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Diunggah oleh Rupesh Jain

HPCL and IOCL Valuation

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INTRODUCTION

The companies chosen for the project are HPCL and IOCL which belong to the oil sector.

The oil and gas consumption contributes about 15% to India’s GDP .The Oil consumption is

expected to grow at about 5% annually for the next decade and the prices of petrol and diesel

have been deregulated . With this the potential for growth for companies belonging in oil

sector has increased. This in turn will attract the investments of foreign investors as well as

shareholders of the company. Therefore more and more funds in the form of shareholder

capital will be provided to the companies in this sector to fuel their growth. The companies

thus will become an important part of the portfolio holders of the investors and they will be

keen to know the everyday events in the domestic and international market

2. COMPANY OVERVIEW

2.1 HPCL

HPCL (Hindustan Petroleum Corporation Limited is an Indian state owned oil and

natural gas company based in Mumbai. It has been ranked 267th in fortune global 500

rankings of the world’s biggest corporations for the year 2012. The refining capacity has

steadily increased from 5.5 million metric tonnes in 1984 to 13.0 million metric tonnes in

2008. In 2012 HPCL’s fourth quarter net profit jumped to Rs.4631 crores, which is four

times more than the previous year profit. The company has been given the status of

Navratna by the Indian government.

The products dealt by the company are – Petrol, diesel, Lubricants, LPG, Aviation

Turbine Fuel and Furnace Oil.

It has total employee base of 11200, total assets of US$ 15.91 billion and total equity of

US$ 2.46 billion. The company is listed on both BSE and NSE.

2.2 IOCL

IOCL (Indian Oil Corporation Limited) is also a state owned oil and gas corporation

with its headquarters in New Delhi. The company is world’s 83rd largest public

corporation accoding to fortune 500 list. The company has been given the status of

Maharatna by the Indian government. Indian Oil and its subsidiaries account for 49%

share in the petroleum products, 31% in the refining capacity.

In 2012 IOCL sold 75.66 million tonnes of petroleum products and reported a profit

before tax of Rs. 37.54 billion. The products dealt by the company are – Petrol, Diesel,

LPG, Aviation fuel, Naphtha, Lubricants, Kerosene and Furnace oil.

It employs over 36000 people and has total assets of US$ 40.88 billion and Equity of

US$ 11.59 billion.

There are on the other hand some concerns for the companies. The volatility in the

crude and the subsidy burden eats into the profit of these companies. Moreover many

bureaucratic hurdles in projects are hurting company advancement.

1

3. COST OF DEBT

The cost of funds debts, bonds and debentures measures the current cost to the firm of

borrowing funds. There are it is governed by two variables

1. If the level of interest rates increases then the cost of debt increases

2. If the default risk of the firm increases then the cost of bonds and debentures also

increases

The cost of debt can be found out by taking average weight of all the loans and other funds

raised through the sale of bonds and debentures and then computing the average rate of

interest for the loan taken which is termed as cost of debt, represented by Kd.

Tax adjustments for cost of debt –

An important effect of cost of debt is the tax shield. As the interest is a tax deductible

expense, the firm gets a saving in terms of tax liability. The interest thus acts as a tax shield

and the tax liability of the firm is reduced. Therefore the effective tax rate for the firm will be

Ki = Kd (1- t)

Where Ki is the cost of debt after tax

Kd is cost of debt before tax

t is tax rate

Total debt stood at Rs.6291.37cr in the financial year 2011-12. Out of this Rs.1000cr was due

to non-redeemable bonds at 7.7%. Unsecured loans from various sources like banks foreign

investors amounted to Rs.5291.37cr.

The total interest paid to loan providers and debenture holders was Rs.1203.26cr.

