Selan ExplorationTechnology Limited

Investment View: Buy

CMP: Rs.263.25

Target Price: Rs 327.77

Hindustan Oil ExplorationCompany Limited

Investment View: Sell

CMP: Rs.114.30

Target Price: Rs 104

SELAN HOEC

Sales (Rs. Cr) 137.3 116.2

EBITDA Margin 69% 68.9%

EPS 37.12 5.20

P/E 7.09 22

Estimated Figures

Date: 13th Sept 2008

Oil & Gas Exploration and Production (E&P) IndustryWe initiate our coverage on two mid-cap Oil & GasExploration and Production players with a mixed view ofbuy & sell on these stocks under coverage. While SelanExploration Technology Ltd (SELAN) & Hindustan OilExploration Company Ltd (HOEC) operates on a similarbusiness model but we believe that SELAN carries lessbusiness risk and is better valued as compared to HOEC.

This industry in India functions under a ProductionSharing regime, in which the Company enters into aProduction Sharing Contract with Indian Government forexploration and development of hydrocarbon resources.The Government has awarded and signed a number ofProduction Sharing Contracts with Private Sector OilCompanies for Exploration Blocks under New ExplorationLicensing Policy (NELP) and Coal Bed Methane (CBM)Projects.

The latest effort in the industry is regarding NELP – VIIwhich shall further expand the industry. The Private Sectorwith its Joint Ventures has contributed significantly inexploitation of existing oil reserves in the country with thestriking of huge discoveries of oil and gas within thecountry. As a result, the domestic crude oil production iscontinuously improving with significant contributions ofcrude production from private operators, thus reducingforeign exchange outflow on crude imports. Oil sectortoday is one of the most prospective sectors where newergrowth avenues for business and employment are openingup, even though import of crude oil represents India’ssingle largest item of import.

Over the years, the Government, in its effort to promoteE&P activities to help in bridging the increasing supply-demand gap in oil & gas, has been offering explorationtracts – onshore and offshore – to companies on aninternational competitive bidding basis as per the NewExploration Licensing Policy (NELP).Besides participationin Indian basins, there are opportunities in severalinternational provinces to participate in exploration & ifsuccessful production of hydrocarbons.

Selan Exploration Technology LimitedWe initiate the coverage on Selan Exploration, with a buyrecommendation as the company is at a stage to takeoffwith new well developments in the existing oilfields anddevelopment of new oilfields also nearing completion,where production is about to commence. Even with oilprices stabilizing at lower levels, we expect the company toexhibit enhanced performance with increased productionand reasonable margins.

Operational Oilfields warrant certainty of productionAfter opening the oil sector by Government of India in 1992for private initiative in exploration and production ofHydrocarbons, SELAN was amongst the first private sectorcompanies to have obtained rights to develop threediscovered oilfields situated in the state of Gujarat namelyBakrol, Indrora and Lohar, all with proven oil and gasreserves. SELAN was subsequently awarded two morefields in Gujarat namely Ognaj Oilfield and Karjisan Gasfield. Mining lease has also been executed for Ongaj Oilfield with Government of Gujarat and the mine is about tocommence development and production activities.

Low marketing risk but performance impacted by oilpricesWith assured offtake of the entire oil and gas productionfrom these blocks by the Government, as per the terms ofthe Production Sharing Contract there is zero marketingrisk associated with this project. However, the pricing islinked to the prevailing oil prices & therefore sales andmargins are also affected by international oil prices.

Outperformance in financial resultsThe company has shown impressive performance in Q1’09during which, revenue raised up to Rs 35.8 Crores from Rs10.1 Crores of the Q4’08 on the back of higher productionfrom new wells and high crude prices. EBITDA margin alsoincreased to 92%. Net profit was Rs. 17.8 Crores was grownby 479% on Q0Q basis in this quarter.

Secured Growth plansThe company has relatively low financial gearing andhence there is scope for syndicating debt to fuel its growthplans in future.

Selan ExplorationTechnology Limited

Investment View: Buy

BSE Code: 530075

NSE Code: SELAN

Reuters Code: SELA.BO

CMP: Rs.263.25

Target Price: Rs: 327.77

52 Week High: Rs.329.90

52 Week Low: Rs.124.00

Market Cap: Rs. 379.5 Cr

P/E: 13.63

Market Lot: 1

Face Value: 10

Company OverviewSelan Exploration Technology Limited (SELAN) is a private sector listed company,incorporated in 1985, engaged in oil exploration and production since 1992.

