stock info gearing to leverage domestic growth in...

September 2016 1

12th Annual Global Investor Conference

Harshad Borawake ([email protected]); +91 22 6129 1529 Abhinil Dahiwale ([email protected]); +91 22 3980 4309 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.

BSE Sensex S&P CNX 29,045 8,953

Stock Info Bloomberg HPCL IN Equity Shares (m) 339 52-Week Range (INR) 1,329/636 1,6,12 Rel. Perf. (%) -8/55/49M.Cap. (INR b) 424.4M.Cap. (USD b) 6.4 12M Avg Val (INR M) 1,196 Free float (%) 48.9

Financial Snapshot (INR b) Y/E Mar 2016 2017E 2018E Sales 1,793 1,833 1,914 EBITDA 76.2 88.8 93.9 Adj. PAT 38.6 45.2 48.1 Adj.EPS (INR) 113.9 133.4 142.0 EPS Gr. (%) 41.3 17.1 6.4 BV/Sh.(INR) 546.2 632.8 725.0 RoE (%) 22.4 22.6 20.9 RoCE (%) 11.4 12.0 11.4 Payout (%) 35.4 35.1 35.1 Valuations P/E (x) 11.0 9.4 8.8 P/BV (x) 2.3 2.0 1.7 EV/EBITDA x) 6.6 5.6 5.4 Div. Yield (%) 2.8 3.2 3.4

Relative to Index

Gearing to leverage domestic growth in deregulated era Takeaways from CEO track

We hosted Mr. M K Surana, CMD of HPCL, at our 12th AGIC in Mumbai. Following are the key takeaways from his presentation.

India’s petroleum consumption on strong footing, although mix could change India’s domestic petroleum consumption growth will be 4-5x the world average,

and is expected to grow at ~5% over the coming decade. However, the mix is expected to change in favor of gas (current share at ~7% v/s world average of ~24%) and clean energy sources.

Indian petroleum consumption will be supported by (a) rising affluence andurbanization, (b) massive potential in end-market growth, (c) young, vibrant and upwardly mobile working class and (d) stable and pro-development government.

Supportive macroeconomic trends that will drive energy demand and mixinclude: (a) improving GDP – more freight movement, (b) increasing disposable income, (c) thrust on clean energy sources and (d) demographic change with a higher share of working age population.

62% refining capacity addition required; government policy supportive India’s refining capacity stands at 230mmt and net of exports capacity at

203mmt. With the expected consumption growth, India will need at least130mmt of additional refining capacity over the next 10-15 years.

Government policy has been supportive with auto fuel (petro land diesel)deregulation and LPG DBTL (direct benefit transfer). Further, the government istrying to implement DBTL for PDS kerosene with pilot projects alreadyunderway.

OMCs’ balance sheet and return ratios strengthened post diesel deregulation asit lowered their debt and offered retail petroleum pricing freedom.

HPCL well placed; focus on capacity addition and efficiency improvement HPCL is targeting 85% product self-sufficiency (refining/marketing volume ratio)

in the long term, as against ~50% currently (~63% with Bhatinda JV share),through refinery capacity addition in its own and JV refineries.

Mr. Mukesh Kumar Surana Chairman & Managing Director Hindustan Petroleum Corporation

CEO TRACK

Company update | Sector: Oil & Gas

HPCL

CMP: INR1,252 TP: INR1,490 (+19%) Buy

HPCL

September 2016 2


HPCL has started dynamic pricing (based on location, demand and competition)for auto fuels, which should help the company to sweat marketing assets betterand improve profitability.

HPCL plans capex of INR558b over FY16-21, which includes ~INR257b forrefineries, ~INR262b for marketing, and the remaining for renewables, R&D andJV projects.

Refinery capex of INR257b includes INR42b for Euro VI upgradation and forbrownfield expansions (a) at Vizag from 8.3 to 15mmt (~INR208b) along with up-gradation, (b) at Mumbai from 6.5 to 9.5mmt (INR42b) and (c) at JV Bhatindarefinery from 9 to 11.3mt (INR24b).