To compute the interest rate on loan we need to find the interest paid in rupees to the loan

providers. For this we subtract the interest given to debenture holders from the total interest

paid and get interest on loans as –

Interest on loans = (interest paid on loans / unsecured loans value)

= 1126.26 / 5291.37

= 21.28 %

Kd (weighted average) = (5291.37 * 21.28 + 1000*7.7) / 6231.37

= 19.125%

Tax rate is 33.2175 %. The corporate tax is 30 % with 7.5% surcharge, 2% education cess

and 1% further SHE cess. So net tax rate comes out to be 30 * 1.075 * 1.03 which equals

33.2175 %

2

Kd (after tax) = 19.125 * (1 - 0.332175)

= 12.772%

Unsecured loans of Rs.11007.6cr which is financed by foreign investors, foreign oil

companies and raising bonds in international market. Also in 2011-12 period a total of

Rs.4711.4cr was raised by issuing convertible bonds under various series which consisted of

different interest rates –

Series 8 of Rs.1070 cr @ 11%

Series 11 of Rs.1415 cr @ 9.28%

Series 9 of Rs.1600 cr @ 10.70%

Series 8b of Rs.500 cr @ 7.40%

Series 5 of Rs.126.4 cr @ 10.25%

The cost of debt Kd can be computed by taking weighted average of all the series of

bonds as –

Kd (cost of debt) = (1070*11 + 1415*9.28 + 1600*10.7 + 500*7.4 + 126.4*10.25) /

4711.4

= 9.973 %

The cost of debt for the unsecured loans is assumed to be equal to the cost of debt by

computing weighted average of the series of bonds because in the balance sheet of IOCL

the interest rate for the unsecured loans is not mentioned.

Kd (after tax) = 9.973*(1 – 0.332175)

= 6.661 %

Computing the cost of equity is the most difficult exercise as there is no commitment

from the board of directors to pay a fixed dividend to the shareholders. Moreover equity

shareholders are the last claimant of the money. On the other hand as the investment in

the shares is most risky, the investors expect maximum returns from the company in this

case.

For calculating the cost of equity which is a measure of the return to the shareholders we

have used the Dividend growth model in which it is assumed that the dividend grows

over a period of time. And that the rate of discount at which the expected dividends are

discounted to determine their present value is called the cost of equity share capital.

3

Ke = D1 / P0 + g

Where, Ke is the cost of equity

D1 is the dividend given in the next year, D1 = D0 * (1+g)

P0 is the present share price of the company

G is the growth rate.

In computing Ke we have ignored the addition of g to the equation as it was negative and the

overall value of Ke would be negative which is not possible. The reason for this behavior is

that the dividend per share has been on a constant decline over the past 4 years for both the

companies. To determine the value of Ke more in line with the actual value we have used

CAPM model also.

Putting the values in the equation Ke = D1 / P0

D0 = Rs.8.5,

g = -2.786%

P0 = Rs.294.9

Ke = 2.81 % ,which is very low for an investor

Also Ke = Kr = 2.81 %

Where Kr is the cost of retained earnings. This is because if the retained capital if distributed

to the shareholders then the shareholders would invest the same money in the shares of the

company and hence would expect the company to invest them in some projects and receive a

minimum return which is equal to Ke . Hence the cost of retained earnings (Kr) is equal to Ke.

Similarly the Ke value for IOCL can be computed by the same model –

The values are –

Growth rate = -2.41%

D0 = Rs.5

P0 = Rs.257.22

Ke = 1.89 %

Also Ke = Kr = 1.89%

4

4.3 INTERPRETATIONS OF KD AND KR VALUES

The cost of debt for HPCL is more as compared to the cost of debt for IOCL

This implies that the borrowing cost for HPCL is more as compared to that of IOCL

For Ke and Kr the dividend growth model computed values of Ke very low. So nothing

concrete could be inferred from these values. CAPM model is used for determining the Ke

values for the firms. This is because the growth of dividends is highly negative for the past 4

years.

HPCL 12.957% 2.81%

5

5. CAPM MODEL

Systematic risk can be defined as the risk a company pertained due to external factors, like

government policies, inflation rate or any other factor which is out of the management’s

control.

Beta β is termed as the measure of systematic risk, it can also be defined as the number

describing the correlated volatility of an asset in relation to the volatility of the benchmark

that said asset is being compared to, which is BSE Sensex in our case.

Technically it can be find out through following equation,

𝜷 = 𝒄𝒐𝒗𝒂𝒓𝒊𝒂𝒏𝒄𝒆(𝑹𝒋, 𝑹𝒎)/𝝈𝒎𝟐

Where,

Rj= firm’s return

Rm= Market return

𝜎𝑚𝟐 = Market’s variance

In our case we have used last 12 years data from 01/04/2000 to 31/03/2012 in order to

calculate beta for respective companies.