In year 1992 Government of India opened the oil sector for private initiative inexploration and production of Hydrocarbons, SELAN was amongst the first privatesector companies to have obtained rights to develop three discovered oilfields situated inthe state of Gujarat namely Bakrol, Indrora and Lohar, all with proven oil and gasreserves. SELAN was subsequently awarded two more fields in Gujarat namely OgnajOilfield and Karjisan Gas field. The various seismic and reserves assessment studieshave established substantial amounts of oil and gas reserves in these blocks, whichrequire developmental work and for the purposes it would require substantial amountsof Capital investment to augment its development and growth objectives.

SELAN also has taken significant steps in terms of further development of Bakrol,Indrora and Lohar oilfields where seven new wells have been drilled in the drillingcampaign which commenced in the last quarter of F.Y. 2007-08. The production testingof these wells has been encouraging and they have yielded good production levels. TheCompany has been analyzing the well logging data from the newly drilled wells tofurther identify 8-10 prospective drilling locations which would be taken up for drillingin the fiscal year 2008-09.

All the oil and gas blocks have a well laid out infrastructure. Hence these blocks areeasily accessible and are in close proximity to the Government's crude gathering stationas well as are in close proximity to a large industrial town

Operational ReviewThe confirmed and feasible Reserves of Bakrol Oilfield have been upgraded from theprevious 43.22 mmbbls to 73.30 mmbbls after the completion of the current drillingcampaign in Bakrol Oilfield.

Escalation in productionThe Company has been taking steps to develop its oil and gas fields so that productionfrom the fields can be enhanced. Further prospective drilling locations are also beingidentified on an ongoing basis for developing the oilfields and enhancing crude oilproduction.

Crude oil production increased by 132% during the Q1’09 as it was 72,000 barrel in thisquarter in the comparison of Q4’08 (31,000 barrel). Company expects to achieve volumesof 500,000 – 700,000 barrels per year within the next 2-3 years.

Year 2004 2005 2006 2007 2008Crude Oil Production (barrels) 62699 70206 73875 100963 120226

Crude oil production

SELAN has rights over these 5 discovered oil fields given by MoPNG located within40Kms radius from Ahmedabad. Company currently functions in 3 oil fields at Barkol,Indrora & Lohar. The company has warrant for 25 years and the lease for the abovefields started 10 years back. The company has a lease period left of 15 years. The averageproducing life of a well is about 15-20 years. In 2004, company was given 2 more fields:Ognaj & Karsijan where the commercial production is yet to be start.

Company have plan to drill 8-10 new wells and do some seismic work at a capex of 50-70crores in each of the next 3 years. Funding shall be through a combination of debt,internal accruals and promoter funding.

Location Indrora Lohar Barkol

Covered Area (Sq KM) 130 5 36Operating Wells 4-5 2-3 7Production 100bpd 80-100bpd 700bpd2P Reserves (mn Barrels) Under assessment Under assessment 73.3Status Producing Producing Producing

BarkolThis oil field is account for almost 90% of production for the company. The proven andprobable reserves are revised up to 73.3 mn barrels from 43.22 mn barrels in the oil field.This oil field is covering the area of 36 Sq KM.

IndroraIndrora, the biggest oil field owned by the company, covering area around 130 Sq Km(More the 3.5 times of Barkol Oilfield). Company management is confident about the oilreserve in this field, but the oil is trapped in shale/loose sands. Company is planning todilute the participatory share of the oilfield and will use different technology in order tosustain higher production rate.

KarsijanThis field was awarded to the company in 2004. The commercial production is yet tostart in the field. This is the only gas producing field of the company, for which thecompany has taken all the mining and regulatory approvals. Drilling and CommercialProduction in Karjisan shall commence during this year.

LoharLahar oilfield is covering the 5 Sq KM area, currently 2-3 wells are operating in the field.The total production from this small oilfield is around 100bpd. Total reserves are underassessment in this field.

OgnajCompany has received the mining lease for this oil field on 5th-August-2008. Thephysical handover of the field is yet to be done. Commercial production from this oilfield is expected in FY 2009-10. This oil field is covering around 13.9 Sq KM area.

SELAN has a Development Plan for drilling of additional wells in these blocks in thenext 3 to 5 years. The Plan is intended to be executed in a phased manner and wouldinvolve large capital expenditures, to be funded through a combination of externalborrowings and internal accruals. The proposed external borrowings shall be drawn invarious stages of completion of each phase.

Environment ClearanceCompanies need to obtain Environment Clearance (EC) from Ministry of Environmentand Forests (MoEF) in order to start new drilling activities according to revisedguidelines from MoEF. The Company has already obtained the EC’s for Bakrol, Indrora,Lohar and Ognaj in 2007-08. The EC for Karjisan has also subsequently been approvedby MoEF in the Expert Advisory Committee (EAC) meeting held on 10 June 2008 andissued to the Company.

