Hindustan Oil Exploration Company: Oiling the pipeline - Buy

The stock of Hindustan Oil Exploration Company (HOEC) has more than doubled over the past year. Change in management and ownership, a turnaround plan that has been making good progress, wins in the recent discovered fields block auctions and other positive news have contributed to the rally. Despite the run-up, investors with a long-term perspective and high risk appetite can buy the stock.

At ₹78, the stock trades at 37 times its 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.

But now, with good scope for revival and strong earnings growth, valuations should moderate and the stock can have good upside. That said, the stock is suitable only for those with an appetite for risk; exposures can be limited. One, HOEC is a micro-cap stock with just about ₹1,000 crore market capitalisation. Also, the oil and gas exploration business is inherently risky, with a propensity to throw up negative surprises.

The immediate growth trigger for HOEC is the expected gas production from the Dirok field in Assam in which the company has 27 per cent stake and is the operator. The partners in the field are public sector majors Indian Oil and Oil India. Work on four wells, pipeline and gas gathering station has been completed and tested. Phase I of production and commercial sales was to commence by March end, but this has got delayed as Oil India is awaiting the Petroleum Mining Lease from the Assam government. This is expected by May 2017 after which HOEC expects production of 10 million cubic feet per day during the first quarter of this financial year (2017-18). This is expected to further rise to 25 million cubic feet per day by the end of the second quarter, aided by additional wells and a larger pipeline. Oil India will be buying the gas at the formula-linked price being notified by the government every six months.

While this means a low $2.48 per mmbtu (latest notified price for April to September 2017), HOEC should still be able to make good profit given its low operating cost for the field at about $0.5 per mmbtu. Along with the gas, the company also expects to produce about 100 barrels of condensate per day which should fetch the price of Brent oil. Cash flows from the Assam field should help HOEC monetise its other assets too.

The company has also won the rights to develop two discovered, marginal fields in the auction conducted by the government last year. Being discovered fields, risks are reduced significantly.

Also, output from these fields is eligible for market-linked pricing. One of these, the Kherem onshore field in Arunachal Pradesh, is quite close to the company’s Dirok field in Assam.

The company expects to monetise the Kherem field (in which Oil India is an equal partner) soon with a small investment. The other bigger asset, the B-80 offshore field near Mumbai, could take a couple of years to monetise but holds higher potential.

HOEC is also awaiting approval to start work on its PY-3 oil field off the Puducherry coast in the Bay of Bengal.

The company has 21 per cent stake in the field, which has been shut since 2011.

Re-opening the field could mean an output of about 3,000 barrels of oil a day.

The other asset in the Bay of Bengal, the PY-1 gas field, currently produces negligible gas due to technical issues, but could see a turnaround in fortunes if connected to the PY-3 field.

HOEC has a debt-free balance sheet which should help fund development plans. During the nine months ended December 2016, its revenue fell about 24 per cent to ₹17 crore, but aided by one-off incomes, profit rose to ₹27 crore from ₹5 crore in the year-ago period.

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