Following can be interpreted from respected beta values

Beta value Interpretation

β<0 Market and stock moves opposite to each

other

β=0 There is no correlation between market and

stock movement

0<β<1 Both market and stock moves in same

direction but degree of movement is less for

stock

β=1 Both market and stock are moving

simultaneously

β>1 Both market and stock moves in same

direction but degree of movement is greater

for stock

6

Daily return for the stocks of IOCL was computer through following formulae:

Rj= P1-Po/ P1

Where,

P1= Price of current day

Po= Price of previous day

Average was taken for the return and then it is annualized through following formulae:

Annualized return= ((1 + average return)245)-1%

By applying the values in our model, we calculated following as our results:

PARTICULARS DETAILS

Variance 2.956033

Beta 0.494778

This signifies that if market escalates by 1 point, there is positive movement of .49 in IOCL,

vice-versa.

Similarily, we have calculated financials for HPCL by first calculating return, market

variance and covariance for HPCL over these years. Following are the details of systematic

risk for HPCL:

7

PARTICULARS DETAILS

Variance 2.956033

This

Beta 0.55

signifies that if market escalates by 1 point, there is positive movement of .55 in HPCL.

From above analysis we can say that both the stocks are quite stable and does not show too

much of volatility towards market risk. Following graph shows the movement of these stocks

throughout these years.

8

350.00

300.00

250.00

200.00

150.00

100.00

50.00

0.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

-50.00

-100.00

On following three occasions there was dip in all three stocks due to systematic risk:

1) GULF WAR II took place in 2003-2004 shooting up crude prices. Downsizing annual

return for all three stocks.

2) Due to sub-prime crisis returns failed sharply in 2008.

3) Due to weak ₹ and higher crude prices, both companies conceded high losses again

downsizing returns in 2010-11.

Cost of equity is calculated through capital asset pricing model (CAPM), through following

formulae:

Ke=𝑅𝑓+𝛽(𝑅𝑚−𝑅𝑓)

Where,

Rf= Risk free rate of T-Bill 8.4%

Rm=Market return of BSE 15.65%

Following are the cost of equity for both the companies:

IOCL: 11.99%

HPCL: 12.45%

9

6. WACC (WEIGHTED AVERAGE COST OF CAPITAL)

A calculation of a firm's cost of capital in which each category of capital is proportionately

weighted is called working average cost of capital. All capital sources - common stock,

preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All

else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as

an increase in WACC notes a decrease in valuation and a higher risk.

The WACC equation is the cost of each capital component multiplied by its proportional

weight and then summing:

HPCL

Particulars Value(in Crores) Weight Cost in % WACC in %

Reserves & Surplus 12,783.51 0.65847 11.99 7.8969

Long-Term Borrowing (DEBT) 6291.37 0.32407 12.77 4.1383

Total 19,413.89 1.00 12.1959

* Cost of Debt used here is After Tax Cost of Debt.

Weighted Average Cost of Capital (Ko) for HPCL = 12.2445%

IOCL

Particulars Value(in Crores) Weight Cost WACC

Share Capital (EQUITY) 2,427.95 0.0325 12.45 0.4046

Reserves & Surplus 55,448.75 0.7423 12.45 9.2410

Long-Term Borrowing (DEBT) 16,826.76 0.2252 6.66 1.5001

Total 74,703.46 1 11.1458

* Cost of Debt used here is After Tax Cost of Debt.

Weighted Average Cost of Capital (Ko) for IOCL = 11.1458%

In both the cases we have taken, Kr = Ke, as cost of retained earnings can be calculated as

opportunity cost which company incurs.

By Calculating WACC for both the companies, we find that cost of capital is more for

HPCL than IOCL.

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6.1 CAPITAL STRUCTURE

Capital structure refers to the way a corporation finances its assets through some combination

of equity, debt, or hybrid securities. A firm's capital structure is then the composition or

'structure' of its liabilities. When people refer to capital structure they are most likely referring

to a firm's debt-to-equity ratio, which provides insight into how risky a company is. Usually a

company more heavily financed by debt poses greater risk, as this firm is relatively highly

levered.