Production Sharing ContractProduction Sharing Contract (PSC) is signed between the Government of India (GOI)and SELAN for a period of 25 years for the exploration and production of crude oil. Priceof crude oil is based on international market rates; however, payment is receivable inIndian Rupees at the prevailing US Dollar / Rupee conversion rate. Historically, thecompany has been receiving a price at 5-7% discount to Brent.

EBITDA Margins vs International Crude oil PricesCompany’s earnings before interest tax depreciation and amortization is heavily dependon crude oil prices prevailing in international market. As In the terms of ProductionSharing Contract (PSC) with Government of India, selling price of crude oil per barrel isto be determined FOB delivery point at the prevailing international market rates in USDollars. However, payment is receivable in Indian Rupees at the prevailing US Dollar /Rupee conversion rate.

Thus the southward crude oil prices in the international prices may affect the EBITDAmargins of the company in current quarter.

EBITDA vs. Crude Oil

Crude oil prices touched its peak in the 1st quarter of FY 08-09 more than US$ 140/barrel. EBITDA margins in this quarter was at 90.7% which was at 65.8% in ths samequarter of last year while crude oil prices was moving around US$ 65-70 / barrel. As theinternational crude oil prices are now moving downwards it may affect the EBITDAmargins of the company in the quarter.

Risks and Concerns

· Revenues of the company is depends upon the international crude oil prices andexchange rates, hence sudden drop in crude oil prices and US$ exchange rate mayaffect the company’s revenues.

· Companies working in Exploration & Production segment require variousenvironment clearances in order to drill the wells in the oilfields; it may take thetime so the plane of expansions of the company may be delay.

· Dry wells (wells having insufficient oil), could result into low rate of production.

· Availability of rigs and crews at reasonable rates could emerge as significantbottleneck and also impact the capital costs.

Historical Crude Oil Prices

Investment Rationale

Significant Oil & Gas ReservesThe Proven and Probable Reserves of Bakrol Oilfield have been upgraded from theprevious 43.22 mmbbls to 73.30 mmbbls after the completion of the current drillingcampaign in Bakrol Oilfield. Further the company’s biggest oilfield Indrora (3.5 times thesize of Barkol field) is under assessment and is expected to have significant reserves. Theplan is intended to be executed in a phased manner and would involve large capitalexpenditures, to be funded through a combination of external borrowings and internalaccruals. We expect the company to ramp up production from 120,000 barrels in FY08 to400,000 barrels in FY10. The company should be able to increase the annual productionto 1 million barrels in 3-4 years.

Low Production CostThe company’s Oilfields are discovered oilfields thus there are no exploration risks. Thecompany incurs the seismic survey costs, drilling costs and the matter of concern is notwhether there is oil but how much of it is there. Accordingly, the production costs arelow and stand at USD 15 per barrel (including $4 royalty/cess paid to ONGC). Further,the company’s capex costs for drilling a well is also comparatively lower and thus have ashort payback period making drilling attractive.

Low Debt CompanySelan has a Debt/Equity ratio of 0.15 thus it will not be affected by high interest costs.Further, the company can take on leverage to fund and support its growth at competitiverates.

Valuation:DCF valuation F/Y 2009E F/Y 2010E F/Y 2011E F/Y 2012E Terminal ValueFree Cash Flow (40.7) 7.3 13.3 35.5 902.2Discounted Cash Flow (35.7) 5.6 8.9 20.9 465.7

TerminalGrowth 5.0%

Total DCF 465.5Net debt 7.0Shareholders Value 472.5No. of shares 1.4Price per share 327.77

Debt 16.6Equity 54.7

71.3WACC 14.1%Cost of debt 8.0%Risk free return 10.0%Beta 1.2Expected return 15.0%Cost of equity 16%

Shareholding PatternQuarter Ending 31-Dec-07 30-Sep-07 31-Mar-08 30-Jun-08Promoters Holding (Indian) 13.98% 13.71% 14.16% 14.23%