Expects overall GRM to improve ~USD1.5-2/bbl. (a) Vizag to complete by April2020 and expand GRM by USD4-5/bbl, (b) Mumbai to complete in three yearsand expand GRM by USD1-1.5/bbl and (c) Bhatinda by Jun-17.

Exhibit 1: 4 key macro-economic trends will drive energy demand and mix

Source: Company, MOSL

HPCL

September 2016 3


Exhibit 2: Factors influencing the Indian petroleum industry


HPCL has 2nd largest product pipeline network


HPCL

September 2016 4


Exhibit 3: HPCL’s on-going Projects Projects Details

LPG pipelines 356 km Mangalore – Hassan – Mysore – Bengaluru LPG Pipeline (3.1 MMTPA) 168 km Uran –Chakan LPG pipeline (1.0 MMTPA)

POL Depots Revamp at Jabalpur Depot (Madhya Pradesh) and Loni Terminal (Maharashtra), Nalagarh Depot (Himachal Pradesh).

LPG Plants New LPG Plants at Bhopal (Madhya Pradesh) Karimnagar (Telangana) and at Panagarh (West Bengal).


Exhibit 4: Planned Projects Type Projects Details

Expansion of Refineries

Mumbai Refinery

− Expansion of capacity from 6.5 MMTPA to 9.5 MMTPA − Salient features:

• Euro VI compliant Petrol & Diesel• Propylene Manufacturing facilities• Estimated Capex of INR42b

Visakh Refinery

− Expansion of capacity from 8.3 MMTPA to 15 MMTPA − Salient features:

• Residue up-gradation• Euro VI compliant Petrol & Diesel• Estimated Capex of INR208b

New POL Pipeline Projects

Mundra-Delhi (MDPL Phase II)

− Extension from Palanpur to Vadodara with a new green field marketing terminal near Vadodara

− Approx. Cost : INR19b

Visakh Vijayawada Secunderabad Pipeline (VVSPL Phase II)

− Capacity expansion from 5.38 MMTPA to 8 MMTPA for evacuation post Visakh Refinery Expansion

− Extension of VVSPL from Vijayawada to Dharmapuri in Tamilnadu (628 Km) with a new green field terminal at Dharmapuri

− Approx. Cost : INR30b

New Marketing Projects

LPG Plants − Haldia (West Bengal) Varanasi (UP) and Sagauli (Bihar)

POL Depots − Bilaspur (Chhattisgarh), Leh ( J&K) and Revamp at Meerut ( UP)

Lube Blending Plants − Lube Blending Plants at Mumbai (Maharashtra) & Kasna (UP) Source: Company, MOSL

HPCL

September 2016 5


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


Exhibit 6: Industry level gross under recoveries have come down sharply; LPG shifted to DBTL (INRb)

Source: PPAC, Industry, MoPNG

- - - - - - - - - - - - - - - - - - - - -

299

92 187 241 290 236 207 182

105 186 185 152 90 26 (7) - - - - - -

66

60

73 78

73 71 77 75

64 75 85 82

75 73 64 36 39 32 29 16 24

70

63

65 87

115 70 110 105

85

93 127 159 121

125 103

17 49 40 33 40 28

436

215

325 406

478

378 393 362

254

354 398 393

287 224

159

53 87 72 61 55 52

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q

FY12 FY13 FY14 FY15 FY16 FY17

Petrol Diesel PDS Kerosene Domestic LPG TotalGross under recoveries HPCL + BPCL + IOCL (INRb)

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

HPCL

September 2016 6


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-upby 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 andin turn their profit normalization had been derailed for a decade after an earlierbrief de-regulation period in 2004-06. However, this time around we believegovernment will stay put with its deregulation decision given the hard lessons offinancial stress of last decade. Increased excise duties offer some flexibility tomoderate prices in event of spike in oil prices, but huge and growing Indiaconsumption volumes will make it practically impossible to again revisit theprice control model.

