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ONGC: The subsidy setback… - Views on News from Equitymaster

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ONGC: The subsidy setback…

Jun 27, 2007

Performance summary
Exploration and production major, ONGC, has declared results for 4QFY07 and FY07. Topline has registered a growth of 4% YoY and 18% YoY for 4QFY07 and FY07 respectively. Operating margins tumbled by a huge 2092 basis points (20.9%) in 4QFY07 due to escalating input costs and higher subsidy burden. The bottomline registered a decline of 13% YoY for 4QFY07, while the same grew during FY07 (up 8% YoY). On a consolidated basis, the performance has been slightly better as the bottomline growth has stood at 15% YoY on the back of a 16% YoY growth in topline.

Financial snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net sales 118,984 123,970 4.2% 479,280 566,328 18.2%
Expenditure 51,730 79,825 54.3% 205,821 281,598 36.8%
Operating profit (EBDITA) 67,254 44,145 -34.4% 273,459 284,730 4.1%
EBDITA margin (%) 56.5% 35.6%   57.1% 50.3%  
Other income 6,299 21,790 245.9% 23,550 42,431 80.2%
Interest (net) 323 65 -80.0% 470 215 -54.2%
Depreciation 31,574 28,637 -9.3% 84,573 94,994 12.3%
Extraordinary inc/(loss) 6,405 4,751 -25.8% 6,405 4,751 -25.8%
Profit before tax 41,656 37,232 -10.6% 211,966 231,952 9.4%
Tax 17,202 15,167 -11.8% 74,064 80,273 8.4%
Profit after tax/(loss) 30,859 26,816 -13.1% 144,308 156,429 8.4%
Net profit margin (%) 25.9% 21.6%   30.1% 27.6%  
No. of shares (m) 1,426.0 2,138.9   1,426.0 2,138.9  
Diluted earnings per share (Rs)* 57.7 50.1   67.5 73.1  
Price to earnings ratio (x)**         12.7  
(* annualised, ** on trailing twelve months earnings)

What is the 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 performance in FY07?
The subsidy dampener: ONGC registered a growth of 18% YoY in its topline during FY07. Crude oil production increased to 26.05 million metric tonnes (MMTPA) compared to 24.4 MMTPA in FY06, thus registering a growth of 9% YoY. Gas production was recorded at 22.4 billion cubic metres (BCM) as against 22.6 BCM in FY06, a marginal fall of 1%. However, if one views this marginal fall in the light of operational disruptions at the Hazira plant, then the performance remains satisfactory. Subsidies dampened the proceeding as ONGC registered its highest-ever payout of Rs. 170 bn in FY07 (up 42.4 % YoY). It realized $ 44 per barrel after a discount of $ 22. ONGC is seeking a review in the subsidy policy. It wants the subsidy to be calculated in rupee terms and not in dollars. The tariff commission recommendation (May ’07) of $ 2.21 MMBTU, excluding royalty, is also a concern as there are huge under recoveries in the gas business.

Particulars 4QFY06 4QFY07 Change FY06 FY07 Change
Offshore Segment            
Revenues 80,355 102,860 28.0% 341,942 420,893 23.1%
% of total revenues 67.5% 83.0%   71.3% 74.3%  
PBIT 28,973 45,639 57.5% 169,906 215,366 26.8%
PBIT margins 36.1% 44.4%   49.7% 51.2%  
Onshore Segment            
Onshore revenues 42,637 38,165 -10.5% 150,042 170,733 13.8%
% of total revenues 35.8% 30.8%   31.3% 30.1%  
PBIT 12,028 (9,907) -182.4% 34,922 5,131 -85.3%
PBIT margins 28% -26%   23% 3%  

As far as the revenue break up is concerned, 60% of the revenues were from crude oil (24.41 MMT), 12% from natural gas (20.30 BCM), 11% from value added products (MMT), 10% from trading and 7% from others.

Input costs escalate: Raw materials cost registered a whopping increase of 301% YoY in Q4FY07 and 155% in FY07 respectively. Staff costs also shot up and were higher by 209% YoY in Q4FY07 and 134% in FY07 respectively. With increased threat of poaching from the private sector, ONGC is taking steps towards retaining talent with attractive social welfare and post retirement benefits and this is likely to put continued pressure on its staff costs in the medium term.

Cost break-up…
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Raw materials 275 1,103 301.8% 1,616 4,125 155.3%
% sales 0.2% 0.9%   0.3% 0.7%  
Staff cost 5,027 15,549 209.3% 12,727 29,818 134.3%
% sales 4.2% 12.5%   2.7% 5.3%  
Other expenditure 20,582 22,239 8.1% 60,133 68,324 13.6%
% sales 17.3% 17.9%   12.5% 12.1%  
Statutory levies 18,275 28,392 55.4% 97,008 119,931 23.6%
% sales 15.4% 22.9%   20.2% 21.2%  
Purchases (trading) 7,571 12,543 65.7% 34,338 59,401 73.0%
% sales 6.4% 10.1%   7.2% 10.5%  

A significant fall in net interest outgo and benign depreciation charges has helped the company post an 8% growth in bottomline for the full year. The fact that the other income grew by a strong 80% has also helped matters. Thus, these three factors combined have helped translate a muted 4% growth in EBITDA to a more respectable 8% YoY bottomline growth for the full year ended FY07.

What to expect?
At the current market price of Rs 929, the stock is trading at a price to earnings multiple of 12.7 times its annualised FY07 earnings. Crude oil prices have rebounded after softening from the historical highs of US$ 77 per barrel and have been hovering around US$ 70 per barrel. Ad-hoc subsidy sharing agreement makes it difficult to gauge the impact of the same for ONGC. Realisation per barrel for the company is estimated at around US$ 44, which highlights the fact that the company is relatively insulated from the recent movement in prices. However, the subsidy-sharing formula caps the revenue growth for the company via increase in realisation. Given the stable nature of the industry, the production is also not going to increase significantly in the medium term. Thus, the growth prospects are capped to that extent.

The company however, is taking steps to keep the growth engine chugging along. 25 out of the 52 blocks awarded in NELP-VI were bagged by ONGC. The capital expenditure on exploration and production was Rs 131bn. 22 discoveries were made in FY07 out of which 9 are new prospects and 13 are new pools. The reserve replacement ratio for FY07 was 1.35 with reserve accretion at 65.56 MTOE and production at 48.49 MTOE. On June 4, 2007, ONGC signed an agreement with PETROBRAS for swapping of interest in 3 offshore oil blocks. ONGC will be the operator in E&P stage while it’s the joint operator in the development stage. This is a strategic step towards countering the ageing oil and gas fields in India. In light of these positive developments, the stock does look a good long-term bet.

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