With Cairn agreeing to share royalty on the Rajasthan block, earnings to rise, with further boost from higher output at new and existing fields.
Oil and Natural Gas Corporation’s consent on the Cairn-Vedanta deal, after Cairn India agreed to share royalty in its Rajasthan block, should mark an end to the prolonged uncertainty and is positive for both the companies. While Cairn can now concentrate on approvals for production ramp-ups, ONGC will benefit from a reduction in its royalty costs. Earlier, despite ONGC having 30 per cent stake in the Rajasthan block, it had to bear 100 per cent of the royalty outgo.
With royalty sharing now to be in line with equity participation, thus lower costs for ONGC, its earnings per share (EPS) estimates are being upgraded by analysts. Further, with the ONGC follow-on public offer (FPO) being deferred, the hangover on the stock is also over, albeit temporarily. Crude oil prices have also started cooling and the government’s earlier decision on fuel price rises will help lower the under-recoveries/subsidy burden of oil companies. Citing these developments, the stock has outperformed the Sensex since mid-September. At current levels, most analysts are bullish on the stock, with a buy rating.
| STEADY PROFIT GROWTH | |||
| In Rs crore | FY11 | FY12E | FY13E |
| Net sales | 117,611 | 132,863 | 134,795 |
| % chg y-o-y | 15.60 | 13.00 | 1.50 |
| Ebitda | 48,436 | 52,230 | 57,730 |
| Margin | 41.2 | 39.3 | 42.8 |
| Profits | 22,456 | 25,775 | 27,663 |
| % chg y-o-y | 15.7 | 14.8 | 7.3 |
| EPS (Rs) | 26.3 | 30.6 | 32.8 |
| PE (x) | 10.1 | 8.6 | 8.1 |
| E: Estimates; do not include gains on account of change in royalty sharing with Cairn Source: CapitaLine, Bloomberg, Analyst reports | |||
LOWER ROYALTY, HIGHER EARNINGS
In 2010-11, ONGC had paid Rs 1,300 crore as royalty, almost a third of the earned Rs 3,900 crore revenue from the Rajasthan block. With Cairn agreeing to share royalty, the share of ONGC in a similar scenario will come down to around Rs 400 crore. What’s more, the extra royalty burden that ONGC shared in FY10 and FY11 will also be adjusted. If it takes place retrospectively, it will lead to a one-time gain of Rs 1,500 crore for ONGC, observes Ashutosh B, analyst at Nirmal Bang Institutional Equities.
Also, with Cairn expected to nearly double its production to 240,000 barrels of oil per day at the Rajasthan block in the long run, it should have a positive rub-off on ONGC’s earnings.
Owing to the lower royalty burden, the EPS estimates for ONGC are being upgraded. Ashutosh has increased his EPS estimates for FY12, FY13 and FY14 by 3.27 per cent, 3.77 per cent and 4.04 per cent, respectively. This is based on the Rajasthan block’s Mangala, Bhagyam and Aishwarya fields producing 150,000 barrels of oil per day during FY12 and 190,000 during FY13. However, if Cairn India gets another nod from the government to increase its production to 205,000 a day from these fields, Ashutosh B says the EPS will increase by another five per cent for FY12, though he thinks the ramp-up approval for all the three fields during FY12 itself is unlikely.
MORE GAINS?
Apart from benefits of the reduced royalty burden, the postponing of ONGC’s FPO has also reduced overhang on the stock, though temporarily. The expectations are that the government is expecting a higher price band whenever the next attempt at the FPO is made. Analysts also say that during the FPO campaign, ONGC’s management realised that uncertainty on subsidy sharing remains a big concern for institutional investors. It may be recalled that while ONGC was expected to share 33 per cent subsidy burden, the government had raised the share of upstream companies to 38.7 per cent for the March 2011 quarter at the last minute.
A September 19 report by Credit Suisse had observed that “if the government was uncomfortable with FPO valuations, it is unlikely to see much better numbers without clarity on subsidies, we think”. They had also observed that ONGC’s net realisations can fall to $45 a barrel, compared to $54 a barrel in FY11, looking at higher subsidy sharing burden. Thus, expect some measures on this front, say analysts, which should help improve clarity on subsidy sharing.
For FY12, Alok Deshpande at Elara Capital observed that with the price rises and duty cuts on fuels as decided by the enmpowered group of ministerser in June, the July 2011 to March 2012 period should be much better than the June quarter for the entire PSU oil pack. Crude oil prices have also started softening, which can bring some respite to the subsidy burden.
OUTLOOK
With these developments, analysts are bullish on the prospects of ONGC, with a 12-month average target price of Rs 342, indicating a 29 per cent upside from current levels. Additional kickers will come from higher output. The company’s new chairman on Tuesday said the company should see its output rise by 15 per cent to 28 million tonnes by 2013. That apart, ONGC Videsh, its foreign subsidiary, is also aiming to increase its current output of 9.5 million tonnes annually to 20 mt by 2020.