Marketing division to drive profitability: Post de-regulation, we expectmarketing division profitability to grow rapidly, hence should also command ahigher valuation. An INR0.5/ltr increase in petrol and diesel marketing marginsincreases HPCL’s FY18E EPS by 22%. We model gross per liter diesel margin ofINR1.6/230 in FY17/FY18.

Pure play marketing companies trade at higher valuations: Pure playpetroleum marketing companies - US based CST Brands (CST US; M Cap:USD3.6b) and New Zealand based Z Energy (ZEL NZ; M Cap: USD2b) trade at>10x EV/EBITDA. These valuations (in-line with the underlying businessdynamics) are more similar to consumer business than refining or oil & gas.

We value HPCL (on FY18E) at 5x for refining and 7.5x for marketing to arrive at afair value of INR1,490 implying a 19% upside. HPCL trades at 8.8x FY18Estandalone EPS and 7x FY18E consolidated EPS of INR175. Maintain Buy.

Exhibit 7: HPCL – Key Assumptions FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E

Exchange Rate (INR/USD) 45.8 47.5 45.7 47.9 54.5 60.6 61.1 65.5 68.0 70.0 Brent Crude (USD/bbl) 84.8 69.6 86.5 114.5 110.6 107.8 86.0 47.6 50.0 55.0 Market Sales (MMT) 25.4 26.3 27.0 29.5 30.3 31.0 32.0 34.2 36.1 38.1

YoY (%) 3.8% 3.5% 2.9% 9.1% 2.8% 2.1% 3.2% 7.1% 5.5% 5.5% GRM (USD/bbl)

HPCL Blended GRM 5.17 2.97 4.47 5.20 2.08 3.43 2.84 6.67 5.25 6.00 Reuters Singapore GRM 5.75 3.55 5.18 8.17 7.70 5.62 6.36 7.49 5.50 6.50 Prem/(disc) (0.58) (0.58) (0.70) (2.96) (5.62) (2.19) (3.52) (0.82) (0.25) (0.50)

Refining capacity utilization (%) 118% 116% 106% 99% 98% 95% 101% 106% 110% 110% Total Refinery throughput (MMT) 16.5 16.3 15.8 16.1 15.8 15.4 16.4 17.2 17.9 17.9

YoY (%) -1.5% -1.5% -3.1% 1.9% -1.4% -2.6% 6.3% 5.1% 3.8% 0.0% Pipeline throughput (mmt) 10.6 12.0 13.0 13.6 13.8 15.7 14.9 14.9 14.9 14.9 Net subsidy sharing (0.0) 12.3 15.1 0.1 2.3 4.8 5.0 0.1 - - Net sharing (%) 0% 12% 9% 0% 1% 1% 3% 0% 0% 0%


HPCL

September 2016 7


Story in charts

Exhibit 8: HPCL’s GRMs have underperformed Singapore GRM (USD/bbl)


Exhibit 9: While refining capacity has been largely flat, marketing sales have shown steady increase


Exhibit 10: Expect EBITDA to be driven up higher marketing margins


Exhibit 11: Expect D/E ratio to decline with increasing profitability (x)


Exhibit 12: Diesel deregulation to reduce working capital leading to lower interest costs


Exhibit 13: HPCL: 1 Year Forward P/E Chart


(0.6) (0.7) (3.0)

(5.6) (2.2) (3.5)

(0.8) (0.3) (0.5) 3.0

4.5 5.2

2.1 3.4 2.8

6.7 5.3 6.0

3.6 5.2

8.2 7.7 5.6 6.4 7.5

5.5 6.5

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E

Prem/(Disc) to Singapore HPCL Blended GRMSingapore GRM

26 27 29 30 31 32

34 36

38

17 16 16 16 16 15 16 17 18


Marketing Sales (mmt) Refinery Throughput (mmt)

25 33 34 39

52 54

76 89 94

13 15 9

9 17 27

39 45 48


EBITDA (INRb) PAT (INRb)

1.8 2.0

2.3 2.4 2.1

1.1 0.8 0.8 0.7

FY10 FY12 FY14 FY16 FY18E

D/E Ratio

213 250 298 325 319 171 145 177 177

9 9

17 18

15

7 6 6 7


Total Debt (INRb) Interest Cost (INRb)

