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ONGC: Shackles broken...

Feb 1, 2007

Performance summary
Exploration and production major, ONGC, has declared results for 3QFY07 and 9mFY07. Topline has registered a growth of 25% YoY and 23% YoY for 3QFY07 and 9mFY07 respectively. Operating margins tumbled by 180 basis points (1.8%) in 3QFY07 on the back of higher revenue contribution from the trading business (a lower margin business). However, excluding the same, operating margins stand to expand. Crude oil realisations, which were range bound (between US$ 42 per barrel to US$ 45 per barrel) during the last few quarters, have surged to US$ 51 per barrel on the back of lower subsidy burden during the quarter. The bottomline registered a growth of 20% YoY during the quarter, while the same grew at a lower pace during 9mFY07 (up 14% YoY).

Financial snapshot...
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 124,761 155,645 24.8% 360,245 442,358 22.8%
Expenditure 51,150 66,553 30.1% 154,041 201,773 31.0%
Operating profit (EBDITA) 73,611 89,093 21.0% 206,204 240,585 16.7%
EBDITA margin (%) 59.0% 57.2%   57.2% 54.4%  
Other income 5,619 7,045 25.4% 17,251 20,642 19.7%
Interest 70 77 10.0% 147 151 2.7%
Depreciation 20,118 25,576 27.1% 52,999 66,357 25.2%
Profit before tax 59,042 70,485 19.4% 170,310 194,719 14.3%
Tax 20,165 23,802 18.0% 56,861 65,106 14.5%
Profit after tax/(loss) 38,878 46,683 20.1% 113,449 129,613 14.2%
Net profit margin (%) 31.2% 30.0%   31.5% 29.3%  
No. of shares (m) 2,138.9 2,138.9   2,138.9 2,138.9  
Diluted trailing earnings per share (Rs) 18.18 21.83   53.04 75.03  
Price to earnings ratio (x)*         12.1  
*Based on trailing twelve months earnings.

What is company's business?
ONGC is the country's largest oil exploration and production (E&P) company accounting for majority of India's proven oil and gas reserves. At the current rate of production, the company accounts for over 80% of oil and gas production. Apart from E&P, the company also produces value-added petroleum products such as LPG, kerosene, naphtha and diesel. While LPG is sold to the PSU marketing companies, a major chunk of naphtha is exported and diesel is used for captive consumption. ONGC also has a 72% stake in MRPL, a stand-alone refinery with a capacity of nearly 9.7 MMT (million metric tonnes). Together with MRPL, ONGC has planned its downstream fuel-retailing venture and has a license to set up nearly 1,600 retail outlets.

What has driven the performance in 3QFY07?
Volumes rise, realizations soar: ONGC registered a growth of 25% YoY in its topline during 3QFY07. Crude oil production increased to 7.13 million metric tonnes (MMTPA) compared to 6.37 MMTPA in 3QFY06, thus registering a growth of 12% YoY. This increase was largely a function of low base as production was impacted due to fire at the Bombay high last year. Gas production has increased marginally by 1% YoY to 6.36 billion cubic metres (BCM) as against 6.30 BCM. Crude oil prices recovered by ONGC during the quarter stood at US$ 51 per barrel, against US$ 43 per barrel in 3QFY06. This was due to lower subsidy burden on the company during the quarter. To put things into perspective, the subsidy discounts offered to oil marketing companies was Rs 22 bn during 3QFY07, compared to Rs 28.4 bn in 3QFY06, a reduction of 22% YoY.

