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ONGC: Propelled by crude prices - Views on News from Equitymaster
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ONGC: Propelled by crude prices
Oct 31, 2007

Performance summary
  • Topline increases by 10% YoY during 2QFY08 on the back of higher production and increased realisations. Rupee appreciation continues to hurt.
  • EBITDA margin expand to 54.6% during 2QFY08, up from 50% in 2QFY07. Lower raw material and staff costs help matters.

  • Other income grows by 29% YoY.

  • Bottomline registers a growth of 22% YoY during 2QFY08 owing to operating margin expansion and higher other income.

Financial snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 140,686 154,139 9.6% 286,713 291,016 1.5%
Expenditure 70,287 69,986 -0.4% 135,221 127,640 -5.6%
Operating profit (EBDITA) 70,398 84,153 19.5% 151,493 163,376 7.8%
EBDITA margin (%) 50.0% 54.6%   52.8% 56.1%  
Other income 9,397 12,100 28.8% 13,597 20,488 50.7%
Interest 41 305 643.7% 74 352 377.5%
Depreciation 18,473 19,871 7.6% 40,781 37,417 -8.2%
Profit before tax 61,282 76,077 24.1% 124,234 146,094 17.6%
Tax 19,542 25,102 28.5% 41,304 49,014 18.7%
Profit after tax/(loss) 41,740 50,975 22.1% 82,930 97,080 17.1%
Net profit margin (%) 29.7% 33.1%   28.9% 33.4%  
No. of shares (m)         2,138.9  
Diluted earnings per share (Rs)*         79.7  
Price to earnings ratio (x)*         15.4  
(* 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 2QFY08?
Rise in production: There was a 2% YoY increase in production as 7 MMT (million metric tonnes) of crude oil was produced compared to 6.85 MMT in 2QFY07. Natural gas production increased to 6.35 BCM (billion cubic meter) in 2QFY08 from 5.70 BCM in 2QFY07.

Increase in realisations: Crude price realisations, net of subsidy discounts to downstream companies, increased 23% YoY to US$ 55.93 per barrel in 2QFY08 from US$ 45.42 per barrel in the corresponding quarter last year.

Unfavorable exchange rate: ONGC’s topline was lower by Rs 16 bn as it accounted for the value of the US dollar at Rs 40.53 as opposed to Rs 46.37 in 2QFY07. It may be recalled that ONGC bills its customers in US dollars and then collects equivalent rupees at the prevalent exchange rate. As the rupee has strengthened by more than 10% this year, ONGC received less rupees per dollar billed in 2QFY08.

Fall in the subsidy burden: Subsidies continue to play a pivotal role in the performance of the company. ONGC sold crude oil to the PSU oil marketing companies at US$ 55.93 a barrel against the market price of US$ 78.04 per barrel in 2QFY08. The subsidy burden on the company was Rs 38 bn in 2QFY08, down from Rs 50 bn in the corresponding quarter last year. A part of the decline can be attributed to the strengthening of the rupee, as subsidised oil received by the downstream companies is billed in US dollars and hence was cheaper in rupee terms.

Cost break-up
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Raw materials 17,247 16,115 -6.6% 34,988 29,669 -15.2%
% sales 12.3% 10.5%   12.2% 10.2%  
Staff cost 6,274 3,668 -41.5% 9,249 6,211 -32.8%
% sales 4.5% 2.4%   3.2% 2.1%  
Statutory levies 29,816 31,973 7.2% 60,956 60,964  
% sales 21.2% 20.7%   21.3% 20.9%  
Other expenditure 16,950 18,230 7.5% 30,028 30,796 2.6%
% sales 12.0% 11.8%   10.5% 10.6%  
Total cost 70,287 69,986 -0.4% 135,221 127,640 -5.6%
% sales 50.0% 45.4%   47.2% 43.9%  

Lower costs aid margins: ONGC’s staff expenditure decreased by 42% YoY in 2QFY08, as the company had included Rs 3 bn on account of Golden Jubilee and additional annual incentive in 2QFY07. 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 1.2 bn.

What to expect?
Crude oil (Brent) prices have rebounded strongly after softening from the historical highs of US$ 77 per barrel and have recorded new highs at around US$ 90 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$ 56 for 2QFY08, which highlights the fact that the company is able to participate in the recent upward movement in prices. However, the subsidy-sharing formula caps the revenue growth for the company via increase in realisations in oil while the benefits of the recent decision in KG gas pricing also remains uncertain for the company.

ONGC seems more aggressive than before in moving ahead with its joint ventures and exploration activities. The company bagged 25 out of the 52 blocks awarded in NELP-VI. 9 discoveries were made in 1HFY08. On June 4, 2007, the company signed an agreement with the Brazilian Petrobras for swapping of interest in 3 offshore oil blocks. ONGC will be the operator in E&P stage while it is the joint operator in the development stage. OVL, the 100% subsidiary of the company continues to be a growth driver by acquiring oil equity around the world. On the strategy of countering the ageing oil and gas fields in India, the company has entered into service contracts for development of 14 onshore marginal fields. Moreover, Rs 57 bn is being invested for the second phase of redevelopment of Mumbai High in Western Offshore, to enhance production by an incremental 22 MMTs.

At the current market price of Rs 1,231, the stock is trading at a multiple of 15.4 times its trailing twelve months earnings. We believe the price has factored in the positives and suggest a cautious approach at this juncture.

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