Higher subsidy: Near-term overhang

The third quarter standalone results of Oil and Natural Gas Corporation (ONGC) confirmed the rising subsidy burden on the company, the impact of which was marked on the bottom line in the form of royalty reimbursements from Cairn.

Of the subsidy burden borne by public sector oil and gas companies for the quarter ended December 2011, ONGC’s share came at 47 per cent, compared to 33 per cent in the first two quarters. The management did not comment on how it would shape up in the fourth quarter.

On the flip side, FY13 production guidance is encouraging, which can see an upside from ramp-up at Bombay High, a large producing field, during September 2012.As for the stock, near-term prospects look subdued, given the lack of clarity on the subsidy burden for fourth quarter, production issues, as well as overhang of the follow-on public offer or the proposed share auction. However, any positive decision on a fuel price hike post-elections (next month) or diesel decontrol can provide a trigger for the stock.
 

ROYALTY INCOME MASKS FY12 PROFITABILITY
In Rs crore	Q3' FY12	FY12E	FY13E
Revenues	18,184	141,870	151,892
% chg y-o-y	-2.5	20.6	6.6
Ebitda	10,658	57,527	62,045
Ebitda(%)	58.6	40.5	40.8
Adjustment net profit	6,741	26,242	28,192
% chg y-o-y	-4.8	15.0	7.4
EPS (Rs)	-	32.0	33.6
PE (x)	-	8.8	8.4
E: Estimates                                     Quarterly results are Standalone (only ONGC) Source: CapitaLine Plus, Bloomberg, Analyst reports

Subsidy dents profits
The subsidy burden for upstream companies like ONGC came at Rs 36,900 crore for the nine months ended December. The company provides subsidy in the form of a lower sale price vis-a-vis the market price of crude oil. Based on a discount (subsidy) of $56 a barrel, multiplied by total crude sales of upstream companies (ONGC and Oil India), the latter’s share for the first nine months worked out to 37.9 per cent, say analysts. While upstream firms had shared 33 per cent of the subsidy burden during the first half of FY12, their share zoomed to 47 per cent during the December quarter.

Gross crude oil realisation in December quarter stood at $111.7 a barrel. Adjusting for higher subsidy payout of $66.8 a barrel, the net realisation works out to $45 a barrel, down 31 per cent year-on-year and 46 per cent over September 2011 quarter. ONGC got support from the royalty reimbursement of Rs 3,142 crore by Cairn India for the August 2009-September 2011 period, which limited the year-on-year decline in net profit (Rs 6,741 crore) to 4.8 per cent. Adjusting for royalty, net profit was down 33 per cent at Rs 4,748 crore.

Production volumes
ONGC recorded a four per cent fall in crude oil production to 6.74 million tonnes (mt) year-on-year (both, domestic operations and JVs); while gas sales rose by one per cent to 6.4 billion cubic metres (BCM) in the quarter. Oil production at its global subsidiary ONGC Videsh Ltd (OVL) (not included in the results) was also affected due to political unrest in the fields in Syria and Sudan, which account for 25 per cent of OVL’s output.

The medium-term outlook for future volumes, though, is strong. Arindam Pal at Asian Market Securities says that total crude production prospects for FY13 at 28.75 mt and gas production prospects at 27 BCM is positive. He says an uptick of 3 mt in crude oil production can be provided by Bombay High from September 2012. Analysts at Goldman Sachs estimate ONGC’s production to rise quickly over the next two years driven by development of marginal fields, implementation of IOR/EOR (production enhancing) projects and ramp-up at the Rajasthan block. They add ONGC’s abroad assets have oil price leverage and would be key to drive the next level of growth.

Any fuel price increase would create an upside to their FY13 estimates, which do not factor in any fuel price increases. Production from OVL’s overseas assets like Venezuela is also expected to start from December 2012, with initial daily production of around 20,000 barrels.

Valuations
Analysts at Motilal Oswal Securities remain positive from a longer term perspective, due to expected rationalisation of subsidy sharing and potential reserve accretion from its large E&P acreage. While they believe near-term profits will get impacted due to high under-recoveries and lower production from OVL led by geopolitical tensions, they say ONGC (at Rs 281.30) trades at a 45 per cent discount to its global peers on EV/BOE (enterprise value per barrel of the equivalent).