Hindustan Oil Exploration Company (HOEC) is in a sweet spot with projects being implemented on time and greater visibility on monetization of assets in the coming quarters. With the government announcing the second stage of auction of discovered small fields and putting forth a proposal to allow private firms to bid for a majority stake, HOEC stands well positioned to benefit from these measures.
HOEC is a pure exploration and production player in the oil and gas space. The company is one of the few private sector players who were allotted small fields in the 2016 auction of discovered small fields (DSF). It has a strong mix of both onshore and offshore assets in appraisal, development and production stages.
The stock had seen a sharp fall since 2011 due to the close down of production from one of its producing reserves PY3. Over the years the company has acquired and developed other gas and oil fields which have either started production or have a greater visibility of the revenue generation timeline now.
With clear plans the company seems well poised for a turnaround and the stock has already started picking up momentum running up 63 percent since the beginning of the year.
Financial and Peer Analysis
The stocks seems like an attractive pick with Q2 revenue growth of 51 percent YoY and a normalized net margin of 66 percent. The company expects operating margins to grow rapidly up to 75 percent with production ramping up at the fully installed Dirok block.
With the commercialization of the Dirok facility the company aims to stretch production to full utilization and avail the benefits of no/low profit-sharing with partners in the initial years of production. Although the company expects a much larger multi-fold increase, keeping a conservative view we expect FY18 revenues to be around Rs 42 crore and FY19 revenues around to Rs 110 crore.
With carry-forward tax benefit and no finance cost liability and 75 percent margin profile given the gas rates and crude oil trends, a majority portion would flow down to profitability. Moreover, the company has sizeable financial investments which would continue to earn additional income.
About the company
HOEC has a portfolio of 9 blocks with discovered resources: 5 onshore (2 North East, 3 Gujarat); 4 offshore (2 West Coast & 2 East Coast). Of these, 4 are oil reserves, 2 gas reserves and the rest 2 are a mix of both oil and gas.
Monetization of the Dirok Assam block
After significant investments towards the development of assets the company now has greater visibility of monetization. The ramping-up of the Dirok production (the key project for company’s turnaround) is on track and commercial sale has started since August 2017. The fiscal terms for production stand in favour of HOEC with no profit-sharing for next two years given the carrying cost. All gas and condensate produce will be supplied to partners Oil India and IOCL which minimize the demand-side risks.
Moreover, attractive gas price at USD 2.89/mmbtu for gas and international price parallel for crude leave strong operating margins of around 75 percent for the company. To benefit further, the company expects a possibility of higher than expected reserves in this block
PY1 reserves – a big positive
The hydrocarbon resources discovered at the PY1 reserves are larger than expected. The company plans to start extraction from this reservoir through reentry from Q1FY19 onwards. Reentry through wells would be cost beneficial and would generate quick output and returns without significant incremental costs.
Balance Sheet Comfort
HOEC has a debt-free balance sheet and an immense scope for benefits from leveraging in future providing capacity for inorganic as well as organic expansion. The cash flow position seems positive with a working capital at Rs 167 crore and cash reserves of Rs 82 crore to fund operations. HOEC has a deferred tax in its books and a carryover loss which would be utilized against future liabilities in this respect. Moreover, the company is looking for inorganic growth which might give it a strong upward momentum.
Government initiatives/inclination for auction to private players
The government’s proposal to sell some block might further benefit – although this is only an anticipation and we do not have any confirmed news. We believe HOEC is one private player which would be well positioned
Minimization of geopolitical risks
The geopolitical risks associated with sensitive situation in the valley near Dirok block seems to be waning with the project fully commissioned and only indoor work remaining. Moreover, the company has seen immense support from both the local population and the government in the region.
The proposed revival of the PY3 block and inclusion of the upstream segment under GST could provide additional tailwinds to the stock in the future.