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Raghuvir Srinivasan

The company faces a challenging period ahead both on the refining and marketing fronts. If the challenge in refining is to protect margins, in marketing, it is in taking on the high quality private competition that is emerging. It may be prudent to exit the stock for now and await further developments to consider a re-entry at a later date.

SHAREHOLDERS in Hindustan Petroleum Corporation can consider exiting the stock. The company has just reported a big 70 per cent drop in post-tax earnings during the third quarter and the outlook for the current one appears none too promising.

Oil prices are projected to remain range-bound in the near term, which means that the prospects of a spike in refining margins is limited. There are also a couple of other issues that could have a say on valuation. First, the possibility of an overhaul of the duties on petroleum products in the coming Budget. A drop in duties on products could cause an adverse impact on refining margins.

Second, restructuring of the industry appears imminent following the constitution of a committee to deliberate the issue. With as many as eight restructuring options under consideration, there is a lot of uncertainty over the possible impact on the companies in the industry.

Inventory losses

The prime reason for the sharp fall in Hindustan Petroleum's earnings during the third quarter is losses on the inventory of products that it carries. The company has accounted for a massive Rs 977 crore (post-tax earnings of Rs 236 crore) as decrease in inventory compared to an increase of Rs 20 crore during the same quarter last year. While some of the decrease could be plain draw down of inventory, a large part of it appears to be the effect of fluctuating oil prices.

Oil prices peaked at $55 during end-October and retreated thereafter ending 2004 at close to $48 levels. Product prices also fell correspondingly and, therefore, Hindustan Petroleum's inventory as of December 31 was valued lower compared to the opening inventory of the quarter. This is a problem that oil refiners face during times of retreating global crude oil prices.

The last quarter was also not a good one for refining margins, which, after peaking along with oil prices in October, retreated to more sober levels. This has also had an adverse impact on the performance of Hindustan Petroleum.

In addition to this, the burden of LPG and kerosene subsidy of which Hindustan Petroleum has to take a one-third share also appears to have weighed down on the bottomline. The company has accounted for this on a provisional basis based on the payout in 2002-03 when oil prices were substantially lower than what prevailed during the last few months. Therefore, the chances are that the company may have to make good the subsidy shortfall in the final quarter, which means that the bottomline will come under additional pressure.

The company also appears to have increased its reliance on short-term borrowings perhaps because of the outflow on subsidy. This has resulted in interest costs almost doubling during the quarter to Rs 32 crore; for the first nine months, it was up 65 per cent to Rs 65 crore.

Hindustan Petroleum faces a challenging period ahead both on the refining and marketing fronts. If the challenge in refining is to protect margins, in marketing, it is in taking on the high quality private competition that is emerging on the horizon. Reliance, Shell and Essar have already started rolling out their retail outlets while Oil and Natural Gas Corporation has begun the groundwork for its own network.

With Hindustan Petroleum's existence as an independent entity (as indeed of Bharat Petroleum and the other companies in the industry) under review by the committee and with the latest disinvestment policy of the government ruling out privatisation altogether, the stock market valuation of oil companies could come under a cloud. It may be prudent to exit the stock for now and await further developments to consider a re-entry at a later date.

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