Ramesh Damani few months back hinted at HPCL as a good contrarian buy in many of his chats .HPCL /BPCL are great companies but are being killed due to government policies but there is a thought that with recession looming over in America it will lead to Oil prices coming down .



Any takers for HPCL as a Contrarian Buy or  Graham Buy at this stage ?


Vivek  ,you are the best Graham follower here .Kindly do a Copy Book Graham Analysis on HPCL .


Edited by valueman - 18/Mar/2008 at 10:45am

I found the following analysis on HPCL from another blog and sharing the same .Others also pass their comments .I am yet to make an investment in HPCL and will do so when the market corrects still further down . Primarily my interest in HPCL is due to the dividend yield and no better opportunity but now to get a better yield .If external situation improves in its value unlocking them it is an added bonus .

http://valueinvestorindia.blogspot.com/2007/07/graham-idea-selling-below-replacement.html

July 19, 2007
Graham idea – Selling below replacement cost – HPCL

Statutory warning – A long post with links to other analysis.

I have analysed the oil & gas industry and specifically refineries earlier (see here). In addition an analyis of the industry is also posted on my spreadsheet.

The oil majors have not been a part of the current bull run and the main reason is the convoluted pricing and subsidy structure. As a result the sector is not doing too well and may have some opportunities.

I have developed an investment thesis for HPCL which is given below

About
HPCL is one of the Oil majors with almost 13MMT refining capacity. It is engaged in the business of refining crude and marketing end products. In addition it is also integrating backwards into E&P, lube marketing via its Lube SBU and into the Gas distribution business.

The problem
The Oil & gas business in india has one of the worst economics possible. The pricing though supposed to be decontrolled, is still controlled by the government. As a result in a rising crude price scenario, where other Oil majors across the world are minting money, companies like HPCL, BPCL, IOC etc have been bleeding.

The typical Gross refining margins for companies like RPL has been around 10 usd per barrel. A company like HPCL should easily be able to make 6-7 usd / barrel. However in the last 1-2 years the Gross margins have been 3-4 and net margins have been around 1 usd/ barrel.

The above is due to subsidized sales of products such as Petrol, diesel and kerosene etc Due to the above situation, O&G companies have been beaten down and now sell below replacement value of their asset.

The opportunity and investment thesis
HPCL now sells at around 9000 crores. The EV is around 10000-11000 crores at best.

The replacement cost for the assets of HPCL can be calculated as follows

1.Refinery – 13MMT ( greefields projects cost around 1200-1800 Crs/ MMT) – 19000 (approximate)
2.Petrol pumps / retail outlets – 7313 (average cost atleast 1 cr/ outlet – 7000 Crs (approximate)
3.LPG distributors – 2202, customers 2.28 crores - ??
4.Other gas assets such as pipeline – 2000 Crs + (1700 crs invested in last 5 years), avantika gas, Bhagyanagar gas etc.
5.Other assets – some value
6. JV’s – MRP (17%) – 1200 Crs and other JV’s

The above assets can conservatively be valued at 25000 – 30000 Crs. So the company sells at 25-30 % of the replacement value of its assets.

The above discount is definitely not an abberation. It is mainly due to policies of the government. However I think the gap is higher than it should be and the main reason is that the market is assuming that the current state of affairs would continue as is.

I don’t believe the government is going to change its ways, however I think the bottom line of company should improve due to the following reasons

1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.

Conclusion
Although there exists a substantial discount to the assets value and possible cash flows, the gap is not likely to close any time soon. However even if the market reduces the gap to 50-60% of asset value, the returns should be reasonable. In addition the company is selling at a 5 year low in terms of its PE and P/B ratio. The key triggers to watch would be crude prices and the level to which the government compensates for the underrecoveries.

[QUOTE=valueman]I found the following analysis on HPCL from another blog and sharing the same .Others also pass their comments .I am yet to make an investment in HPCL and will do so when the market corrects still further down . Primarily my interest in HPCL is due to the dividend yield and no better opportunity but now to get a better yield .If external situation improves in its value unlocking them it is an added bonus .

http://valueinvestorindia.blogspot.com/2007/07/graham-idea-selling-below-replacement.html

Hi valueman

Originally posted by Vivek Sukhani Hi value and Rohit,   A small piece of note, nothing connected with HPCL in particular. During these times, I believe one should ask himself a few questions before he takes a plunge:   1.Am I buying because its not likely to go down further....   2. What will I do in case it becomes 50 p.c. cheaper( price-wise) from here. Will I be cursing my luck or be happy to load it more.   Its a mistake to buy on the presumption of a stock is not likely to fall more from present levels. Markets have made a monkey of such value mongers.   However, if the answer to the question is that we will be happy to load it more, then one shall not mind buying at all. Its a buy at every level, and a bigger buy at lesser levels.   Just a random thought....nothing connected with HPCL directly.