For HPCL

Share Capital 339.01

Reserves & Surplus 12,783.51

Equity (Share Capital + Reserves & Surplus) 13,122.52

Debt 6291.37

Debt to Equity Ratio 0.479:1

For IOCL

Share Capital 2,427.95

Reserves & Surplus 55,448.75

Equity (Share Capital + Reserves & Surplus) 57,876.70

Debt 16,826.76

Debt to Equity Ratio 0.290:1

Below graph depicts the Capital structure of both the companies by representing equity and

debt in form of percentages in the respective companies. So for HPCL we have 67.59 % equity

and 32.40 % debt. Similarly in case of IOCL we have 77.47% equity and 22.52 % debt.

CAPITAL STRUCTURE

Percentage

80

60

40

20

0

HPCL IOCL

Equity 67.59346015 77.47526018

Debt 32.40653985 22.52

• Variability of earnings for the equity shareholder is more for levered company HPCL

than less levered company IOCL as Debt to Equity ratio is higher for HPCL compared

to IOCL. Also investment in HPCL will be more risky than IOCL due to higher debt

to equity ratio.

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6.2 VALUATION

It’s the process of determining the current worth of an asset or company. There are many

techniques that can be used to determine value, some are subjective and others are objective.

NOI Approach

The essence of this approach is that the capital structure decision of a firm is irrelevant. Any

change in leverage will not lead to any change in the total value of the firm and the market

price of shares as well as the overall cost of capital is independent of the degree of leverage.

Formulaes:

The value of the firm, given the level of EBIT, is determined by,

V = EBIT/Ko

Where V-D = E, market value of the Equity

EBIT = Earnings before Interest & TAX

Interest = Interest on Debt

Profit before Tax 1219.24

Finance cost 2139.24

Earnings Before Interest and Tax (Profit before Tax + Finance cost) (Amount In Rs Crores) 3358.48

Capitalization rate (Ko) 0.122445

Total firm value (Amount In Rs Crores) 27428.47809

Debt (Amount In Rs Crores) 6291.37

Market value of equity (Amount In Rs Crores) 21137.10809

Profit before Tax 3,754.31

Finance cost 5,590.54

Earnings Before Interest and Tax (Profit before Tax + Finance cost) (Amount In Rs Crores) 9,344.85

Capitalization rate (Ko) 0.111458

Total firm value (Amount In Rs Crores) 83841.8956

Debt (Amount In Rs Crores) 16,826.76

Market value of equity (Amount In Rs Crores) 67015.1356

For calculating the value of equity, we find Value of a share in market on 31 st March 2012.

From Yahoo Finance we found the historical Value for both the companies. Also No. of shares

were found from the respective companies Annual report for the financial year 2011-12.

FOR HPCL

Market Value on 31st March 2012 (Amount In Rs) 294.9

12

No. of Shares 338,627,250

Value of equity as per Market Capitalization as on 31st March 2012 (Amount In Rs ) 99,861,176,025

FOR IOCL

Market Value on 31st March 2012 (Amount In Rs) 257.22

No. of Shares 2,427,952,482

Value of equity as per Market Capitalization as on 31st March 2012 (Amount

624,517,937,420

In Rs)

Relative valuation, also referred to as comparable valuation, is a very useful and effective tool

in valuing an asset. Relative valuation involves the use of similar, comparable assets in valuing

another asset.

Some of the most common and useful metrics to utilize in relative valuation include:

a) price to earnings ratio

b) return on equity

c) operating margin

d) enterprise value

e) price to free cash flow

When performing a relative valuation, a company's sector should be used to determine the most

logical multiple to use. Here we have used Price to Earnings Ratio of the industry to calculate

the value of equity. Market Value per share is calculated by multiplying P/E ratio and Earning

per share. Value of equity is calculated by multiplying no. of shares with the market value.

FOR HPCL

P/E Ratio 12.89

EPS (Amount In Rs) 26.29

Market Value of Equity Per Share (P/E * EPS) (Amount In Rs) 338.8781

Value of Equity as per Relative Valuation (Amount In Rs) 114,753,359,088

FOR IOCL

P/E Ratio of industry 12.05

EPS (Amount In Rs) 16.29

Market Value of Equity Per Share (P/E * EPS) (Amount In Rs) 196.29

Value of Equity as per Relative Valuation (Amount In Rs) 476,593,718,478

Interpretation:

From all the above methods, we find that Value of IOCL is much more than value of

HPCL.

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Also from the above methods used, we find that, value of share for HPCL is undervalued and

value of share for IOCL is overvalued from industry average respectively.