9.2

24.6

9.1

2.6 2

7

12

17

22

27

Aug-

06

Nov

-07

Feb-

09

May

-10

Aug-

11

Nov

-12

Feb-

14

May

-15

Aug-

16

PE (x) Peak(x) Avg(x) Min(x)

HPCL

September 2016 8


Financials and Valuations

Income Statement (INR Million) Y/E March 2012 2013 2014 2015 2016 2017E 2018E Net Sales 1,781,392 2,065,293 2,231,454 2,063,804 1,792,811 1,832,519 1,914,292 Finished Goods 1,093,707 1,281,786 1,451,380 1,292,784 1,159,484 1,222,719 1,221,824 Raw Materials Cons 561,189 639,921 613,881 599,079 407,012 438,524 526,373 Employee cost 15,831 25,256 20,303 24,147 23,145 26,617 32,739 Other Exp 76,583 78,907 93,809 93,618 127,001 55,832 39,506 EBITDA 34,082 39,424 52,081 54,176 76,168 88,828 93,850

% of Net Sales 1.9 1.9 2.3 2.6 4.2 4.8 4.9 Depreciation 17,129 19,315 21,884 19,712 26,668 28,346 30,894 Interest 16,977 18,377 15,046 7,066 6,401 6,316 6,738 Other Income 12,222 12,300 11,004 14,142 14,282 13,764 15,614 Extraordinary Items (net) -5 714 0 0 0 0 PBT 12,192 14,746 26,155 41,541 57,381 67,930 71,831 Tax 3,077 5,699 8,817 14,209 18,753 22,694 23,704

Total Rate (%) 25.2 38.6 33.7 34.2 32.7 33.4 33.0 PAT 9,115 9,047 17,338 27,333 38,627 45,235 48,127 Adjusted PAT 9,115 9,047 17,338 27,333 38,627 45,235 48,127

% of Net Sales 0.5 0.4 0.8 1.3 2.2 2.5 2.5 Change (%) -40.8 -0.7 91.6 57.6 41.3 17.1 6.4

Balance Sheet (INR Million) Y/E March 2012 2013 2014 2015 2016 2017E 2018E Share Capital 3,390 3,390 3,390 3,390 3,390 3,390 3,390 Reserves 127,835 133,874 146,732 156,831 181,775 211,145 242,376 Net Worth 131,225 137,264 150,122 160,221 185,165 214,535 245,766 Loans 298,312 324,583 319,301 170,556 145,220 177,320 177,320 Deferred Tax 30,853 35,984 39,084 41,036 48,105 51,745 58,929 Capital Employed 460,390 497,830 508,506 371,813 378,490 443,601 482,015

Gross Fixed Assets 334,590 370,062 424,668 481,749 541,493 615,493 645,493 Less: Depreciation 126,094 144,575 165,545 191,121 217,789 246,135 277,029 Net Fixed Assets 208,496 225,487 259,122 290,628 323,705 369,358 368,464 Capital WIP 44,445 51,729 45,856 34,744 30,000 8,000 58,000 Investments 103,705 106,269 108,598 112,415 109,947 115,694 115,694 Curr. Assets, L & Adv. 354,427 378,962 362,204 237,719 241,865 286,035 283,076 Inventory 194,545 164,387 187,754 129,723 127,091 136,524 140,354 Debtors 35,652 49,350 54,660 36,031 42,296 43,232 45,162 Cash & Bank Balance 2,264 1,471 347 171 1,483 42,584 33,865 Loans & Advances 116,484 160,008 114,693 67,364 67,364 60,064 60,064 Other Current Assets 5,483 3,745 4,750 4,432 3,632 3,632 3,632 Current Liab. & Prov. 250,683 264,617 267,275 303,693 327,027 335,487 343,220 Liabilities 230,847 241,622 243,978 273,903 305,459 311,763 317,123 Provisions 19,836 22,995 23,296 29,790 21,568 23,725 26,097 Net Current Assets 103,744 114,345 94,930 -65,974 -85,162 -49,452 -60,144Application of Funds 460,390 497,830 508,506 371,813 378,490 443,601 482,015 E: MOSL Estimates

