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Hindustan Petroleum Corporation (HPCL)
Action
Since its recent peak in mid-September, HPCL has underperformed the Sensex by
25%. Hopes of reforms have taken a backseat again, with plans for diesel now on
the backburner. Given inflation worries, a near-term price hike looks unlikely. The
entire subsidy-sharing mechanism remains ad hoc. Firming up oil prices are likely
to derail any plan for reforms, in our view. REDUCE reiterated.
Catalysts
Tightening fundamentals, weakening US dollar, potentially higher inflation
expectations and abundant money supply will likely all lead to higher oil prices.
Anchor themes
We believe the oil price will strengthen further, driven by QE2 and improving
fundamentals, thus further dashing hopes of de-regulation/reforms. We continue to
believe that for OMCs to emerge as a long-term investment idea, concrete and
transparent policies on the subsidy-sharing mechanism are a must.
Deflating hopes
Markets getting sceptical on deregulation/reforms
Since reaching its recent peak in mid-September, HPCL has
underperformed the Sensex by some 25%. Hopes of deregulation/
reforms have been dashed in recent months, as the government
decided to put the diesel de-regulation issue on the backburner, and
has yet to provide clarity on the sharing mechanism for the current
fiscal year and going forward. The stock’s underperformance
suggests to us that the market is starting to doubt the deregulation/
reform story. Even with its recent underperformance, we believe the
stock is factoring in too much hope of deregulation and reforms.
Higher oil prices could play spoilsport
We maintain our bullish view on oil prices and believe that oil prices
could reach US$100/bbl in the coming year. Higher oil prices mean
higher under-recoveries (unless the retail price increases, which we
think is unlikely) and more pain for the oil marketing companies. We
estimate that at our oil price assumption of US$100/bbl, underrecovery
size increases to US$20bn in FY12, far higher than the
actual US$10bn in FY10 and our estimate of US$15bn for FY11.
Difficult to be positive — REDUCE reaffirmed
We believe that both price-setting and the subsidy-sharing
mechanism remain ad-hoc and non-transparent. Post the June price
hike, subsidy amounts are lower but remain very large, and
forecasting earnings (or losses) is still difficult, in our opinion.
Although hopes remain in some quarters that there will be some sort
of reform before the planned FPOs of ONGC and IOC, we remain
circumspect. We continue to believe that for OMCs to re-emerge as
long-term investment ideas, further clarity is needed on future steps
towards de-regulation, as well as the sharing mechanism. REDUCE
maintained.
Valuation methodology
Our 12-month price target of INR270 is based on a 0.8x P/BV multiple applied to our
estimate of FY12F book value per share.
Risks
The key upside valuation risk is a significant change in government policy on fixing
retail prices. We believe complete deregulation would be a big positive in the long term
and could lead to a rerating of the stock. Even partial deregulation, but with a clear
policy on sharing of any under-recoveries, would be positive for HPCL, in our view. A
significant and sustained decline in global oil prices would also be positive, as losses
on retail fuels decline sharply at low oil prices. Also, refining margins that are higher
than our estimates would be a positive for HPCL.
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