7. INDIFFERENCE POINT

It’s that point where a common Earnings Before tax and Interest (EBIT) is calculated when

Earnings per Share (EPS) for two companies are equated. So at that value of EBIT for both

the companies we get EPS same for both the companies.

Therefore, Equating Earnings Per Share for HPCL and IOCL we have:

((EBIT-Interest HPCL) (1-Tax Rate))/No. of shares of HPCL =

((EBIT-Interest IOCL) (1-Tax Rate))/No. of shares of IOCL -------------------------------A

Assuming EBIT to be ‘x’, we have

Interest HPCL = Rs 2139.24 (in Crores)

Interest IOCL = Rs 5590.54 (in Crores)

No. of shares of HPCL= 338627250

No. of shares of IOCL= 2427952482

Tax Rate = 33.2175%

From the calculation, by using the equation A we have value of x = Rs 1579.87097 Crores.

So for EBIT of Rs 1579.87097 Crores, we have equal Earnings per Share for HPCL and

IOCL.

8. LEVERAGE ANALYSIS

Operating leverage: A type of leverage ratio summarizing the effect a particular

amount of operating leverage has on a company's earnings before interest and taxes

(EBIT). Operating leverage involves using a large proportion of fixed costs to variable

costs in the operations of the firm. The higher the degree of operating leverage, the

more volatile the EBIT figure will be relative to a given change in sales, all other

things remaining the same. The formula is as follows:

% change in EBIT

% change in sales

financial leverage has on a company's earnings per share (EPS). Financial leverage

involves using fixed costs to finance the firm, and will include higher expenses before

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interest and taxes (EBIT). The higher the degree of financial leverage, the more

volatile EPS will be, all other things remaining the same. The formula is as follows:

% change in EPS

% change in EBIT

Combined leverage: A leverage ratio that summarizes the combined effect the

degree of operating leverage (DOL), and the degree of financial leverage has on

earnings per share (EPS), given a particular change in sales. This ratio can be used to

help determine the most optimal level of financial and operating leverage for a firm.

The formula used is:

% change in EPS

% change in sales

Financials - IOCL

15

Financial leverage (-)40.77 / (-)20.59 = 1.98

The above table shows the computation of the operating, financial & combined leverage for

IOCL. The operating leverage of IOCL is (-) 0.64 which means that if there is 1% increase in

the sales of the company then the EBIT (Earnings before Interest & Taxes) goes down by

0.64%. Similarly the financial leverage of the company shows the relation between the

percentage changes in Earnings per Share (EPS) due to a percentage change in EBIT. The

financial leverage of IOCL is 1.98 which shows that the volatility of change in EPS with a

change in EBIT is high. The financial leverage indicates if there is 1% change in the EBIT

then the change in EPS will be 1.98% in the same direction.

Financials – HPCL

16

Leverage Calculations - HPCL:

The above table shows the computation of the operating, financial & combined leverage for

HPCL. The operating leverage of HPCL is 0.12 which means that if there is 1% increase in the

sales of the company then the EBIT (Earnings before Interest & Taxes) goes up by 0.12%.

Similarly the financial leverage of the company shows the relation between the percentage

changes in Earnings per Share (EPS) due to a percentage change in EBIT. The financial

leverage of HPCL is (-)11.76 which shows that the volatility of change in EPS with a change

in EBIT is very high. The financial leverage indicates if there is 1% change in the EBIT then

the change in EPS will be 11.76% on the opposite side.

Dividend is the distribution of a portion of a company's earnings, decided by the board of

directors, to a class of its shareholders. The dividend is most often quoted in terms of amount

each share receives (dividends per share).

In 2011-12 HPCL gave 287.83 Crore Rupee as the total annual dividend, 186.25 Crore Rupees

less than previous year. IOCL gave 1214 Crore Rupee as total annual dividend, 1093 Crore

Rupee less than previous year.

Dividend Yield- It shows how much a company pays out in dividends each year relative to its

share price = Dividend per Share / Market Price per share

Dividend Payout Ratio - It is the fraction of net income a firm pays to its stockholders in

dividends

17

= Dividend per share

Earning per share

Retention Ratio- The percent of earnings credited to retained earnings/ the proportion of net

income that is not paid out as dividends.

P/E Ratio – A ratio of a company's current share price compared to its per-share earnings.

