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ONGC’s 2QFY2011 numbers were in line with our expectation on top-line front, while
it was lower than our expectation on the bottom-line front on account of higher DD&A
expenditure. On account of likely fuel reforms going ahead, we recommend an
Accumulate on ONGC.
Higher-than-expected DD&A spoils the show; PAT comes below estimates: Operating
income during the quarter grew 20.2% yoy to `18,430cr (`15,338cr) primarily on
account of higher crude oil price and sales, and increase in the APM gas selling price
to US $4.2/mmbtu w.e.f June 2010 from US $1.8/mmbtu. Crude oil sales volumes
were up yoy to 5.91MMT (5.55MMT), whereas gas sales volume fell yoy to 5BCM
(5.2BCM). During the quarter, the company shared a subsidy burden of `3,019cr
(`2,630cr) as against our expectation of `3,300cr. Both gross and net realisations
were in line with our estimates. Net realisations stood at US $62.8/bbl (US $56.4/bbl).
OPM during the quarter improved by 288bp yoy to 61.4% (58.6%) on account of
higher net crude oil realisations aided by lower other operating expenses resulting in
EBITDA registering a growth of 26.1% yoy to `11,322cr (`8,981cr). Depreciation,
depletion and amortisation (DD&A) cost during the quarter increased by a substantial
86.8% yoy to `4,400cr (`2,356cr), which was higher than our estimate of `3,300cr.
Net profit during the quarter increased 5.9% yoy to `5,389cr (`5,090cr), which was
lower than our estimate of `6,198cr.
Outlook and Valuation: ONGC reported good set of numbers on the operating front
during the current quarter. However, on the bottom line front the performance was
dented on account of higher DD&A expenditure. We expect the trend of strong
operating performance to continue on account of impact of the gas price hike, decline
in subsidy burden with deregulation of petrol prices and increase in diesel prices.
Moreover, chances of further reforms in the oil sector are high owing to the expected
FPO by IOC and ONGC in the last quarter of the current fiscal. Following the recent
correction in the stock price, we recommend an Accumulate on the stock, with a
revised Target Price of `1,391(`1,356).
Net crude realisation at US $62.8/bbl: ONGC’s top-line registered a growth of
20.2% yoy to `18,430cr (`15,338cr), primarily on account of higher crude oil
price and sales and increase in APM gas selling price to US $4.2/mmbtu w.e.f
June, 2010 from US $1.8/mmbtu. ONGC’s top-line was in line with our
expectation of `18,942cr. ONGC’s gross realisations from crude oil sales stood at
US $79.2/bbl (US $62.8/bbl). During the quarter, the company shared subsidy
burden of `3,019cr (`2,630cr) as against our expectation of `3,300cr. Hence, net
realisations stood at US $62.8/bbl (US $56.4/bbl), up 11.2% yoy. Crude oil sales
volumes were up yoy to 5.91MMT (5.55MMT), whereas gas sales volume fell yoy
to 5BCM (5.2BCM). Crude oil sales volume increased 11.3% qoq to 5.91MMT
(5.31MMT) despite lower rate of 3.6% qoq increase in crude production to
6.85MMT (6.63MMT) as inventory built up, which happened in the last quarter due
to production disruption at the Numaligarh refinery and was sold during the
current quarter. Thus, the sales-to-production ratio improved during the quarter on
a qoq basis.
OPM expanded by 288bp yoy 61.4% : OPM during the quarter improved by
288bp yoy to 61.4% (58.6%) on account of the higher net crude oil realisations
aided by lower other operating expenses resulting in EBITDA registering a growth
of 26.1% yoy to `11,322cr (`8,981cr). Other operating expenses during the
quarter fell 7% yoy to `2,789cr (`3,000cr).
DD&A cost increases; Other income declines: Depreciation, depletion and
amortisation cost (DD&A) cost during the quarter increased by a substantial 86.8%
yoy to `4,400cr (`2,356cr), which was higher than our estimate of `3,300cr. This
was on account of significantly higher dry well written off during the quarter. It
increased by a whopping 372.7% yoy to `2,441cr (`655cr). Other income during
the quarter fell by 8.7% yoy to `906cr (`993cr).
PAT increases 5.9%: Net profit during the quarter increased 5.9% yoy to `5,389cr
(`5,090cr), which was lower than our estimate of `6,198cr. This was mainly due to
the higher-than-expected DD&A expenditure during the quarter.
Investment Arguments
Oil sector reforms provide re-rating trigger: ONGC’s stock performance is strongly
correlated with the reforms in the Indian oil and gas sector. The government has
recently increased the price of the APM gas and has brought it on par with the KGD6
gas prices. The increase in the APM gas prices has added around `18.9/share
on an annualised basis to ONGC’s earnings. ONGC is likely to report earnings
growth of more than 16.6% over FY2010-12E as against a decline of (1.2%) over
FY2008-10. Improved earnings trajectory is likely to provide the require boost to
development efforts in the form of EOR and IOR to increase the production of gas
from the ageing fields. Similarly, the reforms in diesel de-regulations and clarity
over the subsidy sharing mechanism are further likely to improve the profitability
and earnings visibility of ONGC.
Strong exploratory portfolio and improving business fundamental: ONGC is
India’s premier exploration company with 45% of the India’s NELP acreage
(prospective blocks). However, given the higher focus on the nomination block, the
company has not been able to deliver good exploratory results. However, we
expect the company’s focus to increase in the NELP block over the next 2-3 years.
ONGC has drilled only 13 NELP blocks and has established commercial prospects
in the same, which implies potential for future discoveries and reserve accretion.
Thus, increased focus on the NELP block could result in reserve and valuation
upside from current levels.
Outlook and Valuation
ONGC reported good set of numbers for operating performance during the
current quarter, however on the bottom-line front the performance was dented on
account of higher DD&A expenditure. We expect the trend of strong operating
performance to continue on account of impact of the gas price hike, coupled with
decline in subsidy burden with deregulation of petrol prices and increase in diesel
prices. Moreover, the chances of further reforms in the oil sector have strengthened
on account of expected FPO of IOC and ONGC in the last quarter of current
financial year.
The biggest variable impacting the company’s stock price is the announcement
associated with the subsidy sharing mechanism. ONGC’s stock price registered
gains post the announcement of petrol price deregulation. However, post the
announcement of the subsidy sharing mechanism some weakness has been
witnessed in the stock. The key rationale for the same being uncertainty related to
the subsidy-sharing mechanism. The government has yet again resorted to ad-hoc
subsidy sharing mechanism, wherein it is likely to bear 50% of the total subsidy
burden, while the upstream companies would bear 33%. However, there is not
clarity over the sharing of the balance 17% subsidy burden. If the government were
to increase the upstream share of the subsidy burden, it could adversely impact
ONGC. Thus, there remains some uncertainty over the subsidy sharing
mechanism. However, given the proposed FPO we see limited risk on account of
higher subsidy during the fiscal.
However, despite the uncertainties on the near-term subsidy sharing mechanism,
we believe that given the government’s intent to gradually deregulate the diesel
prices, coupled with the increase in the APM gas price, the risk-reward ratio is now
favourable with limited downside from current levels. At `1,303, the stock is
currently trading at 10.6x FY2012E EPS of `123.1. We have valued the company
at 10x FY2012E EPS and added the value of cash and listed investments, thereby
arriving at a revised Target Price of `1,391 (` 1,356). We recommend Accumulate
on the stock.
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