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Oil & Natural Gas Corporation (ONGC)
Energy
Getting there slowly but surely. We see OVL’s 1QFY12 net income of `14.4 bn as
providing comfort to our FY2012E earnings estimate for ONGC. We have updated our
earnings model for FY2011 annual report of ONGC and OVL. We highlight that ONGC
continues to adopt a very conservative accounting approach as is evident from its
FY2011 annual report (discussed in detail in the note). We maintain our BUY rating
given 36% upside to our revised target price of `380. The stock price is currently
discounting net crude price realization of US$48/bbl versus US$53.8/bbl in FY2011.
Healthy earnings for OVL in 1QFY12
We are encouraged by OVL’s strong 1QFY12 results with net income at `14.4 bn (+70% yoy)
versus `26.9 bn in FY2011. This translates into an annualized EPS of `6.7/share. The positive
impact of high crude oil prices on earnings of OVL will benefit ONGC’s consolidated earnings.
OVL’s earnings are outside the purview of India’s subsidy-sharing mechanism.
FY2012E consolidated EPS of `37 is achievable despite conservative assumptions
We estimate ONGC’s FY2012E consolidated EPS at `37 versus `25 in FY2011. The yoy increase
reflects (1) higher net crude price realization (`3.5), (2) higher gas price for full year (`1), (3) costrecoverability
of royalty in Cairn’s Rajasthan block (`2), (4) higher production from Cairn’s
Rajasthan block (`1.5) and (5) higher net income from OVL (`3.4). Our FY2012E EPS estimate of
`7.2 for OVL (versus `3.8 in FY2011) looks reasonable given reported EPS of `1.7 in 1QFY12. We
see low risks to our estimate in light of our conservative assumptions of (1) subsidy share of
upstream companies at 39% of gross under-recoveries, (2) exchange rate assumption of
`44.8/US$ and (3) lower yoy oil and gas sales from own domestic fields.
High level of disclosures is very heartening
We are appreciative of the high level of disclosures in the annual accounts of ONGC and OVL. We
highlight the higher level of disclosures by OVL in its FY2011 annual report in comparison to its
previous annual reports. ONGC has provided detailed block-wise breakdown of reserves, goodwill
amortization, producing assets and exploratory and development well-in-progress. We look
forward to other companies in our sector emulating ONGC’s disclosure standards.
Fine-tuned earnings; maintain BUY with a target price of `380
We have fine-tuned our FY2012-14E EPS to `37.2 (-1.2%), `40.8 (-1.7%) and `42.4 (-2.1%) to
reflect (1) FY2011 annual report of ONGC and OVL and (2) other minor changes. We assume that
upstream companies will bear 39% of total under-recoveries. We maintain BUY rating on the
stock with a revised target price of `380 (`385 previously) based on 9X FY2013E EPS plus value of
investments. We find current valuations attractive with the stock trading at 6.8X FY2013E EPS and
3.3X FY2013E DACF.
Key highlights from FY2011 annual report and OVL 1QFY12 earnings
`9.4 bn written off on a discovered asset. We highlight that ONGC continues with its
conservative policy of providing for dry wells on discovered assets if development work is
not started within two years. A case in point is its KG-DWN98/2 block, where it has
cumulatively written off `9.4 bn (from FY2008-11) as dry wells. We note that this would
be written back once the company commences development work on the block.
`7.5 bn provision for a pending case which has already delivered a favorable
ruling. ONGC has made a provision of `7.5 bn in an ongoing dispute with the
Government of India (GoI) on the Ravva joint venture. We highlight that the High Court
of Malaysia has already ruled in favor of ONGC but the company has made a provision
pending an appeal filed by the GoI.
Surrender of Sudan pipeline. We note that OVL made a provision of `5.1 bn in FY2011
on account of payment due to surrender of Sudan crude oil pipeline. This reflects the
settlement reached for the transfer of settlement system to GOS based on the following
ownership pattern:
70% ownership as of October 1, 2006 till August 31, 2014
100% ownership as of September 1, 2014 to be transferred to GOS.
The write-back of `5.1 bn reflects the write-back of revenues for the period October 1,
2006 to March 31, 2010. The write-back for the period April 1, 2010 to October 31,
2010 has been adjusted against actual revenues for FY2011.
Significant write-offs in several blocks for OVL. We note that OVL’s FY2011 financials
were impacted by significant write-offs as dry wells written off (`7.3 bn) and provisions
and write-offs (`3.5 bn). These include (1) `1.5 bn for exploration wells in Farsi block, Iran,
(2) `1.3 bn on account of relinquishment of North Ramadan block in Egypt, (3) `2.9 bn as
dry wells in Block Nemed in Egypt, (4) `0.4 bn on account of relinquishment of AD-2, AD-
3 and AD-9 blocks in Myanmar and (5) `0.2 bn on account of relinquishment of Block
81-1 in Libya.