Earnings per share

Ratios for IOCL and HPCL for last five years:

HPCL

Year 2011-12 2010-11 2009-10 2008-09 2007-08

Dividend per

Share 8.500590667 14.00118 12.00089 5.250443 3.000295

share 387.52 370.49 341.32 316.88 311.59

18

IOCL

Year 2011-12 2010-11 2009-10 2008-09 2007-08

Dividend per

Share 5.000205939 9.502039 12.99889 7.496005 5.503356

share 238.38 227.9 208.21 362.43 344.58

Graphs:

16

14

12

10

8 DPS HPCL

6 DPS IOCL

4

2

0

2011-12 2010-11 2009-10 2008-09 2007-08

19

DPS OF HPCL AND IOCL

0.35

0.3

0.25

0.2 DPR HPCL

0.15

DPR IOCL

0.1

0.05

0

2011-12 2010-11 2009-10 2008-09 2007-08

0.1

0.08

0.06

Dividend Yield HPCL

0.04 Dividend Yield IOCL

0.02

0

2011-12 2010-11 2009-10 2008-09 2007-08

18

16

14

12

10 P/E HPCL

8

P/E IOCL

6

4

2

0

2011-12 2010-11 2009-10 2008-09 2007-08

Interpretation:

20

HPCL has been increasing the total Dividend every year except last year and IOCL has

decreased the total dividend paid for the last two years.

In 2011-12 Dividend Yield of HPCL is higher than that of IOCL implying that HPCL

gives more dividend per share as compared to IOCL for per Rupee invested, but this

has not always been the case.

Higher P/E ratio of IOCL as compared to HPCL shows that investors are willing to pay

a higher price for per Rupee earning from IOCL.

This shows that the investors have a positive image about IOCL and are expecting

higher earnings growth in future.

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10. WORKING CAPITAL MANAGEMENT

Cash flows in a cycle into, around and out of a business. It is the business's life blood and

every manager's primary task is to help keep it flowing and to use the cash flow to generate

profits. If a business is operating profitably, then it should, in theory, generate cash

surpluses. If it doesn't generate surpluses, the business will eventually run out of cash and

expire .The faster a business expands, the more cash it will need for working capital and

investment. Good management of working capital will generate cash will help improve

profits and reduce risks. In this report the working capital turnover ratio was calculated by

using the following ratios:

Application in Business

A low turnover rate may point to overstocking, obsolescence, or deficiencies in the product

line or marketing effort. However, in some instances a low rate may be appropriate, such

as where higher inventory levels occur in anticipation of rapidly rising prices or expected

market shortages.

Conversely a high turnover rate may indicate inadequate inventory levels, which may lead

to a loss in business as the inventory is too low. This often can result in stock shortages.

Cost of sales yields a more realistic turnover ratio, but it is often necessary to use sales for

purposes of comparative analysis. Cost of sales is considered to be more realistic because

of the difference in which sales and the cost of sales are recorded. Sales are generally

22

recorded at market value, i.e. the value at which the marketplace paid for the good or service

provided by the firm. In the event that the firm had an exceptional year and the market paid

a premium for the firm's goods and services then the numerator may be an inaccurate

measure. An item whose inventory is sold (turns over) once a year has higher holding cost

than one that turns over twice, or three times, or more in that time. Stock turnover also

indicates the briskness of the business. The purpose of increasing inventory turns is to

reduce inventory for three reasons.

Increasing inventory turns reduces holding cost. The organization spends less money

on rent, utilities, insurance, theft and other costs of maintaining a stock of good to be

sold.

the revenue from selling the item remains constant.

Items that turn over more quickly increase responsiveness to changes in customer

requirements while allowing the replacement of obsolete items. This is a major concern

in fashion industries.

Debtors turnover ratio accounts receivable turnover ratio indicates the velocity of debt

collection of a firm.

The two basic components of accounts receivable turnover ratio are net credit annual sales

and average trade debtors. The trade debtors for the purpose of this ratio include the amount

of Trade Debtors & Bills Receivables. The average receivables are found by adding the

opening receivables and closing balance of receivables and dividing the total by two. It

should be noted that provision for bad and doubtful debts should not be deducted since this

may give an impression that some amount of receivables has been collected. But when the

information about opening and closing balances of trade debtors and credit sales is not

available, then the debtors turnover ratio can be calculated by dividing the total sales by the

23

balance of debtors (inclusive of bills receivables) given and formula can be written as

follows.

