MOSL: HPCL (Buy)-ONGC-HPCL merger-Finding the right value for HPCL

​HPCL: ONGC-HPCL merger; Finding the right value for HPCL

(HPCL IN, Mkt Cap USD8.7b, CMP INR374, TP INR427, 14% Upside, Buy)

The Department of Investment and Public Asset Management (DIPAM) has invited bids for appointing an advisor for strategic sale of the government’s 51.11% stake in HPCL to ONGC. The bid document mentions the following methodologies for achieving the best valuation for HPCL: (1) discounted cash flow, (2) relative valuation, (3) asset-based valuation, and (4) market valuation. We study the four possibilities to estimate what the reserve price could be. We also take a look at the possibility of a control premium. However, for this report, we leave aside the issue of open offer. While theoretically, an open offer is likely, legal interpretations may be complex and contradictory.

Discounted cash flow method

Using a GRM of USD5.1/bbl, net marketing margin of INR1.1/liter, stretched till 2038, but taking nil terminal value, we arrive at a DCF valuation of INR470/share for HPCL. Our valuation uses a WACC of 11%. Nil terminal growth beyond 2038 suggests the possibility of disruptive technologies like electric vehicles having an adverse impact on refineries. We have only taken imminent capex like expansion of Vizag refinery, and ignored larger ones like petrochemicals complex in Andhra Pradesh and participation in 60mmtpa West Coast refinery.

Relative valuation

Global peers are trading at 6.9x FY19E EV/EBITDA and 10x FY19E P/E. Indian peers are also trading at 6.9x FY19E EV/EBITDA and a little lower 9.5x FY19E P/E. Though there aren’t many comparables for pure marketing plays, Caltex Australia, Z Energy, New Zealand and Petron Corp are trading at an average 7.5x FY19E EV/EBITDA and 12.3x FY19E PE. Our SOTP valuation of HPCL implies 7.8x FY19E EV/EBITDA and 11.5x FY19E EPS.