Promoters Foreign (Foreign) 25.54% 25.54% 25.89% 25.83%

Public Holding Institutions 2.76% 3.89% 3.12% 2.14%

Public Holding Non - Institutions 57.71% 56.86% 56.83% 57.80%

Total 14,416,070 14,416,070 14,416,070 14,416,070

FinancialsQuarterly Income Statement 4Q F/Y

20081Q F/Y2009

2Q F/Y2009

3Q F/Y2009

4Q F/Y2009

1Q F/Y2010

Revenue 10.1 35.8 37.6 33.6 30.3 30.0Growth (Q/Q) 30.0% 254.5% 5.0% -10.5% -9.9% -0.8%Direct expenses (1.4) (2.9) (4.2) (5.4) (7.9) (9.3)Gross Profit 8.7 32.9 33.4 28.2 22.4 20.7Gross Margin 86.2% 92.0% 89.0% 84.0% 74.0% 69.0%Employee Cost (1.2) (0.5) (0.6) (0.7) (1.0) (0.8)Operating Expenses (SG&A) - - (7.1) (6.4) (5.8) (5.7)Operating expense as % of sale 0.0% 0.0% 19.0% 19.0% 19.0% 19.0%EBITDA 7.5 32.5 25.7 21.2 15.7 14.2EBITDA Margin 74.5% 90.7% 68.4% 62.9% 51.7% 47.3%Depreciation (2.1) (2.3) (2.5) (2.8) (3.0) (3.3)Operating Profit 5.5 30.2 23.2 18.4 12.6 10.9Operating Margin 54.2% 84.3% 61.7% 54.7% 41.6% 36.2%Interest (0.5) (0.6) (0.6) (0.6) (0.6) (0.6)Other Income/(expenditure) 0.5 0.4 0.3 0.3 0.3 0.3Profit Before Tax 5.5 29.9 22.9 18.1 12.3 10.6Provision for tax (2.8) (12.1) (7.5) (6.0) (4.1) (3.5)Tax Rate 50.8% 40.4% 33% 33% 33% 33%Net Profit- continuing operation 2.7 17.8 15.3 12.1 8.2 7.1Growth Y/Y -20% 479% 349% 210% 205% -60%Net Profit 2.7 17.8 15.3 12.1 8.2 7.1

No. of equity shares 1.4 1.4 1.4 1.4 1.4 1.4EPS- continuing operations 1.87 12.36 10.63 8.40 5.72 4.91Growth Y/Y -20% 479% 349% 210% 205% -60%No. of shares- basic 1.4 1.4 1.4 1.4 1.4 1.4EPS- basic 1.87 12.36 10.63 8.40 5.72 4.91Growth Y/Y -20% 478% 350% 210% 206% -60%No. of shares- diluted 1.4 1.5 1.5 1.5 1.5 1.5EPS- diluted 1.87 12.19 10.48 8.29 5.64 4.84Growth Y/Y -20% 470% 344% 206% 202% -60%

Annual Income Statement 2007 2008 2009E 2010E 2011E 2012ERevenue 26.2 34.5 137.3 141.1 194.9 227.0Growth (Y/Y) 39.8% 31.8% 298% 3% 38% 16%Direct expenses (5.4) (7.1) (20.3) (31.0) (42.9) (49.9)Gross Profit 20.7 27.3 117.0 110.1 152.0 177.1Gross Margin 79.3% 79.3% 85.2% 78.0% 78.0% 78.0%Employee Cost (0.8) (1.9) (2.8) (3.3) (3.8) (4.3)Operating Expenses (SG&A) - - (19.3) (25.4) (35.1) (40.9)Operating expense as % of sale 0.0% 0.0% 14.0% 18.0% 18.0% 18.0%EBITDA 19.9 25.4 95.0 81.4 113.2 132.0EBITDA Margin 76.2% 73.8% 69.1% 57.7% 58.1% 58.1%Depreciation (4.5) (5.3) (10.6) (15.0) (20.0) (25.0)Operating Profit 15.4 20.1 84.4 66.5 93.2 107.0Operating Margin 58.9% 58.4% 61.4% 47.1% 47.8% 47.1%Interest (0.9) (1.6) (2.6) (7.3) (6.9) (5.9)Other Income/(expenditure) 1.4 1.2 1.4 1.4 1.4 1.4Profit Before Tax 15.9 19.7 83.2 60.53 87.77 102.47Provision for tax (5.4) (6.8) (29.7) (20.2) (29.3) (34.2)Tax Rate 33.7% 34.5% 35.7% 33.4% 33.4% 33.4%Net Profit- continuing operation 10.6 12.9 53.5 40.33 58.49 68.29Growth Y/Y 23% 22% 314% -25% 45% 17%Net Profit 10.6 12.9 53.5 40.33 58.49 68.29

No. of equity shares 1.4 1.4 1.4 1.4 1.4 1.4EPS- continuing operations 7.33 8.96 37.12 27.98 40.57 47.37Growth Y/Y 22.8% 22.1% 314% -25% 45% 17%No. of shares- basic 1.4 1.4 1.4 1.4 1.4 1.4EPS- basic 7.33 8.96 37.11 27.98 40.57 47.36Growth Y/Y 19.7% 22.1% 314% -25% 45% 17%No. of shares- diluted 1.4 1.4 1.5 1.5 1.5 1.5EPS- diluted 7.33 8.96 36.60 27.59 40.01 46.71Growth Y/Y 19.7% 22.1% 309% -25% 45% 17%