Accounts receivable turnover ratio or debtor turnover ratio indicates the number of times

the debtors are turned over a year. The higher the value of debtor turnover the more efficient

is the management of debtors or more liquid the debtors are. Similarly, low debtors turnover

ratio implies inefficient management of debtors or less liquid debtors. It is the reliable

measure of the time of cash flow from credit sales.

It indicates the number of times sundry creditors have been paid during a year. It is

calculated to judge the requirements of cash for paying sundry creditors. It is calculated by

dividing the net credit purchases by average creditors. Net credit purchases consist of gross

credit purchases minus purchase return. When the information about credit purchases,

opening and closing balances of trade creditors is not available then the ratio is calculated

by dividing total purchases by the closing balance of trade creditors.

Working capital turnover ratio indicates the velocity of the utilization of net working capital.

This ratio represents the number of times the working capital is turned over in the course

of year and is calculated as follows:

The two components of the ratio are cost of sales and the networking capital. If the

information about cost of sales is not available the figure of sales may be taken as the

numerator. Networking capital is found by deduction from the total of the current assets

the total of the current liabilities.

Significance:

24

The working capital turnover ratio measure the efficiency with which the working capital

is being used by a firm. A high ratio indicates efficient utilization of working capital and a

low ratio indicates otherwise. But a very high working capital turnover ratio may also mean

lack of sufficient working capital which is not a good situation.

HPCL IOCL

Ratios Formula 2011-12 2011-12

Inventory turnover ratio:

Cost of goods sold 56943.23 202283.1

Average inventory 27765.67 106113.72

Cost of goods sold/Average inventory 2.0508502 1.90628601

Days 360 360

Inventory conversion period Days/ITR 175.536955 188.848891

Debtors turnover ratio: Net Credit sales 178139.23 437706.59

Average Debtors 5203.59 19934.735

Net Credit sales /Average Debtors 34.2339097 21.9569806

Days 360 360

Debtor collection period Days/DTR 10.5158892 16.3956969

Creditors turnover ratio: Net Credit purchases 109370.73 190824.41

Average Creditors 17212.35 62897.21

Net Credit purchases /Average

Creditors 6.35420091 3.03390898

Days 360 360

Creditor payment period Days/CTR 56.6554324 118.658801

Working capital turnover

ratio: Cost of goods sold 56943.23 202283.1

Average working capital 5938.27 61855

Cost of goods sold /Net working

capital 9.58919517 3.27027888

Working Capital turnover period 37.5422539 110.082355

Analysis:

HPCL has a higher inventory ratio with a greater inventory conversion rate of 175

days. This means that HPCL is able to sell its products more quickly as compared

to IOCL, thereby reducing the amount of funds blocked in form of inventory

25

HPCL has a higher Debtors turnover ratio of 34.233 with a greater conversion rate

of 10.5 days. This means that HPCL has a much better receivables management

system as compared to IOCL.

HPCL has a higher Creditor turnover ratio of 6.354.However the no of days is 56.4.

The credit period is lower as compared to IOCL.

This means that HPCL gets a lesser credit period from its creditors as compared to

IOCL, Thereby increasing the requirement of cash required for purchases.

HPCL has a lower Net Working Capital however it has a faster turnover ratio. Also

it utilises lesser cash reserves as compared to IOCL which means that it is more

efficient with its working capital.

It is evident from above that HPCL has a better inventory management, receivables

management cash management and working capital management policies, as

compared to that of IOCL.

The only negative point for HPCL is the lesser credit period it gets, which the

management must try to extend, to lower the requirement of working capital further.

HPCL has an aggressive approach towards working capital management, whereas,

IOCL has a more conservative approach. This is evident from the fact that HPCL

uses lesser cash reserves but better working capital turnover ratio.

26

11. PORTFOLIO ANALYSIS

Portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, as well

as their mutual, exchange-traded and closed-fund counterparts. Portfolios are held directly by

investors and/or managed by financial professionals.

Risk-Return Analysis

Calculation Steps:-

The daily stock prices for the years 2004-2012 have been taken from the Yahoo

Finance.

