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ONGC: Growth ‘discounted’ - Views on News from Equitymaster
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ONGC: Growth ‘discounted’
Oct 23, 2006

Performance summary
Exploration and production major, ONGC declared its results for the second quarter and first half ended September 2006 late last week. Topline registered a growth of 11% YoY and 22% YoY for 2QFY07 and 1HFY07 respectively. Operating margins dwindled by 640 basis points (6.4%) in 2QFY07 as discounts on sale of crude, kerosene and domestic LPG to oil marketing companies arrested the growth in realisations. Higher revenue contribution from the trading business (a lower margin business) also affected margins to an extent. Bottomline took a severe blow of the subsidy sharing as the net profit growth during 2QFY07 was flat, while the same grew at a slower pace of 11% YoY in the 1HFY07.

Financial snapshot…
Particulars 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 126,798 140,686 11.0% 235,495 286,714 21.7%
Expenditure 55,245 70,287 27.2% 102,891 135,220 31.4%
Operating profits(EBDITA) 71,553 70,398 -1.6% 132,604 151,493 14.2%
EBDITA margins(%) 56.4% 50.0%   56.3% 52.8%  
Other income 8,635 9,397 8.8% 11,621 13,597 17.0%
Interest expenses 55 41 -25.6% 77 74 -4.0%
Depreciation 19,364 18,473 -4.6% 32,881 40,782 24.0%
Profit before tax 60,770 61,282 0.8% 111,268 124,235 11.7%
Tax 19,387 19,542 0.8% 36,696 41,305 12.6%
Profit after tax 41,383 41,740 0.9% 74,572 82,930 11.2%
Net profit margins(%) 32.6% 29.7%   31.7% 28.9%  
No. of shares (m) 1426 1426   1426 1426  
Diluted EPS 29.02 29.27   52.30 58.16  
Price to earnings ratio *         9.9  

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 2QFY07?
Volumes drive Revenues: ONGC registered a growth of 11% YoY in its topline during 2QFY07. Crude oil production increased to 6.39 million metric tonnes (MMTPA) compared to 5.81 MMTPA in 2QFY06, thus registering the growth of 10% YoY during the quarter. However, the same was on the lower side compared 1QFY07. Gas production has declined by 5.8% YoY to 5.18 billion cubic metres (BCM) as against 5.50 BCM in the corresponding period of previous year on the back of production disruption due to floods. Based on these numbers, we conclude that the sales were primarily driven by increase in volumes during 2QFY07. The same gets substantiated from the fact that crude oil prices recovered by ONGC during the quarter were US$ 45.42 per barrel, against US$ 45.78 per barrel in 2QFY06. Inspite of supernormal growth in the crude oil prices during the period, higher subsidy burden has resulted in lower topline growth for the company. To put things into perspective, the subsidy discounts offered to oil marketing companies was Rs 50 bn in the quarter (compared to Rs 29 bn in the previous year, thus an increase of 72% YoY).

Margins tumbles due to subsidy: Operating profits for the quarter saw a marginal decline of 1.6%, as margins dipped by as much as 640 basis points in 2QFY07. Increase in sale of trading products accounted for roughly 60 to 70 basis points decline in margins for the quarter ended September 2006. Increase in raw material cost (55% YoY) and staff cost (167% YoY) added to the margin pressure. Staff cost increased due to additional annual and golden jubilee incentive to the employees. The subsidy impact on the PBT was Rs 46 bn (33% of the net sales during the quarter).

Expenditure break-up...
% of sales 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Consumption of raw materials 579 899 55% 895 1,918 114%
% of net sales 0.5% 0.6%   0.4% 0.7%  
Purchases( trading) 12,144 16,348 35% 21,500 33,070 54%
% of net sales 9.6% 11.6%   9.1% 11.5%  
Staff cost 2,352 6,274 167% 5,159 9,249 79%
% of net sales 1.9% 4.5%   2.2% 3.2%  
Other expenditure 40,170 46,766 16% 75,336 90,984 21%
% of net sales 31.7% 33.2%   32.0% 31.7%  
Total expenditure as % of sales 43.6% 50.0%   43.7% 47.2%  

Higher depreciation spoils play: Other income increased by 9% YoY during 2QFY07,while the same grew at a pace of 17% YoY for 1HFY07. Depreciation (14% of the net sales in 1HFY07) increased by 24% YoY in the first half of the fiscal, thereby arresting the profitability growth.

Performance summary...
Particulars 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Net Sales growth (%, YoY) 5.6% 7.3% 3.1% -2.1% 34.3% 11.0%
Operating profits growth (%, YoY) 18.5% 12.5% 17.1% 5.5% 55.5% -1.6%
Net profits growth (%, YoY) 43.8% 22.3% 11.3% -35.6% 24.1% 0.9%
Operating profit margins 56.2% 56.4% 59.0% 56.5% 55.5% 50.0%

What to expect?
At the current market price of Rs 1,151, the stock is trading at a price to earnings multiple of 9.9 times its annualised 1HFY07 earnings. Crude oil prices have softened from the historical highs of US$ 77 per barrel and have been hovering around US$ 60 per barrel. Ad-hoc subsidy sharing agreement makes it difficult to gauge the benefits of the same for ONGC. Realisation per barrel for the company is estimated at around US$ 45, which highlights the fact that the company is relatively insulated from the recent decline in prices. However, the subsidy-sharing formula caps the revenue growth for the company via increase in realisation. Given the long-term 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.

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