Key Ratios F/Y 2007 F/Y 2008 F/Y 2009 F/Y 2010 F/Y 2011 F/Y 2012NOPLAT 10.21 13.20 54.30 44.31 62.16 71.33Capital Employed 52.74 63.95 166.76 205.70 256.36 293.70ROIC 21.7% 22.6% 47.1% 23.8% 26.9% 25.9%WACC 11.6% 14.1% 13.4% 13.9% 14.5% 15.5%ROIC-WACC spread 10.1% 8.5% 33.6% 9.9% 12.4% 10.4%

Balance Sheet 2007 2008 2009E 2010E 2011E 2012ECash & equivalents 10.3 23.6 23.6 23.6 23.6 23.6Receivables 7.6 11.5 45.1 46.4 64.1 74.6Inventory 1.4 1.8 5.0 7.7 10.6 12.3Other current assets 6.7 7.5 7.5 7.5 7.5 7.5Total current assets 26.0 44.4 81.3 85.2 105.8 118.1Gross Block 12.7 14.0 71.4 121.4 171.4 221.4Accumulated Depreciation (8.4) (9.1) (19.7) (34.7) (54.6) (79.6)Capital WIP 2.8 7.4 - - - -Net Block 7.1 12.3 51.7 86.7 116.8 141.8Other assets 43.1 53.1 53.1 53.1 53.1 53.1Total assets 76.2 109.7 186.1 225.0 275.7 313.0Short term debt - - (8.1) 1.6 4.9 (14.9)Creditors 2.4 - - - - -Other current liabilities 3.4 19.1 - - - -Total current liabilities 5.8 19.1 (8.1) 1.6 4.9 (14.9)Term Loan and debentures 11.1 16.6 66.6 55.5 44.4 33.3Deferred tax liability 14.9 19.3 19.3 19.3 19.3 19.3Reserves and Surplus 30.0 40.3 93.8 134.2 192.7 260.9Equity Share Capital 14.4 14.4 14.4 14.4 14.4 14.4Total liabilities 76.2 109.7 186.1 225.0 275.7 313.0

Cash Flow 2007 2008 2009E 2010E 2011E 2012EEBITDA 20.5 25.7 95.0 81.4 113.2 132.0Tax paid (2.0) (0.5) (29.7) (20.2) (29.3) (34.2)Change in W/c (0.6) 3.5 (56.0) (3.9) (20.6) (12.3)Change in receivables 1.5 (4.1) (33.7) (1.2) (17.7) (10.6)Change in inventory (0.1) (0.4) (3.2) (2.6) (2.9) (1.7)Change in other current assets - - - - - -Change in creditors (2.0) 8.0 - - - -Change in other current liab. - - (19.1) - - -Operating cash flow 18.0 28.7 9.3 57.3 63.3 85.5Capital expenditure (24.2) (20.5) (50.0) (50.0) (50.0) (50.0)Free Cash Flow (6.2) 8.2 (40.7) 7.3 13.3 35.5Interest paid (0.9) (1.7) (2.6) (7.3) (6.9) (5.9)Payment of dividend - - - - - -Other 0.8 1.3 1.4 1.4 1.4 1.4Cash Surplus/(deficit) (6.3) 7.8 (41.9) 1.4 7.8 30.9Financed/used by/in:Availment/repayment of debt 3.0 5.5 41.9 (1.4) (7.8) (30.9)Change in Short term debt - - (8.1) 9.7 3.3 (19.8)Change in Long term debt 3.0 5.5 50.0 (11.1) (11.1) (11.1)Net Change in Cash (3.2) 13.3 - (0.0) - -Opening Cash Balance 13.6 10.3 23.6 23.6 23.6 23.6Closing cash & equivalents 10.3 23.6 23.6 23.6 23.6 23.6

Price Volume Chart

HOEC LimitedHOEC operates in the Oil & Gas Exploration andProduction (E&P) Industry, with its current portfolio ofassets located in India. The E&P are under a ProductionSharing regime, wherein the Company enters into aProduction Sharing Contract with the IndianGovernment for exploration and development ofhydrocarbon resources.

The Company initiated eight Oil & Gas Blocks under itsmanagement in the state of Gujarat, Tamilnadu andAssam. Due to non commerciality of a block in CambyBasin, it was surrender to Government. Therefore, nowthe Company holds 7 blocks under its name.

