HPCL: Downgrade to Sell: Highest Marketing Exposure; Refining a Laggard:: Citi

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Hindustan Petroleum (HPCL.BO)
Downgrade to Sell: Highest Marketing Exposure; Refining a
Laggard
 Downgrade to Sell — We downgrade HPCL to Sell (3L) from Buy (1H) with a
target price of Rs511. Our downgrade is prompted by the fact that a
transparent subsidy sharing structure is still not in place, and there is lack of
clarity in the Govt’s intent to fully compensate the OMCs for underrecoveries
(the Gov’t has still not provided for 1HFY11 losses). HPCL is most
levered to Gov’t policy and the quantum of under-recoveries and could be
most impacted if diesel deregulation continues to be deferred.
 Risk adjusted TP of Rs511 — We value HPCL by evaluating its earnings
potential in an environment of nil losses, adjusted for probability by applying
appropriate valn discounts, and base our TP on sum of: (i) 6x FY12E
EV/Ebitda in a base-case scenario of 1/3rd upstream sharing, 50% gov't
share, and diesel deregulation, (ii) 1.5x FY12E EV/Ebitda (i.e., 25% riskweightage)
to incremental earnings in an upside scenario of nil net losses
(i.e., full compensation) and (iii) value of investments (Rs70).
 Refining a laggard — HPCL’s refining performance over the last few
quarters, has, on average, lagged that of its peers, driven by both lower
throughput as well as lower margins. HPCL is also setting up a 9 MMTPA
refinery at Bhatinda (in Punjab) in a JV with Mittal Energy Investments.
While the project is expected to be completed by mid-2011, we currently
think it is a trifle premature to ascribe any value to this project. We,
however, simultaneously also net off the estimated capex incurred so far by
HPCL on the project.