HPCL

September 2016 9


Financials and Valuations

Ratios Y/E March 2012 2013 2014 2015 2016 2017E 2018E Basic (INR) EPS 26.9 26.7 51.1 80.6 113.9 133.4 142.0 Cash EPS 77.4 83.7 115.7 138.8 192.6 217.0 233.1 Book Value 387.1 404.9 442.8 472.6 546.2 632.8 725.0 DPS 8.5 8.5 15.5 24.5 34.5 40.0 42.6 Payout (incl. Div. Tax.) 37.0 37.3 35.5 35.6 35.4 35.1 35.1 Valuation (x) P/E 46.6 46.9 24.5 15.5 11.0 9.4 8.8 Cash P/E 16.2 15.0 10.8 9.0 6.5 5.8 5.4 EV / EBITDA 19.0 17.2 12.9 9.7 6.6 5.6 5.4 EV / Sales 0.4 0.3 0.3 0.3 0.3 0.3 0.3 Price / Book Value 3.2 3.1 2.8 2.6 2.3 2.0 1.7 Dividend Yield (%) 0.7 1.2 2.0 2.8 3.2 3.4 Profitability Ratios (%) RoE 7.1 6.7 12.1 17.6 22.4 22.6 20.9 RoCE 5.0 4.2 5.4 7.3 11.4 12.0 11.4 RoIC 4.5 3.8 5.8 7.8 14.4 15.7 15.3 Turnover Ratios Debtors (No. of Days) 6.4 7.5 8.5 8.0 8.0 8.5 8.4 Asset Turnover (x) 5.6 5.9 5.6 4.6 3.5 3.2 3.0 Leverage Ratio Debt / Equity (x) 2.3 2.4 2.1 1.1 0.8 0.8 0.7

Cash Flow Statement (INR Million) Y/E March 2012 2013 2014 2015 2016 2017E 2018E OP/(Loss) before Tax 12,192 14,746 26,155 41,541 57,381 67,930 71,831 Depreciation 17,129 19,344 21,884 19,712 26,668 28,346 30,894 Other op -5,407 -10,771 -1,556 -6,772 -5,536 -7,711 -9,006Interest Paid 21,392 20,193 13,364 7,066 6,401 6,316 6,738 Direct Taxes Paid -2,715 -1,072 -3,668 -7,622 -11,685 -19,053 -16,521(Inc)/Dec in Wkg. Capital -27,301 -30,945 21,121 124,486 20,500 5,391 1,973 CF from Op. Activity 15,291 11,496 77,301 178,411 93,729 81,218 85,910 (Inc)/Dec in FA & CWIP -41,359 -36,807 -41,358 -41,762 -55,000 -52,000 -80,000Free Cash Flow -26,068 -25,312 35,943 136,649 38,729 29,218 5,910 (Pur)/Sale of Investments 6,378 -2,404 -1,297 4,161 2,468 -5,748 0 Inc from Invst 6,345 5,505 4,906 4,688 5,536 7,711 9,006 CF from Inv. Activity -28,636 -33,706 -37,748 -32,913 -46,996 -50,037 -70,994Inc / (Dec) in Debt 37,919 37,072 -25,648 -123,807 -25,336 32,100 0 Interest paid & other Inv -14,836 -22,187 -17,045 -7,647 -6,401 -6,316 -6,738Dividends Paid -5,509 -3,344 -3,367 -6,136 -13,684 -15,865 -16,896CF from Fin. Activity 17,574 11,540 -46,060 -137,590 -45,421 9,919 -23,634Inc / ( Dec) in Cash 4,229 -10,670 -6,507 7,908 1,312 41,101 -8,718Add: Op. Balance 800 2,264 1,471 347 171 1,483 42,584 Bank Balance Adj. -2,766 9,877 5,383 -8,084 0 0 0 Closing Balance 2,264 1,471 347 171 1,483 42,584 33,865 E:MOSL Estimates

HPCL

September 2016 10


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