The PY-3 Block in Cauvery Basin contributes maximumtowards company total revenue. CB-ON/7 and NorthBalol Field in Gujarat are also operating in a healthycondition, but the Asjol Block in same location is on adownward trend with a reducing production capacity of46btupd. The same is being considered for reassessment.A commercial discovery of Gas has been made in PY-1Block & is soon expected to be profitably operational.The other two blocks CB-OS/1 and AAP-ON-94/1, are indifferent phases of Production & Development and thecommercial viability of these projects is not assured atthis point of time.

The Company also has a marketing tie-up with the U.K.based Bardhal, under the name HOEC Bhardal IndiaLtd, which markets Bardhal’s high performance engineadditive products in India.

Eni, a U.K. based company has recently acquiredadditional 20% stake in HOEC, resulting in total of47.17% stake of Eni in HOEC. This led to reduction inHOEC public shareholding from 72.83% to 52.82%.

We believe that at current valuation factors in extremeoptimism from the company’s performance which wehave observed are against the previous businessexperience of company operations.

Hindustan Oil & ExplorationCompany Limited

Investment View: Sell

BSE Code: 500186

NSE Code: HINDOILEXP

Reuters Code: HOEX.BO

CMP: Rs.114.30

Target Price: Rs. 104

52 Week High: Rs.176.90

52 Week Low: Rs.98.00

Market Cap: Rs. 1491 Cr

P/E: 57.44

Market Lot: 1

Face Value: 10

The CompanyHOEC operates in the Oil & Gas Exploration and Production (E&P) Industry, with itscurrent portfolio of assets located in India. The E&P industry in India operates under aProduction Sharing regime, wherein the Company enters into a Production SharingContract with the Government of India for exploration and development of hydrocarbonresources. Typically, players form an unincorporated joint venture consortium toaddress specific opportunity with flexibility to farm-out or farm down its participatinginterest subject to customary government approvals. This structure allows the E&Pplayers to, not only diversify risk, but also helps bringing in collaborative and variedexpertise.

Over the years, the Government, in its endeavor to promote E&P activities to help inbridging the increasing supply-demand gap in oil and gas, has been offering explorationtracts – onshore and offshore – to companies on an international competitive biddingbasis as per the New Exploration Licensing Policy (NELP).

Operations OverviewThe Company’s activities relate to exploration and production (based on explorationsuccess) of hydrocarbons - crude oil and gas, which are natural resources. TheCompany’s aggregate production during the FY 2006-07 was 503,408 barrels of oilequivalent (boe) (crude oil: 494,622 bbls; gas: 1,548,788 scm) as against 460,172 boeduring the previous year.

Field located in Cauvery Basin continues to be the predominant source of the Company’sproduction.

Name of the Block HOEC Interest Remarks

AAP-ON-94/1(Assam-Arakan Basin)

Exploration – 40.32%Dev. & Prod. – 26.88%

After abandoning the wellsinitially, new seismic data wascollected in 2003 pursuant to whichinitial exploration has confirmedpresence of gas reserves. It isplanned to for further exploration& appraisal.

CY-OS-90/1 (PY-3Field)(Tamilnadu - CauveryBasin)

Exploration – 21.00%Dev. & Prod. – 21.00%

Being the largest oil producingblock of the company, it contributes80-90% crude production of thecompany. All the crude oil fromthis field is sold to Chennai

Petroleum Corporation Limited(CPCL), the Government’snominee, at a price linked to Brent.

PY – 1(Tamilnadu - CauveryBasin)

Exploration – 100%Dev. & Prod. – 100%

The block contains basement gasfield & the Company’s revised planof development (RPoD) envisagesdevelopment of these gas reservesby drilling 3 extended wells. Theproject is expected to be completedin the year 2009. The company hasentered into natural gas sale andpurchase agreement with a powercompany for 51,000 btupd.

Asjol(Mehsana, Gujarat –Camby Basin)

Exploration – 50.00%Dev. & Prod. – 50.00%

3 Wells are on production since1995, however the productionlevels have dropped significantlyand the company is in the processof reassessment.

North Balol Field(Mehsana, Gujarat –Camby Basin)

Exploration – 25.00%Dev. & Prod. – 25.00%

Currently with 3 wells onproduction, the Company hasexecuted a Gas Sharing Agreement(GSA) with GSPC. AdditionalDevelopment has also beenplanned for implementation.

CB – OS/1(Gujarat – CambyBasin)

Exploration – 57.11%Dev. & Prod. – 38.07%

Commercial Discovery has beendeclared & currently Operator ispreparing Plan of Development forapproval. ONGC [licensee] hasbacked in for their 30% share in thedevelopment phase. Evaluation ofHarinagar area, of about 846 sq.km. for commerciality is underprogress.

Block CB-ON-7 (Palej)(Bharuch, Gujarat –Camby Basin)

Exploration – 50.00%Dev. & Prod. – 35.00%

After the completion of explorationphase, 2 oil fields have beendiscovered, is under production &development phase.

