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ONGC: Subsidy proposes, appreciation disposes - Views on News from Equitymaster

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ONGC: Subsidy proposes, appreciation disposes

Jul 25, 2007

Performance summary
  • Topline declined by 6.3% YoY while bottomline grew by 11.9% YoY.

  • An 11.2% decline in expenditure resulted in an improved EBITDA margin of 57.9% for the quarter as against 55.5% in the corresponding quarter last year.

  • Other income increased by 100% on the back of surplus from Gas Pool Account.

Financial snapshot
(Rs m) 1QFY07 1QFY08 Change
Net sales 146,028 136,877 -6.3%
Expenditure 64,933 57,654 -11.2%
Operating profit (EBDITA) 81,094 79,223 -2.3%
EBDITA margin (%) 55.5% 57.9%  
Other income 4,200 8,388 99.7%
Interest (net) 33 48 44.8%
Depreciation 22,309 17,546 -21.4%
Profit before tax 62,952 70,018 11.2%
Tax 21,763 23,913 9.9%
Profit after tax/(loss) 41,190 46,105 11.9%
Net profit margin (%) 28.2% 33.7%  
No. of shares (m) 1,426.0 2,138.9  
Diluted earnings per share (Rs)* 77.0 86.2  
Price to earnings ratio (x)**   12.3  
(* 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 1QFY08?
Rupee appreciation and fall in production: Net sales declined by 6% due to rupee appreciation by 9.3% over 1QFY07. This shaved off Rs 15 bn off the topline.

There was a marginal decrease in production as 6.88 MMT (million metric tonnes) of crude oil was produced compared to 6.93 MMT in the same period in FY07. This was due to processing problems at the Nawagam Desalter plant. Natural gas production declined to 6.10 BCM (billion cubic meter) from 6.42 BCM in the corresponding previous quarter.

Fall in the subsidy burden: Subsidies continue to play a pivotal role in swinging the performance of the company. However, this time, they came to the rescue of the company, as the subsidy burden was Rs 37 bn, down from Rs 51bn in the corresponding quarter last year.

ONGC sold crude oil to the PSU oil marketing companies at 50 dollars a barrel against the market price of 72 dollars per barrel. It should be remembered that it realized $ 45 per barrel when the gross realisation was $ 71 in 1QFY07.

Cost break-up
(Rs m) 1QFY07 1QFY08 Change
Raw materials 17,741 13,554 -23.6%
% sales 12.1% 9.9%  
Staff cost 2,975 2,543 -14.5%
% sales 2.0% 1.9%  
Statutory levies 31,140 28,991 -6.9%
% sales 21.3% 21.2%  
Other expenditure 13,078 12,566 -3.9%
% sales 9.0% 9.2%  
Total cost 64,933 57,654 -11.2%
% sales 44.5% 42.1%  

Falling costs: The company changed its accounting policy of charging certain employee benefits at various locations and general administrative expenses at Assets, Basins, Services and Regions to ‘Production, Transportation, Selling & Distribution Expenditure’. During the quarter, such expenses have been allocated to respective activities. This change has resulted in lower allocation to Profit & Loss Account with an impact of increase in profit before tax by approximately Rs 950 million.

Surge in Other Income: A transfer of Rs 890 million being surplus in Gas Pool Account was included by the company under ‘Other Income´.

What to expect?
At the current market price of Rs 930, the stock is trading at a price to earnings multiple of 12.3 times its trailing twelve months earnings.

Crude oil prices have rebounded after softening from the historical highs of US$ 77 per barrel and have been hovering around US$ 73 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$ 50 for 1QFY08, 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 in Oil while the ambiguity in gas pricing also makes the realisations from KG basin gas uncertain.

The company seems more aggressive than before in moving ahead with its joint ventures and exploration activities. 25 out of the 52 blocks awarded in NELP-VI were bagged by ONGC. 5 discoveries were made in 1QFY08. 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 its the joint operator in the development stage. It has also entered into service contracts for development of 14 onshore marginal fields. 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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