Segmental revenues and profitability...
Particulars 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Offshore Segment            
Revenues 94,962 111,830 17.76% 261,587 318,033 21.58%
% of total revenues 73.5% 70.8%   70.9% 70.6%  
PBIT 49,231 56,752 15.28% 140,933 169,727 20.43%
PBIT margins 51.8% 50.7%   53.9% 53.4%  
Onshore Segment 34,203 46,040 34.61% 132,568 107,405 -18.98%
Onshore revenues 26.5% 29.2%   29.1% 29.4%  
PBIT 8,897 9,475 6.50% 22,894 15,037 -34.32%
PBIT margins 26.0% 20.6%   17.3% 14.0%  

Trading business hurts margins: Share of trading products in the net revenues increased from 4.2% (in 3QFY06) to 8.9% in 3QFY07. As this trading business is a low margin business, it dampened the overall operating profitability of the company. However, if one excludes the impact of the same, margins stand to improve during 3QFY07. The subsidy impact on the PBT was Rs 20.3 bn (34% of the PBT during the quarter) compared to Rs 25.9 bn (36.7% of the PBT during 3QFY06). Staff cost as a percentage of sales increased by 120 basis points. This was due to the fact that staff cost included Rs 2,250 m on account of proposed contribution to post retirement benefit scheme. Staff expenditure for the 9mFY07 period also included the expenditure of Rs 3,030 m towards golden jubilee and additional annual incentives.

Expenditure break-up...
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Consumption of raw material 446 1,104 147.47% 1,341 3021.8 125.27%
as a % of sales 0.4% 0.7%   0.4% 0.7%  
Staff Cost 2,540 5,020 97.65% 7,700 14,269 85.33%
as a % of sales 2.0% 3.2%   2.1% 3.2%  
Other expenditure 15,834 16,058 1.42% 39,552 46,085 16.52%
as a % of sales 12.7% 10.3%   11.0% 10.4%  
Stautory levies 27,064 30,582 13.00% 78,682 91,538 16.34%
as a % of sales 21.7% 19.6% 21.8% 20.7%
Purchases( trading) 5266.4 13788.4 161.82% 26766.6 46,859 75.06%
as a % of sales 4.2% 8.9%   7.4% 10.6%  

Higher depreciation spoils play: Other income increased by 25% YoY during 3QFY07 and 20% YoY during 9mFY07. Depreciation (16.4% of the net sales in 3QFY07) increased by 27% YoY, thereby arresting the profitability growth. The higher depreciation could be attributed to write-offs on the dry wells.

Performance summary...
Particulars 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07
Net Sales growth (%, YoY) 5.60% 7.30% 3.10% -2.10% 34.30% 11.00% 24.8%
Net profits growth (%, YoY) 43.80% 22.30% 11.30% -35.60% 24.10% 0.90% 20.1%
Operating profit margins 56.20% 56.40% 59.00% 56.50% 55.50% 50.00% 57.2%

What to expect?
At the current market price of Rs 910, the stock is trading at a price to earnings multiple of 12.1 times its trailing 12 month earnings. Realisations have for the first time crossed the mark of US$ 50 per barrel for the company. This was largely due to lower crude oil prices; once again highlighting the fact that lower crude prices insulate realisations to an extent. Crude oil prices of between US$ 50 to US$ 55 augurs well for the company as the same leads to faster reduction in the subsidy burden vis--vis reduction in the international prices.

Several steps are being taken by the management to improve technological side of the business, as the company is trying to source technology for EOR (enhanced recovery rate). Also, the efforts at development of the marginal fields and ageing fields are likely to enhance the volumes from the domestic fields. However, over the medium term, significant volumes are likely to be contributed by ONGC Videsh (OVL). India is a highly unexplored country in terms of hydrocarbons, a fact further reinforced by huge discoveries in the KG basin. ONGC, India's biggest exploration company is set to benefit immensely from the same.

On the valuations front, the stock is currently trading at a steep discount to its peer Cairn energy in terms of EV/BOE. This is explained by lack of significant discoveries by the company post discovery of Mumbai High and subsidy-sharing agreement with OMCs. Despite these factors, the stock is currently available at an attractive dividend yield of more than 3.5% and at an EV/Boe (P1) of less than 7 times. This makes ONGC one of the preferred plays in the upstream sector.

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