Special tax on high crude prices in Venezuela from April 2011. We note that OVL’s
reported net income for 1QFY12 included a special contribution tax of `1.66 bn for San
Cristobal project in Venezuela. We note that a special contribution of 20-95% on
extraordinary/exorbitant prices has been imposed in Venezuela from April 2011 as a stepwise
function of Venezuelan crude basket price.
Watch out for the following potential triggers
Lower subsidy burden. We continue to assume upstream share of under-recoveries at
39% of the gross under-recoveries based on the subsidy borne in FY2011. However, we
see a significant upside for ONGC if the government reverts to 33.33% share for
upstream companies as was the case in 1QFY12. Exhibit 1 gives our scenario analysis of
the likely earnings of ONGC at different levels of subsidy burden.
Higher gas production. We currently assume gas sales volumes from ONGC’s own fields
to remain stable. This is significantly lower versus the management guidance of a sharp
increase in gas production to 72 mcm/d of gas production by FY2014E and 100 mcm/d
by FY2016E versus 63.3 mcm/d in FY2011. We compute a positive impact of `1/share on
EPS if the management guidance materializes for FY2014E. We note that ONGC has
undertaken 10 major projects for development of new fields and one project for
additional development of D-1 field which should bolster gas production from its fields.
Exhibit 2 gives the list of these fields which are expected to be commissioned by FY2014E.
Development of new gas fields by ONGC
1 Development of C-Series
2 Additional development of D-1 field
3 Development of B-22 cluster fields
4 Development of B-193 cluster fields
5 Development of B-46 cluster fields
6 Development of North Tapti gas field
7 Development of Cluster-7 fields
8 Development of BHE & BH-35 fields
9 Development of WO-16 cluster fields
10 Development of G-1 & GS-15 fields
11 Development of SB-14
Source: Company, Kotak Institutional Equities
Weakening rupee. We see the recent weakening of rupee as a positive for ONGC’s
earnings as it would lead to higher crude price in rupee terms; global crude prices are
based in dollars and ONGC’s crude price is linked to prices of certain global crude oils. A
`1/ US$ change will impact ONGC’s earnings by about 4-5% and would increase its
FY2012E and FY2013E EPS to `39.1 and `42.6 versus our base case EPS estimate of
`37.2 and `40.8. This will be partly mitigated by a potential increase in under-recoveries.
A weaker rupee will increase the under-recoveries incurred by R&M companies. This, in
turn, would increase the subsidy loss to be borne by ONGC and other upstream oil and
gas companies.
Key assumptions behind our earnings model
We discuss our key assumptions behind and changes to our earnings model below. Exhibit 3
gives the major assumptions behind our earnings model and Exhibit 4 gives sensitivity of
ONGC’s EPS to key variables (rupee-dollar rate, crude oil price, natural gas price).
Subsidy amount. We model subsidy amount for FY2012E, FY2013E and FY2014E at
`323 bn, `196 bn and `140 bn. We assume that upstream companies will bear 39% of
the gross under-recoveries versus ~33% in 1QFY12 and 38.7% in FY2011. We model
ONGC to bear 82.2% of the share of upstream companies in FY2012E and ~81% in
FY2013-14E. We assume a decline in ONGC’s share in FY2013-14E due to increase in
GAIL’s share given lower proportion of under-recoveries on diesel in the overall underrecoveries
over the next two years led by lower crude oil prices.
Crude oil price assumption. We model crude oil (Dated Brent) prices for FY2012E,
FY2013E and FY2014E at US$110/bbl, US$100/bbl and US$95/bbl. However, we would
focus more on ONGC’s net realized crude price and our long-term crude price
assumption. Exhibit 5 gives ONGC’s historical net realized price and our expectations for
FY2012E (US$61.3/bbl), FY2013E (US$70.8/bbl) and FY2014E (US$74.3/bbl).
Natural gas price assumption. We assume FY2012-14E natural gas price at `7.5/cu m
(US$4.2/mn BTU).
Rupee-dollar exchange rate. We assume exchange rate for FY2012E, FY2013E and
FY2014E at `44.75/US$, `45.63/US$ and `45/US$.
