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Project execution poses greatest risk hereafter

* HPCL reported a beat on our estimates, driven by a better-than-expected performance from the Marketing segment. On the other hand, Refining performance was below estimate due to a planned shutdown at the Mumbai refinery and higher fuel & loss during the quarter.

* The management expects to commission the Mumbai expansion project by the end of the month (which would add 2mmt to the company’s total throughput) and would take another 2–3 months to ramp up capacity to optimal levels. The Vizag refinery expansion would be completed by endCY21 (while the bottom upgradation unit would be completed by CY22-end).

* The company stated that marketing volumes have recovered quickly this time around with the easing of lockdown restrictions. In July, MS consumption exceeded 2019 levels (+5%), while HSD/ATF consumption was lower (by 8.9%/49% v/s July 2019 levels).

* We expect that with the total phasing out of the COVID lockdowns and the closure of refinery complexes (est. ~3mnbopd over the next 2–3 years), the refining margin would return to its long-term average (of USD5/bbl). SG GRM improved to USD2.9/bbl in July’21 (v/s USD2 in 1QFY22), with the margin averaging higher at ~USD3.3/bbl in the first week of Aug’21.

* As the macroeconomic environment improves, we highlight that the company is Battling a three headed-monster – i) the loss of marketing leverage, ii) rising debt, and iii) key risks related to project execution.

* We expect consolidated net debt to rise to INR604b in FY24E (from INR421b in FY21), almost 1.6x its current m-cap. We expect interest costs to rise to INR13.8b by FY24E (from INR9.6b in FY21). This would result in cumulative FCFF loss of INR37b over FY22–24E.

* We value the stock at 1x Sep’23E P/BV and recommend a Neutral rating on the stock, with TP of INR295/share. The major risk to our call would be the sustainability of high marketing margins.

Beat – better-than-expected performance from Marketing

* Refining operational data was below our estimates.

* Refining throughput stood at 2.5mmt (-10% est.; -37% YoY / -43% QoQ) as HPCL undertook a planned shutdown at its Mumbai refinery in light of capacity expansion. Reported GRM stood at USD3.3/bbl (est. USD4 and USD0.04/USD8.1 in 1Q/4QFY21).

* Marketing operational data was above our estimates.

* Sales volumes stood at 8.8mmt (+9% est.; +16% YoY / -13% QoQ). The marketing margin (including inv.) stood at INR5.7/liter (+34% est.; -31% YoY / -5% QoQ).

* EBITDA stood at INR32.6b (-25% YoY), with PAT at INR18b (-36% YoY).

Valuation and view – maintain Neutral

* INR145b capex is planned for FY22 (of which INR30b was spent in 1QFY22).

* The completion of various ongoing projects would drive growth for the company over the next 3–5 years, such as (a) the bottom upgradation unit in Vizag by 3QFY23, (b) the Rajasthan (Barmer) refinery in CY23, (c) the HMEL petchem project in CY21, (d) the Charra LNG terminal in CY22, and (e) the development of 20 CGD GAs in nine states.

* Moreover, the company is working on multiple petchem integration projects totaling ~6.2mmt (~15% of total refining capacity) over the next 3–4 years:

* An additional cracker at HMEL would have a capacity of ~2.7mmt.

* The Rajasthan refinery would have 2.2mmt of petchem capacity.

* OMPL and MRPL combined should have another 1.2–1.4mmt capacity.

* Despite the potential highlighted above, we maintain Neutral on the stock, with risks such as project execution in Vizag and rising debt levels.

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