ONGC - "Confluence of positives boosts performance":: LKP

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ONGC posted strong Q2 FY12 results with net sales & production volume in line with our estimates whereas lower dry well expenses, lower tax rate & higher other income resulted in better than expected net profit.

Q2 FY12 subsidy halves q-o-q to $33.2/bbl ($32.4/bbl expected)

Q2 FY12 subsidy burden of Rs 57,134.4 mn ($33.2/bbl) was just 1.3% ahead of our estimate of Rs 56,419.1 mn ($32.4/bbl). While it was double the subsidy burden of $16.5/bbl in Q2 FY11, it was less than half of the Q1 FY12 figure of $72.5/bbl. Thus, net realization rebounded from $48.8/bbl in Q1 FY12 to $83.7/bbl in Q2 FY12, 4.7% above our estimate of $80/bbl due to higher gross realization.

Confluence of positives boosts performance

While statutory levies at Rs 46.5 bn were higher by 25% sequentially, staff expenses and other expenses were up 6% & 20% sequentially. Helped by higher than expected net realization, operating profit of Rs 144.7 bn was 4.6% above our estimate of Rs 138.3 bn and OPM improved by 540 bps sequentially. Other income stood at Rs 11.3 bn, 9% higher than our estimate, due to higher than expected yields. Q2 FY12 dry well expense at Rs 11.8 bn was significantly lower than Rs 18.8 bn in Q1 FY12 & Rs 24.4 bn in Q2 FY11. This resulted in DD&A expense being 26% lower than our estimate. Tax rate for Q2 FY12 came in at 29.8% (33% expected) due to reversal of Rs 1.3 bn on R&D expenses being made tax deductible.

Consequently, net profit above expectations

Net profit at Rs 86.4 bn was much above expectations and was also up 111% sequentially. EPS for the quarter was Rs 10.1, against Rs 4.8 in Q1 FY12 & Rs 6.3 in Q2 FY11.

Upstream subsidy sharing expected at 57% for H2 FY12

The upstream sector’s share of the gross under recoveries, which was fixed at ~33% during FY08-10, had been increased suddenly to ~39% in FY11. Since our FY12 & FY13 estimates of gross under-recovery at Rs 904 bn & Rs 700 bn are not significantly lower than the gross under recovery of Rs 782 bn in FY11, we assume 39% of the gross subsidy burden to be borne by the upstream sector in perpetuity. Taking into account the fact that the upstream sector has shared 33% of the subsidy burden in H1 FY12, we expect the upstream sector to share 57% of the total under recoveries for H2 FY12 which will be a big negative for crude realizations and the stock price.

Outlook and Valuation

We believe the stock would react to news flow regarding the subsidy sharing pattern that would emerge over the course of this year and the price band that would be fixed for the FPO (expected in Dec 2011). We expect consolidated revenue & PAT to post FY11-13 CAGR of 8.9% & 9.7% respectively. We estimate EPS of Rs 30.9 and Rs 31.6 in FY12 & FY13 respectively. Our SOTP valuation for ONGC yields a target price of Rs 320. Our price target translates into EV/boe of $5.6/boe and FY12E & FY13E P/E of 10.4x and 10.1x respectively.