The stocks of public sector oil refiners and marketers have been quite volatile since January this year. An iffy market coupled with a rally of crude oil from its lows saw these stocks take a beating until February end. But they have recouped much of the lost ground since then, thanks to improved market sentiment after the budget, an impressive December 2015 report card and positive management commentary.

Robust growth Despite the comeback, these stocks still provide good buying opportunities. For one, valuations are not demanding. The stock of HPCL, for instance, trades at about six times its trailing 12-month earnings, lower than its five-year average of about nine times. Even after the strong run-up over the past couple of years, the stock is not pricey because the company’s earnings have grown rapidly. This is thanks to the fuel pricing reforms which have slashed its under-recovery burden, reduced dependence on debt and cut interest costs. The oil refiners are currently being fully compensated for the under-recoveries they incur.

A favourable refining market environment also helped. HPCL’s profit grew more than 50 per cent Y-o-Y in 2014-15 and quadrupled in the nine months ended December 2015 to ₹2,310 crore. The company’s gross refining margin — the difference between the price of its product slate and the cost of crude oil — increased to $6.35 a barrel during the nine months ended December 2015 from $1.04 a barrel in the year ago period. With debt levels on the decline due to lower requirement of working capital borrowing, interest cost fell 19 per cent Y-o-Y.

Next, the company’s prospects seem healthy. Given the global demand-supply dynamics, even if it goes up further, it seems unlikely that crude oil price would shoot beyond the $60-$70 range. This should keep the under-recoveries of the public sector oil marketing companies, including HPCL, under control; the government will also be comfortable continuing with its key fuel pricing reforms, such as diesel decontrol and pruning of LPG subsidy, implemented over the past few years. Besides, fuel losses on refining should stay subdued.

Also, favourable refining market dynamics should continue to aid HPCL’s margins. That said, the business is cyclical, going through peaks and troughs over the long term. What will help the company in lean patches are an enabling pricing environment, and the significant planned capacity expansion that should aid volume growth in the coming years. Decontrolled diesel price allows the oil marketing companies to earn higher margins on marketing the fuel. And HPCL with a higher marketing-to-refining ratio than peers, Indian Oil and BPCL, is better placed on this front.

Big capex plan The company has lined up ambitious expansion and upgradation plans with an estimated capital expenditure of about ₹ 45,000 crore until FY-20. These include increasing the capacity of the Visakhapatnam refinery from 8.3 million tonnes per annum (mtpa) to 15 mtpa, of the Mumbai refinery from 6.5 mtpa to 9.5 mtpa, and of the Bhatinda refinery (49 per cent joint venture with Mittal Energy) from 9 mtpa to 11.5 mtpa.

The initiatives should give a leg-up to not only volumes but also margins by improving the company’s refinery complexity and distillate yields.

HPCL also plans to participate in a joint venture to set up a 5 mtpa LNG terminal at Chhara in Gujarat. Over the past few years, HPCL has improved its market share in fuel retailing and lubricants. The big capacity expansions over the next few years should help this continue.

With debt-to-equity at a little over one time as of December 2015, the company is well-positioned to fund its expansion plans. Interest cover ratio was a healthy 12 times in the six months ended September 2015.

In the short term (FY-16), the Bhatinda refinery is expected to turn profitable; this should give a boost to HPCL’s bottom-line. The company’s current dividend yield is a healthy 3 per cent.

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