Fair value of ONGC (`/share)
FY2013E EPS 41
Less: income from investments valued separately 0
Adjusted EPS for FY2013E 40
P/E (X) 9
Valuation 3 63
Investments 16
Indian Oil Corp. 10
GAIL 4
Petronet LNG 1
Fair value 379
Source: Kotak Institutional Equities estimates
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Oil & Natural Gas Corporation (ONGC)
Energy
Getting there slowly but surely. We see OVL’s 1QFY12 net income of `14.4 bn as
providing comfort to our FY2012E earnings estimate for ONGC. We have updated our
earnings model for FY2011 annual report of ONGC and OVL. We highlight that ONGC
continues to adopt a very conservative accounting approach as is evident from its
FY2011 annual report (discussed in detail in the note). We maintain our BUY rating
given 36% upside to our revised target price of `380. The stock price is currently
discounting net crude price realization of US$48/bbl versus US$53.8/bbl in FY2011.
Healthy earnings for OVL in 1QFY12
We are encouraged by OVL’s strong 1QFY12 results with net income at `14.4 bn (+70% yoy)
versus `26.9 bn in FY2011. This translates into an annualized EPS of `6.7/share. The positive
impact of high crude oil prices on earnings of OVL will benefit ONGC’s consolidated earnings.
OVL’s earnings are outside the purview of India’s subsidy-sharing mechanism.
FY2012E consolidated EPS of `37 is achievable despite conservative assumptions
We estimate ONGC’s FY2012E consolidated EPS at `37 versus `25 in FY2011. The yoy increase
reflects (1) higher net crude price realization (`3.5), (2) higher gas price for full year (`1), (3) costrecoverability
of royalty in Cairn’s Rajasthan block (`2), (4) higher production from Cairn’s
Rajasthan block (`1.5) and (5) higher net income from OVL (`3.4). Our FY2012E EPS estimate of
`7.2 for OVL (versus `3.8 in FY2011) looks reasonable given reported EPS of `1.7 in 1QFY12. We
see low risks to our estimate in light of our conservative assumptions of (1) subsidy share of
upstream companies at 39% of gross under-recoveries, (2) exchange rate assumption of
`44.8/US$ and (3) lower yoy oil and gas sales from own domestic fields.
High level of disclosures is very heartening
We are appreciative of the high level of disclosures in the annual accounts of ONGC and OVL. We
highlight the higher level of disclosures by OVL in its FY2011 annual report in comparison to its
previous annual reports. ONGC has provided detailed block-wise breakdown of reserves, goodwill
amortization, producing assets and exploratory and development well-in-progress. We look
forward to other companies in our sector emulating ONGC’s disclosure standards.
Fine-tuned earnings; maintain BUY with a target price of `380
We have fine-tuned our FY2012-14E EPS to `37.2 (-1.2%), `40.8 (-1.7%) and `42.4 (-2.1%) to
reflect (1) FY2011 annual report of ONGC and OVL and (2) other minor changes. We assume that
upstream companies will bear 39% of total under-recoveries. We maintain BUY rating on the
stock with a revised target price of `380 (`385 previously) based on 9X FY2013E EPS plus value of
investments. We find current valuations attractive with the stock trading at 6.8X FY2013E EPS and
3.3X FY2013E DACF.
Key highlights from FY2011 annual report and OVL 1QFY12 earnings
`9.4 bn written off on a discovered asset. We highlight that ONGC continues with its
conservative policy of providing for dry wells on discovered assets if development work is
not started within two years. A case in point is its KG-DWN98/2 block, where it has
cumulatively written off `9.4 bn (from FY2008-11) as dry wells. We note that this would
be written back once the company commences development work on the block.
`7.5 bn provision for a pending case which has already delivered a favorable
ruling. ONGC has made a provision of `7.5 bn in an ongoing dispute with the
Government of India (GoI) on the Ravva joint venture. We highlight that the High Court
of Malaysia has already ruled in favor of ONGC but the company has made a provision
pending an appeal filed by the GoI.
Surrender of Sudan pipeline. We note that OVL made a provision of `5.1 bn in FY2011
on account of payment due to surrender of Sudan crude oil pipeline. This reflects the
settlement reached for the transfer of settlement system to GOS based on the following
ownership pattern:
70% ownership as of October 1, 2006 till August 31, 2014
100% ownership as of September 1, 2014 to be transferred to GOS.
The write-back of `5.1 bn reflects the write-back of revenues for the period October 1,
2006 to March 31, 2010. The write-back for the period April 1, 2010 to October 31,
2010 has been adjusted against actual revenues for FY2011.
Significant write-offs in several blocks for OVL. We note that OVL’s FY2011 financials
were impacted by significant write-offs as dry wells written off (`7.3 bn) and provisions
and write-offs (`3.5 bn). These include (1) `1.5 bn for exploration wells in Farsi block, Iran,
(2) `1.3 bn on account of relinquishment of North Ramadan block in Egypt, (3) `2.9 bn as
dry wells in Block Nemed in Egypt, (4) `0.4 bn on account of relinquishment of AD-2, AD-
3 and AD-9 blocks in Myanmar and (5) `0.2 bn on account of relinquishment of Block
81-1 in Libya.
