Acquisitions in overseas markets and favourable gas pricing policy in India are triggers for ONGC.
A host of events have helped the ONGC stock consistently outperform the broader markets, delivering positive returns of 13 per cent vis-a-vis BSE Sensex’s 17 per cent decline, since July 2008. The key reason is the expected improvement in the company’s profitability even as crude oil prices have declined significantly. Typically, for any crude oil producer lower prices would dent performance, but for ONGC, it implicates lower subsidy overhang--its contribution to the subsidy kitty was Rs 28,000 crore in the first nine months of FY09 when prices were at record highs.
The management expects subsidy burden to be nil in Q4FY09, thus hopes of better quarterly numbers. Additionally, analysts expect subsidies to be lower in FY10 compared to FY09 on account of subdued crude oil prices. That apart, news of ONGC being in the race to acquire oil assets aboard and a favourable gas pricing under administered pricing mechanism (APM) have also given fillip to the stock recently, even as concerns over flattish production growth in medium-term exists.
Net realisations improving
Higher crude oil price generally improves realisations, but that has not been the case with ONGC which had to provide discounts (subsidy) to oil marketing companies. For example, in Q4 FY08 when gross realisations were higher at $100.4 per barrel, the actual realisation was lower at $49.7 on account of subsidies. The worst part is that even as oil prices dipped to sub-$40 levels in Q3FY09, the overhang of subsidies led to net realisation of just $34 per barrel.
In Q4, with subsidies expected to be nil, ONGC’s actual realisation would be similar to gross oil price realisations (average price of Nigerian bonny light crude oil, its benchmark in Q4 FY09 was $48, lower by just 4-5 per cent on a y-o-y basis). Notably, given the rupee depreciation of about 25 per cent in the same period, expect rupee realisations to be higher by 21 per cent and net profits to improve smartly. Further, since Q1FY09, the method for calculating royalty charges has been changed, which should result in savings of around Rs 600-700 crore. Thus, expect net profits to rise by around 22-27 per cent y-o-y and 28-33 per cent q-o-q in Q4 FY09.
Going ahead, analysts indicate that the company would lose if the crude oil prices dip below $40-45 range. However, they are hopeful of prices hovering around $57-63 and $70-75 in FY10 and FY11, respectively leading to much lower subsidy in FY10 and, hence stable-to-better realisations.
| EARNINGS CONCERN | |||
| in Rs crore | FY08 | FY09E | FY10E |
| Net sales | 96,782 | 121,850 | 103,165 |
| EBITDA (%) | 40,466 | 43,945 | 41,780 |
| PAT | 19,872 | 21,731 | 19,633 |
| EPS (Rs) | 92.9 | 101.6 | 91.8 |
| PE (x) | 8.7 | 7.9 | 8.8 |
| P/BV (x) | 2.2 | 1.9 | 1.7 |
| E: Analyst estimates | |||
Production stagnates
While ONGC produces around 80 per cent of both crude and gas in the country, output from its existing fields has been flattish. And this too, has been aided by the company’s effort to redevelop its major oil producing fields, which contribute 75 per cent to production. It has employed measures like enhanced oil recovery to arrest production declines, which have led to a 1.6 per cent increase in production during 2000-2008.
On the other hand, while the company has been consistently adding to its domestic oil reserves (reserve replacement ratio of over one during last four years; indicates total reserve addition to production during a year), its record of developing new fields at fast clip is not very exciting. Further, addition of new production capacity in KG-basin is also marred by execution delays, and is now expected to start in FY13 as compared to FY12 earlier.
Due to slower progress of field development in domestic arena, the company is increasingly focusing on overseas markets through its subsidiary, ONGC Videsh, to acquire proven assets. Although costs for acquiring proven assets will be relatively higher as with the case of acquisition of Imperial Energy, nevertheless it escapes the uncertainty of discoveries. Imperial Energy will add 20 per cent to 2P crude reserves of ONGC at the consolidated level, and is seen adding up to 3 per cent to consolidated production volumes.
These acquisitions as well as crude oil price gains have led to OVL, its subsidiary emerging as a growth driver for ONGC; it now accounts for 16 per cent of total production and 25 per cent of overall reserves. OVL’s revenue and net profit have grown at over 50 per cent on average in the last five years compared to ONGC’s standalone growth rate of 16 per cent, both in top-line and bottom-line. Overall, expect limited domestic growth in production volumes in the next two years. This along with expectations of subdued realisations in FY10E is likely to result in a drop of around 13 per cent in consolidated revenues.
Triggers ahead
OVL has been continuously evaluating acquisition of assets globally. It is now reportedly targeting to acquire assets in Venezuela. Such moves should rub positively on the stock, and is in line with its strategy to more than double its production by 2020.
Natural gas contributes around 43 per cent of overall volumes, but only 12-13 per cent to revenues. This is because ONGC sells majority of the domestic gas at APM price of $2 per mmbtu, which is less than half the price realised by private players like Reliance Industries ($4.2). If ONGC’s proposal to the government for higher rates is considered leniently, analysts expect a Rs 15 increase in EPS (assuming gas price hike of $1.6/mmbtu). In the long run, the production of gas from new fields like KG basin (target output level set at 25 mmscmd by FY13) and further oil strike at Block IG are also expected to add to production.
Outlook
With crude oil prices having fallen significantly, expect lower subsidies in FY10 (based on $50 per barrel). While ONGC is estimated to spend $7 billion over five years on 14 projects (at various stages of execution) to improve domestic production from mature assets, expect overseas acquisitions to drive volume growth in the medium-term. The company (post-imperial acquisition) is estimated to have net cash of around $3 billion (adjusted for loans payable), which along with annual profit generation of about $3-4 billion will enable it to meet the above capex needs.
Further, changes in natural gas pricing and reforms in retail fuel pricing mechanism after elections are other triggers for the stock. Also, since ONGC has nearly 60 per cent of its NELP acreage in highly prospective areas, any major new discoveries from these blocks will be additional triggers.
The stock has historically traded at PE of 8-10 and is trading now at a reasonable 9.6 times of its FY10 estimated earnings. However, considering the cash balances and investments in PSUs (IOC, GAIL, etc) worth Rs 6,000 crore, the adjusted PE (8.54) is closer to the lower band, and suggests lower downside risk. While there are no immediate triggers, given the company’s assets and potential therein, one can invest in ONGC with a long-term view and on dips.