= ln (End day price / Previous day price)*100

o Annualized Return = ( 1 + Daily return)n − 1

o where n is the number of the trading days( here we have taken 245 days).

Annualized Risk = ( 1 + Daily risk)n – 1

Beta is calculated using the formula:

= Covariance of security and market / Variance of market

11.1 PORTFOLIO – I

We have made a portfolio of three securities in equal weights.

The securities are IOCL, HPCL and BSE.

BSE sensex has been used as market Index.

Average Return 0.05103463 0.003027313 0.065800559

Annualised Return 0.13315178 0.007444377 0.174870999

Standard Deviation 2.78676873 2.530383798 1.716062158

Variance 7.76607993 6.402842164 2.944869331

Maximum Return 2.83780335 2.533411111 1.781862718

Minimum return -2.7357341 -2.52735649 -1.650261599

Covariance Matrix

27

IOCL 7.76208298 4.3134369 1.50436883

HPCL 4.3134369 6.39954683 1.56862894

BSE 1.50436883 1.56862894 2.9433537

Portfolio risk depends on the co-movements of return of two securities. It can be calculated by

following formula - (in case of 2 securities)

= 𝜎2xW2x + 𝜎2y W2y +2 WxWy 𝜎x 𝜎y Corxy

IOCL HPCL BSE

0.33 0.33 0.33

IOCL 0.33 0.845290836 0.469733278 0.163825765

HPCL 0.33 0.469733278 0.696910649 0.170823691

BSE 0.33 0.163825765 0.170823691 0.320531218

Variance 3.471498173

standard deviation 1.863195688

Mean Return 0.104104162

% Return 10.41

Interpretation

IOCL is the most risky security in the portfolio and BSE Sensex is safest.

Also IOCL is more risky than HPCL, and also gives a higher return as compared to

HPCL.

The portfolio return is equal to 10.41%

assuming in comparison to the amount of return he expects from his investment. In

simple language, the lower the ratio of standard deviation to mean return, the better

the risk-return tradeoff

= 1.863196 = 17.8974

0.104104

11.2 PORTFOLIO – II

The securities are IOCL, HPCL and BSE oil and gas.

Prices for the years 2004- 2012 have been used to analyze the portfolio.

28

BSE oil and gas index has been used as market Index.

Average Return 0.05103463 0.003027313 0.059877967

Annualized Return 0.13315178 0.007444377 0.15795685

Standard Deviation 2.78676873 2.530383798 1.957825294

Variance 7.76607993 6.402842164 3.833079884

Maximum Return 2.83780335 2.533411111 2.017703261

Minimum return -2.7357341 -2.52735649 -1.897947328

Covariance Matrix

0.33 0.33 0.33

IOCL HPCL BSE oil & gas

0.33 IOCL 0.845290836 0.469733278 0.21360309

0.33 HPCL 0.469733278 0.696910649 0.221423494

0.33 BSE Oil & gas 0.21360309 0.221423494 0.417207565

Variance 3.768928774

Standard Deviation 1.941372909

Mean Return 0.098522493

%return 9.85

Interpretation

IOCL is the most risky security in the portfolio and BSE oil and gas is safest.

Also IOCL is more risky than HPCL, and also gives a higher return as compared to

HPCL.

The portfolio return is equal to 9.85%

= 1.94137= 19.70

0.09852

29

Conclusion

Since, the coefficient of variation is lower for portfolio 1 as compared to portfolio 2, it

offers a better risk-return to investors.

30

12. REFERENCES

1. http://www.hindustanpetroleum.com/En/UI/AboutUsHomeLand.aspx

2. http://www.iocl.com/aboutus.aspx

3. http://capitalmind.in/2011/06/t-bill-auctions-at-8-1-indian-yield-curve-inverts/

4. http://www.iocl.com/InvestorCenter/AnnualReport.aspx

5. http://www.hindustanpetroleum.com/En/UI/Financials.aspx

6. http://in.reuters.com/finance/stocks/overview?symbol=HPCL.BO

7. http://in.reuters.com/finance/stocks/overview?symbol=IOC.BO

8. http://in.finance.yahoo.com/q?s=hpcl.bo&ql=1

9. http://in.finance.yahoo.com/q?s=IOC.BO&ql=1

10. http://in.finance.yahoo.com/q?s=%5EBSESN&ql=0

31

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