Block CY-OSN-97/1In the past, the Company with consortium had drilled two exploration wells in BlockCY-OSN-97/1, as per commitment under the Production Sharing Contract (PSC), whichhad been plugged and abandoned. At the end of exploration period, as per the terms ofthe PSC, the Block CY-OSN-97/1 stands relinquished. The Company had 80 %participating interest in this Block.

SubsidiaryHOEC Bardahl India Limited (HBIL)HOEC and Bardahl Manufacturing Corporation Inc., USA, (Bardahl) are engaged in theformulation, manufacturing and marketing of Bardahl range of high performance engineadditives. The companies have agreed to undertake the new project through HOECBardahl India Limited (formerly Hindage Oilfield Services Limited) a wholly ownedsubsidiary of HOEC.

On account of focused marketing strategy, HBIL has been able to increase its presence inthe automotive segment through strategic alliance with OEMs like Maruti and Hyundai.Further, HBIL is targeting industrial segment, more specifically power generation.

Eni UK Holding stake in HOEC (Aug’08)Eni UK Holding Plc, acquired over 2.61 crore shares in HOEC, representing 20 per centstake in the company through an open offer at Rs 144.2 per share, taking the total size ofthe offer to over Rs 376 crore.

Accordingly, the public shareholding in HOEC has decreased to 52.82 per cent from theearlier 72.83 per cent.

In April, Eni had offered to buy an additional 20 per cent stake in HOEC. The open offerfor 20 per cent stake came after Eni SPA, the parent company of Eni Holding, bought UKcrude producer Burren Energy Plc, which owned 27.17 per cent in HOEC. Thetransaction led to an indirect purchase of 27.17 per cent stake in HOEC.

RISKS AND UNCERTAINTIES

The principal risks and uncertainties facing the Company, and the action taken tomitigate these risks, are as follows:

Oil Price VolatilityHOEC is exposed to volatility in the oil price since the company does not have any oilprice hedge. The impact of a falling oil price is however partly mitigated via theproduction sharing formula in the PSCs, whereby our share of gross productionincreases in a falling oil price environment due to cost recovery mechanism.

Cost Inflation impacting both Goods and ServicesUnder the terms of the PSCs, operating expenditure and capital costs are recoverablethrough cost recovery mechanism, and so the effect of cost increase is cushioned tocertain degree, subject always to approval of expenditure by the ManagementCommittees under the PSCs.

Geological RiskExploration is inherently a risky business, with statistically only a relatively smallproportion of exploration wells resulting in commercial discovery. It is not possible toinsure against the risk of failure.

Shareholding PatternQuarter Ending 31-Dec-07 30-Sep-07 31-Mar-08 30-Jun-08Promoter Shareholding - Foreign 27.17% 27.17% 27.16% 27.16%Public Shareholding - Institutional 14.20% 15.58% 18.24% 15.74%Public Shareholding - Non Inst 58.63% 57.25% 54.59% 57.09%Total number of Shares 130493289 130493289 78312668 78312668

FinancialsIncome Statement 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Income 51.0 45.0 90.0 103.2 122.2 96.8

Growth (Y/Y) -11.7% 100.1% 14.7% 18.4% -20.8%

Direct expenses (18.8) (16.7) (18.2) (19.1) (20.6) (35.9)

Gross Profit 32.2 28.3 71.9 84.1 101.6 60.9

Gross Margin 63.1% 62.8% 79.8% 81.5% 83.1% 62.9%

Employee Cost (2.4) (3.3) (5.0) (7.2) (6.1) (7.8)

Operating Expenses (SG&A) (1.0) (1.4) (2.0) (10.2) (11.3) (2.4)

Operating expense as % of sale 1.9% 3.1% 2.3% 9.9% 9.2% 2.4%

EBITDA 28.8 23.6 64.8 66.7 84.3 50.7

EBITDA Margin 56.4% 52.4% 72.0% 64.6% 68.9% 52.4%

Depreciation (14.4) (4.6) (8.8) (7.8) (7.7) (5.3)

Operating Profit 14.3 19.0 56.0 58.9 76.6 45.4

Operating Margin 28.1% 42.2% 62.2% 57.0% 62.6% 46.9%

Interest (0.0) (0.0) (1.6) (1.8) (4.9) (7.6)

Other Income/(expenditure) 7.7 4.5 6.2 12.8 22.8 20.5

Profit Before Tax 22.1 23.5 60.6 69.9 94.5 58.3

Provision for tax 6.4 0.8 (22.9) (9.3) 1.2 (15.8)

