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HRRL — White elephant or prized asset?

* HPCL’s Rajasthan Refinery (HRRL) is set to start operations in FY26 and will add ~30% to HPCL’s refining capacity. At peak capacity utilization (likely in FY28), HRRL will contribute ~37% to HPCL’s FY26E EBITDA. HPCL will account for HRRL on a joint venture basis (74% stake).

* HRRL’s start coincides with what we view as the golden age of refining, as global net refining capacity additions in 2024-30 are estimated to be only 3.3mb/d, implying an average annual net capacity addition of 470kb/d, down 40% compared to the 780kb/d average observed during 2010-19.

* HPCL’s marketing-to-refining ratio is set to improve from 2.1x now to ~1.6x after the completion of its bottom upgradation unit (Oct’24) and HRRL startup, and further to 1x if the merger with MRPL materializes. This will lower earnings volatility/under-recovery related uncertainty and drive structural improvement in the business.

* Lastly, with Castrol trading at 15.5x FY26E EV/EBITDA, the demerger of HPCL’s lubricant business and listing can unlock up to INR33/share in value.

* We reiterate BUY on HPCL with SoTP-based target price of INR460/share.

HRRL to add ~30% to HPCL’s refining capacity

* HRRL will add ~30% to HPCL’s existing refining capacity (adjusted for 74% stake in HRRL).

* After the completion of its bottom upgradation unit and the commissioning of HRRL, the company’s marketing-to-refining ratio will improve to 1.55x from 2.1x, thus lowering earnings volatility from marketing business.

* At peak capacity utilization (likely to be reached in FY28) for both refining and petrochemical units, HRRL will contribute ~37% to HPCL’s FY26E EBITDA.

HRRL to generate >10% RoCE at 100% utilization

* Based on our assumptions, HRRL is estimated to generate RoE of ~5.5% and PAT of INR9.3b in FY28 (~6% of HPCL’s consolidated FY26E PAT of INR100b; adjusted for 74% share).

* Note that while we have assumed mid-cycle margins for both refining and petrochemicals, global capacity growth is decelerating sharply in both segments and every USD1/bbl and USD100/t change in refining/petchem spreads leads to 7%/19% increase in FY27 EBITDA for HRRL.

* While RoE is poor, we estimate HRRL to achieve healthy RoCE of 10.3%/10.6% in FY28/FY29, which will improve to 10.9% by FY30.

We assume GRM of USD8/bbl, mid-cycle petchem margins

* We assume gross refining margin of USD8/bbl and PE/PP spreads over naphtha of USD472/USD468 per ton, based on five-year average spreads.

* We build in refinery utilization of 70%/90%/100% in FY26/FY27/FY28. For the petrochemical unit, we build in utilization of 50%/70%/100% in FY26/FY27/ FY28.

* For the petrochemical segment, PE naphtha and PP naphtha spread of USD468 and USD472 per ton, respectively (in line with five-year average).

* We assume a debt-equity ratio of 67% and an interest rate of 11.5%.

Refining enters a golden period amid annual capacity growth of 470kb/d, down 40% vs. historical

* According to IEA, during 2024-2030, the global refining capacity is expected to see modest growth, with total capacity projected to increase from 104.2mb/d to 107.4mb/d. This period will see net capacity additions of 3.3mb/d, which are lower than the 4.4mb/d forecast earlier by IEA for the 2023-2028 period.

* The net additions include 5.1mb/d from new projects, offset by1.8mb/d from announced closures. About 0.8mb/d of capacity closures would happen in 2025. In addition, IEA potentially sees upside risk to the capacity closure forecast of 1.8mb/d over 2024-30.

* The average annual net capacity additions of 470kb/d represent a notable decrease compared to the 780kb/d average observed from 2010 to 2019.

* We also note that beyond 2026, net refinery capacity additions are expected to be sparse. Of the IEA’s projected net capacity growth of 3.3mb/d, 85% would start operations by 2026, with only 474kb/d (15% of 3.3mb/d) capacity set to be commissioned in 2027-30. ? As such, stronger-than-expected oil demand growth can keep Singapore GRM above the mid-cycle level of USD6-6.5/bbl.

* New refining capacity additions and expansions, as expected, remain concentrated in India, China, Africa and the Middle East, while the Americas and Europe together account for 48% of net forecast capacity closures.

Marketing: Refining ratio to decline from 2.1x to 1x in coming years

* HPCL’s FY24 marketing-to-refining ratio currently stands at 2.1x, i.e., HPCL buys substantial marketing volumes from other refineries, on which it faces earnings volatility. However, once the bottom upgradation facility at its Visakhapatnam refinery is fully operational (expected by 3QFY25), another 1.3mmtpa will be added to the refining capacity.

* Additionally, HRRL’s commissioning will add another 6.67mmtpa to HPCL’s refining throughput (at 100% capacity utilization). HRRL is expected to be commissioned by FY26 and we expect it to attain 70%/100% refining capacity utilization by FY26/FY28.

* In case of MRPL’s merger with HPCL, another 16.6mmtpa of throughput will be added to HPCL’s refining throughput.

* All these additions will reduce HPCL’s marketing-to-refining ratio from 2.1x to 1x, sharply lowering earnings volatility from marketing business.

INR33/share option value from lubricant business listing

* In the 1QFY25 earnings call, HPCL’s management stated that their lubricant business generates annual EBITDA of ~INR10b.

* Even after applying a 20% discount to Castrol’s CY25E EV/EBITDA ratio of ~15.5x, HPCL’s lubricant business attains a value of INR141.5b.

* Currently, HPCL trades at EV/EBITDA of ~5.7x. Hence, the potential demerger of its lubricant business can unlock an incremental value of ~INR33/share

Balance sheet to strengthen further amid healthy FCF generation

* HPCL’s consolidated net debt decreased to INR623b in FY24. The net debt-toequity (D/E) ratio decreased from 2.1x in FY23 to 1.3x in FY24. We expect the D/E ratio to strengthen further to 1.1x by FY26, led by strong EBITDA generation of INR131b/INR192b in FY25E/FY26E.

* We build in healthy FCF generation of INR13b/INR57b in FY25E/FY26E as we see the capex cycle tapering off in coming years.

Valuation and view

* HPCL remains our preferred pick among the three OMCs. We model a marketing margin of INR3.3/lit for both MS and HSD in FY25-26E, while the current MS/HSD marketing margins are INR6.9/lit and INR4.9/lit, respectively. We see the following as key catalysts for the stock: 1) demerger and potential listing of lubricant business, 2) the commissioning of its bottom upgrade unit, and 3) the start of its Rajasthan refinery in 4QFY25-end.

* HPCL currently trades at 1.4x FY26E P/B, which we believe offers a reasonable margin of safety as we estimate FY26E RoE of 18.3%. Our SoTP-based TP includes:

* The standalone refining and marketing business at 6.7x FY26 EV/EBITDA.

* INR33/share as potential value unlocking from de-merger of the lubricant business.

* HMEL at 8x P/E based on its FY24 PAT (HPCL’s share), deriving a value of INR35/share.

* Chhara Terminal at 1x P/B, and HPCL’s HRRL stake at 0.5x of HPCL’s equity investment in the project to date. MRPL stake is valued at MOFSL’s TP.

* Accordingly, we arrive at a revised TP of INR460. Reiterate BUY.

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