After a strong run through much of 2016, the stock of public sector oil marketing company HPCL has slipped about 13 per cent since November.

First, the market volatility induced by the demonetisation move and Trump’s victory in the US took a toll. Next, the rally in oil prices due to the output cut deal by major producers stoked fears of rise in under-recoveries and interest outgo of PSU oil marketers. Also, there were worries that these companies’ profits could be impacted due to the 0.75 per cent discount on digital payments for petrol and diesel purchases announced by the government.

The concerns seem overdone, though, and the stock’s fall presents a good buying opportunity for investors with a long-term perspective.

At ₹441, the HPCL stock trades at about 8 times its trailing 12-month earnings, a tad above its five-year average and lower than what peers BPCL and Indian Oil quote at (10-11 times).

Despite its run-up over the past few years, the stock is not pricey because HPCL’s earnings have grown rapidly — consolidated profit rose nearly 38 per cent y-o-y in 2014-15 and more than tripled in 2015-16. This was thanks to fuel pricing reforms that slashed the company’s under-recovery burden, reduced its dependence on debt and cut interest costs.

Standalone profit more than doubled in the half-year ended September 2016. The Bathinda refinery, expected to turn profitable in the near term, should add to the bottom line. The company’s prospects over the long term seem sanguine.

One, petro-product consumption in India is likely to continue growing at a healthy pace with economic growth and given the largely essential nature of the commodities. Besides, the discounts on digital payments for fuel will reportedly be borne by the government, not the oil companies. Next, oil prices should be capped around $60 a barrel range (currently about $55 a barrel) thanks to global demand-supply dynamics. This should be a comfortable level for the government not to backtrack on its key reforms — petrol and diesel price decontrol, restriction of LPG subsidy and gradual hikes in kerosene price — that have vastly improved the fortunes of the PSU oil marketers.

Under-recoveries that the oil marketers incur on LPG and kerosene should stay under control, and in any case are getting compensated by the government and the upstream companies ONGC and Oil India. The increase in interest cost of the oil marketers due to the higher working capital requirement is unlikely to be significant.

Demand growth

More than oil price fluctuations, what matters for oil marketers is refining margins — the difference between the price of final petro-products and the cost of crude oil. For the half-year ended September 2016, HPCL’s gross refining margin was $5.12 a barrel, a bit lower than $5.45 a barrel in the year-ago period.

After weakness in the September quarter, refining margins have been improving in recent months. Also, higher oil prices should translate into inventory gains for the oil companies in the near-term.

Over the long run, an enabling fuel pricing regime, healthy demand potential in the country and capacity expansion should benefit HPCL. Besides, petrol and diesel decontrol has helped the oil marketers improve their marketing margins; HPCL is better placed than peers on this front, thanks to its higher marketing-to-refining ratio.

HPCL has grown its market share in fuel retailing over the past few years, and capacity expansions should help it retain and improve its position.

Major expansion

The company has lined up major expansion plans with estimated capital expenditure of about ₹45,000 crore until 2019-20. 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 Bathinda refinery (49 per cent joint venture with Mittal Energy) from 9 mtpa to 11.5 mtpa. Besides volume growth, this should aid margin expansion by improving refineries’ complexity. HPCL is also exploring the possibility of setting up a mega-refinery (50 mtpa) on the Western coast in collaboration with Indian Oil and BPCL; HPCL will have 25 per cent stake in the venture.

With debt-to-equity at less than 1 time as of September 2016 and interest coverage ratio exceeding 22 times, the company’s financial position is comfortable to fund its expansion plans.

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