HPCL- Government compensation makes up- Kotak Sec

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Hindustan Petroleum (HPCL)
Energy
Government compensation makes up for weak operational performance. HPCL
reported better-than-expected 2QFY11 net income at `20.7 bn versus our estimate of -
`6.4 bn due to compensation of `28.3 bn from the government for 1HFY11 versus nil
assumed by us. This was partly nullified by lower-than-expected refining margins and
crude throughput. We maintain our BUY rating given 32% potential upside to our
revised target price of `600 (`625 previously). Key downside risk stems from (1) higherthan-
expected crude price and (2) delay in implementation of diesel deregulation.





Government compensation boosts earnings
HPCL reported 2QFY11 EBITDA at `24.8 bn versus -`15.3 bn in 1QFY11 and `1.7 bn in 2QFY10;
our estimate was at -`6.1 bn. The stronger-than-expected performance was due to (1)
compensation of `28.3 bn from the government for 1HFY11 versus nil assumed by us and (2)
adventitious gains of `3 bn. This was partly nullified by (1) lower-than-expected throughput at 3
mn tons (-7.6% qoq and -24.4% yoy) versus our expected 3.3 mn tons and (2) lower-thanexpected
refining margins at US$2.7/bbl versus our expected US$3.2/bbl.

Refining margins and throughput lower qoq led by shutdowns
HPCL’s two refineries crude throughput was lower at 3 mn tons (-7.6% qoq and -24.4% yoy) in
2QFY11 led by planned maintenance shutdown for ~100 days. 2QFY11 refining margin was
US$2.7/bbl versus US$3.7/bbl in 1QFY11 and US$1.8/bbl in 2QFY10. The qoq decline in refining
margins despite increase in global benchmark refining margins reflects shutdown of refineries and
correction in gasoline cracks. 2QFY11 sales volumes (domestic) increased 3.4% yoy to 5.9 mn tons.

Crude near US$90/bbl is a cause of concern but hope for fundamentals to dictate over speculation
We highlight that the recent surge in crude oil prices has been driven by rise in speculative activity
following announcement of Fed’s QE2 program. In our view, short-term and medium-term
fundamentals of crude oil do not support current level of crude oil prices. There is ample OPEC
spare capacity, global inventories are comfortable and supply of alternative energy is rising sharply
in CY2011E. However, speculation and DXY may have an equally big bearing on crude prices.

Valuations remain compelling
We have revised our target price for HPCL to `600 (`625 previously) based on 10X FY2012E
adjusted EPS (9X previously) plus value of investments. We justify a higher multiple based on (1)
the market’s (14.8X FY2012E ‘EPS’) and peers’ higher valuations and (2) higher under-recoveries,
which results in more conservative earnings. We use a lower multiple for HPCL versus BPCL and
IOCL to reflect its higher risk to earnings from its higher leverage to deregulation of auto fuels.