Oil & Natural Gas Corporation (ONGC) has followed up 4QFY02 with an even better performance in the quarter ended June '02. While other industries have struggled to report topline growth, the oil & gas upstream major, operating in amongst the dullest of industries, has reported exciting financials. Investor interest in the stock has increased considerably since beginning of the year with dismantling of administered pricing (APM) and PSU scrips attracting attention.
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ONGC stock has risen from Rs 150 levels to Rs 370 levels. With dismantling of APM in the petroleum sector, ONGC, technically, is expected to be compensated at international prices for crude oil supplies. Consequently, the stock has reflected change in business fundamentals. The reported rise in sales for 1QFY03 is led by better realisations. That said, production of oil and gas for the quarter, encouragingly, increased YoY by an estimated 8.5% and 6.1% respectively, which is likely to be reflected in sale volumes, as India is a net importer of energy sources. The company has been experiencing decline in production over the past five years with output falling from an estimated 30 m metric tonnes per annum (MMTPA) to 26 MMTPA. The company states that improved volumes is through advanced drilling techniques at Mumbai offshore, which could be reflection of efforts to increase yields at Bombay High field to 40%.
As mentioned in our FY02 report, prior to APM dismantling, ONGC was compensated at a ceiling rate of $16/ barrel on crude oil supplies. International crude oil average price (Brent blend) for 1QFY03 was at $ 25/ barrel, which is an estimated 56% above earlier realisation rates. To ensure a smooth transition to market-determined pricing mechanism, we reckon, ONGC crude oil realisations are not completely linked to international rates. That said, while realisations have increased, the Government has doubled cess on public sector produced crude oil to Rs 2,000/ tonne to prevent any windfall gains from de-control. As a result, statutory levies, the largest cost component, has risen by 59% YoY. Consequently, operating margins have declined. Operating profits have been lifted by growth in turnover.
Interest expense had been on a decline over the past three years, as the company repaid debt from excess cash. As per earlier reports, the company planned to become debt free by FY04. However, it seems, the company is likely to bring forward the target date. As per the press release, ONGC repaid World bank and Asian Development Bank loans amounting to Rs 25.1 bn. Surprisingly though, interest expense has increased during the quarter.
Recognising the need of reserve accretion, the company is becoming aggressive on new exploration. Also, as per reports, the company is implementing a plan to boost production yields at Bombay High fields. Over the next two years, the company plans to double reserve accretion. However, the exploration stage is risky with wide variations in anticipated reserves. The company, through a subsidiary, ONGC Videsh Ltd. (OVL), is scouting for opportunities in foreign fields. However, besides Sakhalin - I, OVL has not met with much success. The company has extended an interest free loan of Rs 21 bn to OVL. for exploring and developing fields. As per recent reports, OVL is likely to acquire stakes in two more projects.
A positive for the company, is that with dismantling of APM, it is a matter of time before gas prices are deregulated. As per reports, the Government, in two phases, could link international and domestic prices by FY04. Domestic gas prices are estimated to be ruling at half the international rates. Natural gas accounts for an estimated 21% of revenues. Consequently, deregulation in gas price could be a strong trigger. An important development has been purchase of A.V. Birla group stake of 37.4% in Mangalore Refinery & Petrochemicals Ltd. (MRPL) at beginning of August '02 for an estimated consideration of Rs 594 m. As per reports, ONGC is likely to infuse fresh equity of Rs 10 bn leading to management control of MRPL. Also, financial institutions are likely to convert a portion of debt to equity and accept moratorium of interest to allow for project rehabilitation. ONGC will be the first domestic integrated oil company with upstream & downstream operations. However, clarity is lacking on merger of MRPL with ONGC. Among the considerations for merger is the off set of MRPL's accumulated losses against current tax liability. At Rs 367, the scrip is trading on a multiple of 6.6x 1QFY03 annualised earnings.
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