Tax Rate -29.1% -3.3% 37.8% 13.3% -1.2% 27.1%

Net Profit- continuing operation 28.5 24.3 37.7 60.6 95.7 42.5

Growth Y/Y -15% 55% 61% 58% -56%

Provisions & Write offs (17.0) (2.2) 1.1 (41.9) (93.1) (16.7)

Net Profit 11.5 22.1 38.7 18.7 2.6 25.8

No. of equity shares 5.9 5.9 5.9 5.9 7.8 13.0

EPS- continuing operations 4.85 4.13 6.41 10.31 12.22 3.25

Growth Y/Y -14.8% 55.1% 60.8% 18.4% -73.4%

No. of shares- Basic & Diluted 5.9 5.9 5.9 5.9 7.1 9.8

EPS- Basic & Diluted 1.96 3.76 6.59 3.19 0.37 2.64

Growth Y/Y 91.9% 75.3% -51.6% -88.4% 613.4%

Balance Sheet 2002-03 2003-04 2004-05 2005-06 2006-07Cash & equivalents 31.7 72.4 93.3 74.5 111.2Receivables 4.0 0.6 11.1 9.1 20.5Inventory 3.6 6.5 8.8 19.3 25.8Other current assets 104.5 54.0 69.8 56.9 33.9Total current assets 143.8 133.5 182.9 159.8 191.3Gross Block 135.7 165.2 234.1 293.1 434.6Accumulated Depreciation (81.4) (84.9) (98.3) (107.6) (116.9)Net Block 54.2 80.3 135.9 185.5 317.7Investments 3.6 18.4 4.9 0.1 70.4Deferred tax asset 10.0 12.4 9.2 17.7 48.8Total assets 211.6 244.6 332.9 363.0 628.3Creditors 8.7 21.6 28.4 22.5 73.0Other current liabilities - - - 0.8 -Total current liabilities 8.7 21.6 28.4 23.3 73.0Term Loan and debentures - - 27.5 16.3 132.1Other Liability 19.8 24.4 46.6 80.9 31.6Reserves and Surplus 124.3 139.8 171.8 183.8 313.2Equity Share Capital 58.8 58.8 58.8 58.8 78.3Total liabilities 211.6 244.6 332.9 363.0 628.3

Cash Flow 2002-03 2003-04 2004-05 2005-06 2006-07EBITDA 27.8 20.6 63.7 74.7 94.5Tax paid (2.9) 2.8 (19.6) (15.9) (28.2)Change in W/c (22.3) 84.1 (13.9) (8.5) 17.1Operating cash flow 2.6 107.5 30.1 50.3 83.4Capital expenditure 4.5 (83.3) (51.6) (67.4) (233.0)Free Cash Flow 7.1 24.2 (21.5) (17.2) (149.6)Interest paid (0.0) (0.0) (0.0) (1.8) (14.7)Payment of dividend (6.9) (5.2) (6.5) (6.6) (6.9)Other 3.5 21.7 21.4 18.0 (58.0)Cash Surplus/(deficit) 3.7 40.7 (6.6) (7.6) (229.2)Financed/used by/in:

Availment/repayment of debt (0.0) - 27.5 (11.2) 117.1Issue/redemption of capital - - - - 148.8Net Change in Cash 3.6 40.7 20.9 (18.8) 36.7Opening Cash Balance 28.0 31.7 72.4 93.3 74.5Closing cash & equivalents 31.7 72.4 93.3 74.5 111.2

Price Volume Chart

Investment RationaleThe company’s turnover/sales solely depend upon natural resources & forces. Tuningwith the company’s objective to grow, it is carrying out various expansion activitiesfocused on development of new wells/projects, at most of its assigned blocks. Since thedevelopment is in various stages of completion, it is expected that it will take time tosetup & stabilize and the projects will be commercially profitable after a short– mid term(3-5 Yrs). The geological risk attached with the operations of the company is applicableto these project also and there is a strong probability that if these new projects does notresults in discovery of substantial oil and/or gas resources, the company, as it has donein past, will have to put a blade on its income to write-off these expenses incurred in thedevelopment program. Further, as per the terms of Production Sharing Contract (PSC),the Government holds the right to increase its exploration/development share in theassigned blocks, which hampers the profitability of the company. The situation getsworsened by factors like water entering the well or other natural calamities & results inlowering the production of the blocks. Therefore, in light of these factors of uncertainty,along with the fluctuating financials, which depicts an irregular business cycle, we take a“Sell” view on this stock.

601-602, Sukh Sagar,N.S. Patkar Marg,Girgaum, Chowpatty,Mumbai - 400 007

Research AnalystGovind SabooEmail: govind.saboo@gmail.comContact: +91 94140 72008

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Research AssociatesVikas Chechani, Amit Bakliwal