

4.6

3.5

3.2

3.1

12.8

5.6

7.1

5.0

4.5

6.7

4.2

3.8

12.1

5.4

5.8

17.6

7.3

7.8

22.4

11.4

14.4

21.9

12.1

14.9

20.5

11.9

15.4

12.7

7.4

2.2

0.2

8.3

2.4

9.0

5.3

1.9

0.2

5.6

3.4

7.9

4.8

1.6

0.2

4.8

3.1

7.3

4.4

1.4

0.2

4.6

4.1

45.4

86.9

370.1

14.0

36.1

26.9

77.4

387.1

8.5

37.0

26.7

83.7

404.9

8.5

37.3

51.1

115.7

442.8

15.5

35.5

80.6

138.8

472.6

24.5

35.6

113.9

192.6

546.2

34.5

35.4

129.5

214.8

638.6

31.7

28.6

140.6

233.6

729.8

42.2

35.1

2011

2012

2013

2014

2015

2016

2017E

2018E

Cash Flow Statement

Y/E Mar

Adjusted EBITDA

Non cash opr. exp (inc)

(Inc)/Dec in Wkg. Cap.

Tax Paid

Other operating activities

CF from Op. Activity

(Inc)/Dec in FA & CWIP

Free cash flows

(Pur)/Sale of Invt

Others

CF from Inv. Activity

Inc/(Dec) in Net Worth

Inc / (Dec) in Debt

Interest Paid

Divd Paid (incl Tax) & Others

CF from Fin. Activity

Inc/(Dec) in Cash

Add: Opening Balance

Closing Balance

2011

33,088

10,913

-25,876

-5,645

-2,456

10,024

-46,101

-36,077

5,371

12,330

-28,400

30,408

-8,933

-4,731

16,744

-1,631

2,431

800

2012

34,082

16,632

-27,301

-2,715

-5,407

15,291

-41,359

-26,068

6,378

3,579

-31,401

37,919

-14,836

-5,509

17,574

1,464

800

2,264

2013

39,424

14,859

-30,945

-1,072

-10,771

11,496

-36,807

-25,312

-2,404

15,383

-23,828

37,072

-22,187

-3,344

11,540

-793

2,264

1,471

2014

52,081

9,322

21,121

-3,668

-1,556

77,301

-41,358

35,943

-1,297

10,289

-32,365

-25,648

-17,045

-3,367

-46,060

-1,124

1,471

347

2015

54,176

14,142

124,486

-7,622

-6,772

178,411

-41,762

136,649

4,161

-3,396

-40,997

-123,807

-7,647

-6,136

-137,590

-176

347

171

2016

76,168

14,282

20,500

-11,685

-5,536

93,729

-55,000

38,729

2,468

5,536

-46,996

-25,336

-6,401

-13,684

-45,421

1,312

171

1,483

2017E

85,916

14,069

6,152

-15,071

-6,467

84,600

-52,000

32,600

-5,748

6,467

-51,281

-5,220

-5,536

-12,573

-23,329

9,990

1,483

11,473

(INR Million)

2018E

94,929

13,045

-280

-16,360

-6,437

84,897

-80,000

4,897

6,437

-73,563

-5,320

-16,738

-22,058

-10,723

11,473

750

11 July 2016

HPCL

NOTES

11 July 2016

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