Stock Review: ONGC

 

ONGC is trading at attractive valuations, and headwinds for the company are receding ahead of its FPO. It should also gain from rising profitability of its subsidiaries and new projects that are close to completion

 

   ONGC has become an attractive investment candidate after the fall in its valuations over the last year, and more so in view of recent developments. The government has finally taken steps to rein in the industry's under-recoveries. This benefits ONGC as it bears the largest subsidy burden. The company's tussle with Cairn India over royalty burden of Rajasthan fields was resolved in its favour. Besides, the government is expected to provide some clarity on ONGC's subsidy burden ahead of its long-awaited follow-on public offer (FPO).

Over the last 12 months ONGC has lost 15.1% of its value, against a 5% growth in the Sensex. But the company was able to grow its earnings 15.7% in FY11, in spite of doubled up subsidy burden. As a result, ONGC is now trading at around 10.6 times its 12-month consolidated earnings as against 14.4 a year back.
The government recently raised fuel prices and reduced taxes to lower the industry's under-recoveries. While this was done primarily to improve the liquidity position of oil retailing companies, ONGC's potential burden has come down substantially.

ONGC ends up funding nearly 28% of the industry's overall under-recoveries. Needless to say, if overall under-recoveries come down, ONGC directly benefits.

GROWTH DRIVERS

After stagnating for several years ONGC's aggregate production of oil and gas showed a marked growth in FY11. This was driven by its subsidiaries and joint ventures. However, the company's standalone production, too, showed signs of improvement in the last quarter of FY11.

ONGC Videsh (OVL), the company's wholly-owned subsidiary, reported 6.5% production growth in FY11 to 9.45 million tonne thanks to the commissioning of the Odoptu field in Sakhalin, Russia. Its net profit for FY11 grew 29% at 2,691 crore. ONGC's discoveries off the East Coast are expected to commence production from FY12 in phases. It has lined up capex of 31,150 crore for revamping and modernising existing fields and infrastructure. An additional 24,500 crore will be spent on developing new fields.

ONGC's joint ventures are set to complete two mega-projects in downstream industries in FY12. These are the aromatics complex at Mangalore and the 725 MW gasbased power plant in Tripura. Its 1.4-million tonne petrochemical complex in Dahej under the name ONGC Petro-additions (OPaL) will be completed in FY13.
Cairn India agreeing to bear its proportionate burden of royalty is potentially worth 2,400 crore for ONGC in FY12. Also, the government finalising some formula to work out ONGC's quarterly subsidy burden will bring transparency and help re-rate the stock.

FINANCIALS

ONGC has always been a cash-rich, debt-free company. Over the last eight years, it has shared nearly 1.25 lakh crore of the under-recovery burden. This has restricted its annual profit growth to single digits. Still it remains India's single largest profit-making company at 22,456 crore for FY11. The feat was achieved thanks mainly to the refund of 1,898 crore from the gas pool account. The subsidy outgo at 24,892 crore was more than twice that of last year.

VALUATIONS

Its peers Cairn India and Oil India are trading at a P/E between 9.2 and 11.2. Being the largest of them all, ONGC's P/E of 10.6 should be higher. A growing dividend return on the stock will make it even more attractive for a long-term investor. ONGC's subsidy outgo in FY11 was 24,892 crore, more than double that of last year. Hence, if total under-recoveries decline, it makes a big gain