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* HPCL reported Q2FY23 SA adj. (ex-subsidy) EBITDA loss/net loss of Rs65.1bn/Rs63.7bn, weaker than our estimate of a Rs55.8/55.5bn loss due to potential marketing inventory loss vs our gain estimates. Book GRM and marketing margins seem in-line.

* Reported GRM was USD8.4/bbl, albeit excluding export duty. Book GRM is expected at ~USD4/bbl, while inventory loss in Q2 was ~USD5/bbl, thereby core CP GRM being ~USD13/bbl. Gross debt rose 82% YoY/45% QoQ to Rs685bn, on accumulated losses.

* HPCL’s FY23 earnings visibility is low, with sustained diesel losses, volatile GRM outlook and export levies as key overhangs. We thus expect a marginal RPAT, while also buildingin conservative estimates in FY24/25 (22%/23% cut), on refinery expansions/stabilization.

* We expect H2 to be better for OMCs, building-in auto-fuel price hikes. But HPCL remains a high beta play at 1.2x current P/B (vs IOCL at 0.7x). We reduce HPCL’s Sep-23 TP by 12% to Rs230, although valuing it at 5.5x EV/EBITDA (in line with IOCL); retain HOLD.

Highlights: Refinery volumes were 4% higher than our estimate, at 4.5mmt. Domestic sales grew 12% YoY, while overall volumes were up 14% on higher exports. Petrol/diesel sales volume growth was 12/16% YoY vs. 15/24% for IOCL. Pipeline volumes fell 4% QoQ to 5.5mmt. HPCL’s adjusted gross loss lowered, from Rs68.9bn in Q1 to Rs17.5bn in Q2, as negative marketing margins narrowed in auto fuels and LPG. Total inventory losses stood at Rs25-30bn. Other expenditure rose 10% YoY/2% QoQ to Rs40.2bn, with overall opex lower than estimated. Depreciation fell 1% QoQ, while interest rose 79% QoQ to Rs6.0bn. Share of associate/JV profits turned negative, at -Rs2.6bn vs. +Rs16.8bn QoQ, implying windfall-RTP impact on HMEL. Capex, as per PPAC, was Rs36.1bn in Q2. Core SA EPS was a negative Rs27.5. Reported EBITDA loss/net loss (with LPG subsidy of Rs56.2bn) was Rs8.9/21.7bn.

Guidance: Vizag refinery expansion would progressively commission over the Dec-22 to Mar-23 period, while the Vizag residue up-gradation project would be completed by Dec-23. Barmer refinery capex has been revised from ~Rs430bn to ~Rs700bn and would be complete by FY25. HPCL’s H1FY23 capex was Rs58-60bn. Management expect debt levels to ease when the LPG subsidy payout of Rs56.2bn happens.

Valuation: We value HPCL based on SOTP methodology, with investments at 30% holdco discount. We increase our target EV/EBITDA from 5.0x to 5.5x Sep-24 earnings, matching it with IOCL’s, as we have taken a 22-23% SA EPS cut in FY24/25. We also significantly lower HMEL’s value due to the weak Q2 and impact from windfall levies. We retain HOLD with revised TP of Rs230/sh. A favorable macro and potential policy support along with auto-fuel price movement are key monitorables. As HPCL is the most leveraged OMC, any material improvement it witnesses would have an outsized delta as well. Key risks: Adverse commodity/currency/polices and project issues.

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