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Margins suffer and EBITDA misses est.; debt to increase

* HPCL reported lower-than-estimated refining/marketing margins, while core GRM stood at -USD1/bbl. GRM was lower for HPCL, weighed by subdued gasoil and ATF margins during the quarter.

* The company stated that demand for petroleum products has revived to pre-COVID levels and HSD demand should further spike in the coming months – on the back of increased demand in the summer season in India.

* HPCL has completed ~35% of the targeted buyback of shares till date. As per the proposal, the board has agreed to buy back up to 100m equity shares (not exceeding a value of INR25b), i.e., ~6.56% of the total paid-up equity share capital.

* Currently, retail auto fuel prices in India have reached all-time highs, gross marketing margins are at INR2.8–3.6/lit (v/s INR4.5–5/lit in 3QFY21). Also, gross marketing margins in FY21’TD average INR6.3–6.6/lit (well above the long-term average of ~INR3/lit).

* We reiterate our belief in the sustainability of marketing margins around the long-term average (if not higher) – while aiding poor refining margins in the short term.

* The capex plan for FY21 stands at INR120b (of which INR88b has been completed to date) and guidance for FY22 is ~INR140b – which includes an equity component for the Rajasthan refinery.

* The company is the biggest beneficiary of the highest marketing leverage. While we maintain a Buy rating on the stock, the biggest risks to our recommendation include project execution and rising debt levels.

EBITDA/PAT miss driven by…

* Reported EBITDA came in 43% below our estimate at INR33b (+62% YoY). Adj. EBITDA stood at INR19.8b (50% below our estimate, +17% YoY).

* Forex gains stood at INR3b. Interest expense was lower at INR1.3b (-50% YoY). Reported PAT came in at INR23.5b (36% below our estimate, +215% YoY), with the tax rate at 25.4% for the quarter.

* For 9MFY21, reported EBITDA stood at INR112.6b (+84% YoY), PBT at INR101.8 (+154% YoY – on forex gains), and adjusted PAT at INR76.5b (+193% YoY – on a lower tax rate).

…lower-than-estimated refining/marketing margins

* HPCL reported inventory gains of INR13.2b, of which marketing gains stood at INR7.0b and refining gains at INR6.2b (translating to USD2.8/bbl). Thus, core GRM came in at a loss of USD1.0/bbl (v/s est. profit of USD2).

* Refining throughput was in line with our estimate at 4mmt (-4% YoY). However, reported GRM came in at USD1.9/bbl (our estimate of USD4.5).

* Marketing sales volumes were in line with our expectation at 10.4mmt (-2% YoY), while the implied marketing margin was at INR5.2/liter (v/s our expectation of INR6.7).

* For 9MFY21, refining throughput was down 5% YoY to 12mmt and marketing sales were down 12% to 26.4mmt. Reported GRM averaged USD2.4/bbl in 9MFY21 against USD1.85/bbl in 9MFY20. The implied marketing margin averaged INR6.4/liter against INR4.1/liter in the preceding year.

Valuation and view

* HPCL believes the current weak refining margins should see an uptick with improved product (HSD, ATF) demand across the globe – with an increase in economic activity led by the distribution of vaccines.

* As per our calculations, HPCL requires ~INR0.3/liter of incremental marketing margins to offset USD1/bbl of refining margins.

* Debt at the end of the quarter stood at INR333.4b (v/s INR346b at end-2QFY21). Excluding lease liability, debt stood at INR306.4b (v/s INR320b at end-2QFY21). Government receivables stand at ~INR40b (flat QoQ), down from INR80b at FY20-end.

* The stock trades at 5.3x FY23E EPS of INR42.4 and 1.0x FY23E BV of INR231.

* Owing to huge capex, the company’s FCF profile remains negative for the next two years, with further degradation in return ratios – along with rising Debt to Equity ratio.

* We value HPCL at 1.3x FY23E PBV (20% discount over FY15–18 post the reform period) – factoring in heavy capex and project execution risk in a slurry hydrocracker at Vizag – to arrive at TP of INR301. Maintain Buy.

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