HOEC: Priming the pipeline

The Dirok asset seems set to increase output significantly within a year. Other assets hold promise too

Since end-August, the stock of Hindustan Oil Exploration Company (HOEC) has gained more than 50 per cent. The trigger for the rally was the grant of the Petroleum Mining Lease to the Dirok field in Assam, from where HOEC began commercial production in late August.

HOEC has 27 per cent stake and is the operator of the field; the partners are public sector majors Indian Oil and Oil India. Phase 1 of production and commercial sales from the Dirok field was to commence by March end, but this was delayed as the Petroleum Mining Lease was awaited from the Assam government.

From our buy recommendation in April, the HOEC stock gained about 45 per cent. Despite the rally, investors with a long-term perspective and high-risk appetite can buy the HOEC stock. Over the past two years, the stock has tripled and, at ₹112 now, trades at about 66 times the trailing 12-month earnings.

This is seemingly steep, but historical valuation is not a good measure for stocks of companies in revival mode; the average valuation of the HOEC stock has been in triple digits over the past three years. That’s primarily because the company was more or less grounded for a long time and its earnings were moribund.

Positive changes

The stock meanwhile began heading North thanks to a change in management and ownership in early 2015, a turnaround plan that was making good progress and other positive news such as wins in the discovered field auctions. The momentum has revived since start of production in the Dirok field and there seems to be good upside in the stock even now. From April 2018, HOEC plans to increase production at Dirok by nearly four times from current levels. This should lead to a sharp jump in earnings in FY 2018-19 and the stock’s valuation should moderate.

Also, HOEC has made plans to boost the currently small output from its PY-1 gas field (100 per cent stake) off the Puducherry Coast; this is also expected to start reflecting in earnings from the next fiscal. Besides, the B-80 offshore field (50 per cent stake) near Mumbai seems to have high potential and could add to HOEC’s earnings in the medium to long-term. That said, the stock is suitable only for those with a risk appetite — exposures can be limited. HOEC is a micro-cap stock with market cap of less than ₹1,500 crore. Besides, oil and gas exploration is inherently risky, with a propensity for negative surprises, regulatory troubles and delays.

Dirok drive

From about 8 million cubic feet of gas and 80 barrels of condensate per day currently, HOEC plans to increase output in the Dirok field to about 36 million cubic feet of gas and 1,000 barrels of condensate per day in April 2018. All six wells are expected to be hooked up and the 12-inch pipeline linked to the modular gas processing plant that should be ready by March next year. Currently, though the three wells hooked up can produce more, output is constrained by the 4-inch pipeline.

Oil India will be buying the gas at the formula-linked price notified by the government every six months. For the October 2017 to March 2018 period, the gas price has been increased to $2.89 per mmbtu from $2.48 per mmbtu in April-September 2017. While the revised price is also low, HOEC still expects to make tidy profit given that its operating cost for the field is just about $0.6 per mmbtu, thanks to its low-cost, fast-track development model. The condensate produce will fetch a Brent equivalent price.

HOEC expects profit of about ₹100 crore a year from the Dirok field from FY 2019 onwards, from about ₹10 crore annualised currently; the company expects significant operating leverage from its fixed operating cost model whereby it has outsourced operation and maintenance of the modular gas processing plant to a UK-based company Expro. Output and earnings could go up further if the company is able to prove higher recoverable reserves, improve the recovery factor and drill more wells — plans that are on the anvil.

Other high-potential assets

HOEC is also betting big on its offshore assets PY-1 near Puducherry and B-80 near Mumbai. Currently, the PY-1 asset, a challenging but high-potential asset, is generating just about 2.5 million cubic feet of gas per day. Through a two-well intervention campaign, the company hopes to increase production to about 10 million cubic feet per day, a four-fold rise.

This work is expected to be completed by the second quarter of FY 2019 and will likely add ₹75 crore a year to the company’s earnings.

The B-80 offshore field is another high-potential asset that could start contributing about ₹100 crore a year to HOEC’s bottom-line from FY 2021, if things go by plan. Until now, one-off income such as tax refunds and some revenue from PY1 mostly contributed to the company’s profit; this is set to change with the one-off incomes tapering sharply and significant operating revenue, primarily from the Dirok asset, coming in.

In the half-year ended September 2017, the company posted revenue from operations of about ₹12 crore and profit of ₹8.5 crore, compared with revenue of ₹11.5 crore and profit of ₹22 crore in the year-ago period. The chunk of the profit in the year-ago period was from exceptional items.

Strong balance sheet

HOEC has a debt-free balance sheet and expects to keep it this way by funding capital expenditure through cash and equivalents (about ₹150 crore currently) and earnings from Dirok. The company is also open to inorganic expansion in the future and could go for debt or mezzanine capital to fund such opportunities.

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