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Big upside if bet on refining pays off

We resume coverage on Hindustan Petroleum Corporation (HPCL) with a HOLD rating and target price of Rs296/share (1% downside). Company is set to boost its refining (1.7-2.2x), petrochemical (8.6-11.5x) capacity and raise complexity of its refineries. Full benefit of these projects is likely to accrue in FY25E. However, in the interim, HPCL may be impacted by weak GRMs, sub-optimal gains from stabilising projects, below FY21 peak auto fuel marketing margin, and rise in debt. The key to stock performance is how soon GRM recovers, which depends on pace of global demand recovery and refinery closures. A strong GRM phase coinciding with stabilisation of its projects appears likely. Upside to HPCL’s earnings and fair value would be big in that scenario

To boost refining and petrochemical capacity, and make refineries more complex at cost of Rs975bn:

HPCL is expanding both its refineries, increasing their complexity, through a JV building a refining and petrochemical complex in Rajasthan and JV HMEL is adding an ethylene cracker at a cost of Rs975bn. Merger of MRPL and its petrochemical subsidiaries with HPCL post buying parent ONGC’s 72% stake in the company is a possibility. This would mean 1.7-2.2x jump in refining capacity from 27.1mmtpa (including HMEL) to 44.8-59.8mmtpa and 8.6-11.5x surge in petrochemical capacity from just 0.47mmtpa to 4.03-5.4mmtpa. Thus, HPCL is betting big on refining and petrochemicals. GRM may strengthen on demand recovery and large refinery closures by FY24-FY25E by the time all projects stabilise.

GRM recovery key to HPCL’s outlook:

Auto fuel net marketing margins surged to Rs1.83-3.05/l in FY19-FY21 vs Rs0.97-1.06/l in FY15-FY18. Net margins probably peaked in FY21 and Rs2-2.5/l is likely to be a sustainable margin in the medium term. Sharp GRM recovery from multi-decade lows is therefore key to HPCL’s stock performance. Even before covid hit global demand, global refining capacity addition in CY19-CY24E was expected to be ~2x global refined products demand growth. Large refinery closures, similar to those that helped GRMs rebound a couple of years after 2008 global financial crisis, were expected to help GRMs recover. Covid has meant global refined products demand back above CY19 levels only in CY23E. There is also the prospect of surge in electric vehicles (EVs) resulting in decline in global demand for auto fuels. Possibility of work from home continuing to an extent even post-covid is yet another risk. Thus, post-covid, a larger global refining capacity closure (6m b/d as per IEA) is a prerequisite for the next phase of strong GRMs.

FY22E EPS to be down 62% YoY, but FY23E up 28% YoY; big upside if GRMs recover:

We estimate HPCL’s FY22E EPS to be down 62% YoY hit by no inventory gains and 18% YoY fall in marketing margin to Rs2.5/l. FY23E EPS is estimated to be up 28% YoY on GRM and throughput rise. We estimate its GRM at US$3-4/bbl in FY22E-FY23E vs core GRM of US$1.9/bbl in FY21. GRM rise to US$5-9/bbl on stabilising of projects may boost EPS to Rs60-109 and FV to Rs377-785.

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