Hindustan Petroleum – Back to square on: RBS

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 Hindustan Petroleum – Back to square on


HPCL's shares have corrected sharply as deregulation expectations have now receded following
the sharp rise in global oil prices. We maintain our view that policy status quo will continue,
providing 11-12% ROE for HPCL. Our target price is unchanged at Rs370, resulting in the stock
being upgraded from Sell to Hold.
Rising oil prices have put off earlier positive expectations
Earlier market expectations of auto fuel deregulation and full compensation for cooking fuel
under-recovery have been put off as global oil prices have risen by nearly US$20/bbl in the last
three months. Even petrol, which was ‘deregulated’, is suffering under-recoveries, and prospects
for price hike in other retail regulated products (diesel, LPG, kerosene) are looking dim due to
renewed inflation concerns. The Indian government (GOI)’s estimate of under-recoveries in FY11
has risen from Rs520bn to over Rs700bn in the last three months, raising concerns about
adequate compensation for the oil marketing companies (OMCs) like HPCL.
No change to earnings estimates
We have believed that earlier market expectations would be difficult to achieve, given our view of
rising oil prices (albeit prices have risen far sharper than we expected) – see our report, OMCs:
Challenges to overcome, dated 8 October 2010. Our estimates assume status quo, ie, some
price hikes, no deregulation, under-recoveries on retail products to continue and GOI
compensation pegged at levels that ensure ROE for HPCL (standalone) at 11-12% on an ongoing
basis. Given this assumption, we maintain our earnings estimates, even though oil prices and
resultant gross under-recoveries are likely to end up higher than we were expecting.
Upgrade following stock correction
Our target price is unchanged at Rs370 (1x FY11F P/B). Post correction, the stock price has
come in line with our target price and hence we upgrade the stock from Sell to Hold. Most of the
bad news appears reflected in the stock price, although that investors would need to wait
patiently for the difficult-to-predict positive news flow to emerge (any drop in global oil prices
and/or the next round of domestic price hikes)