Special tax on high crude prices in Venezuela from April 2011. We note that OVL’s
reported net income for 1QFY12 included a special contribution tax of `1.66 bn for San
Cristobal project in Venezuela. We note that a special contribution of 20-95% on
extraordinary/exorbitant prices has been imposed in Venezuela from April 2011 as a stepwise
function of Venezuelan crude basket price.
Watch out for the following potential triggers
Lower subsidy burden. We continue to assume upstream share of under-recoveries at
39% of the gross under-recoveries based on the subsidy borne in FY2011. However, we
see a significant upside for ONGC if the government reverts to 33.33% share for
upstream companies as was the case in 1QFY12. Exhibit 1 gives our scenario analysis of
the likely earnings of ONGC at different levels of subsidy burden.
Higher gas production. We currently assume gas sales volumes from ONGC’s own fields
to remain stable. This is significantly lower versus the management guidance of a sharp
increase in gas production to 72 mcm/d of gas production by FY2014E and 100 mcm/d
by FY2016E versus 63.3 mcm/d in FY2011. We compute a positive impact of `1/share on
EPS if the management guidance materializes for FY2014E. We note that ONGC has
undertaken 10 major projects for development of new fields and one project for
additional development of D-1 field which should bolster gas production from its fields.
Exhibit 2 gives the list of these fields which are expected to be commissioned by FY2014E.
Development of new gas fields by ONGC
1 Development of C-Series
2 Additional development of D-1 field
3 Development of B-22 cluster fields
4 Development of B-193 cluster fields
5 Development of B-46 cluster fields
6 Development of North Tapti gas field
7 Development of Cluster-7 fields
8 Development of BHE & BH-35 fields
9 Development of WO-16 cluster fields
10 Development of G-1 & GS-15 fields
11 Development of SB-14
Source: Company, Kotak Institutional Equities
Weakening rupee. We see the recent weakening of rupee as a positive for ONGC’s
earnings as it would lead to higher crude price in rupee terms; global crude prices are
based in dollars and ONGC’s crude price is linked to prices of certain global crude oils. A
`1/ US$ change will impact ONGC’s earnings by about 4-5% and would increase its
FY2012E and FY2013E EPS to `39.1 and `42.6 versus our base case EPS estimate of
`37.2 and `40.8. This will be partly mitigated by a potential increase in under-recoveries.
A weaker rupee will increase the under-recoveries incurred by R&M companies. This, in
turn, would increase the subsidy loss to be borne by ONGC and other upstream oil and
gas companies.
Key assumptions behind our earnings model
We discuss our key assumptions behind and changes to our earnings model below. Exhibit 3
gives the major assumptions behind our earnings model and Exhibit 4 gives sensitivity of
ONGC’s EPS to key variables (rupee-dollar rate, crude oil price, natural gas price).
Subsidy amount. We model subsidy amount for FY2012E, FY2013E and FY2014E at
`323 bn, `196 bn and `140 bn. We assume that upstream companies will bear 39% of
the gross under-recoveries versus ~33% in 1QFY12 and 38.7% in FY2011. We model
ONGC to bear 82.2% of the share of upstream companies in FY2012E and ~81% in
FY2013-14E. We assume a decline in ONGC’s share in FY2013-14E due to increase in
GAIL’s share given lower proportion of under-recoveries on diesel in the overall underrecoveries
over the next two years led by lower crude oil prices.
Crude oil price assumption. We model crude oil (Dated Brent) prices for FY2012E,
FY2013E and FY2014E at US$110/bbl, US$100/bbl and US$95/bbl. However, we would
focus more on ONGC’s net realized crude price and our long-term crude price
assumption. Exhibit 5 gives ONGC’s historical net realized price and our expectations for
FY2012E (US$61.3/bbl), FY2013E (US$70.8/bbl) and FY2014E (US$74.3/bbl).
Natural gas price assumption. We assume FY2012-14E natural gas price at `7.5/cu m
(US$4.2/mn BTU).
Rupee-dollar exchange rate. We assume exchange rate for FY2012E, FY2013E and
FY2014E at `44.75/US$, `45.63/US$ and `45/US$.
Fair value of ONGC (`/share)
FY2013E EPS 41
Less: income from investments valued separately 0
Adjusted EPS for FY2013E 40
P/E (X) 9
Valuation 3 63
Investments 16
Indian Oil Corp. 10
GAIL 4
Petronet LNG 1
Fair value 379
Source: Kotak Institutional Equities estimates
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