Thursday, April 3, 2014

Oil & Natural Gas Corporation - very stable, massive margins but a subsidy engine

ONGC is the largest Indian upstream oil and gas producer with over 60% market share of the Indian fields. In the oil and gas exploration business ONGC has a massive head start and can garner a share in almost every PSC (Production sharing contract). The large issue is that the majority shareholder the government of India continues to direct these companies to share the burden of oil subsidy to the consumers as 36% on the upstream producers such as ONGC. To put it into perspective ONGC contributed 49,400 Crores to the under recoveries system which is more than 80% of its consolidated EBITDA!

1. How big is the moat?

Grade B moat

  • This is a commodity business and its survival should depend on its ability produce cheap oil and gas (and of-course sane subsidy management)
  • Very strong on the exploration front but there is the sword of the under-recoveries hanging on its head
  • Most of the oil and gas sold in crude form. Some value added products are present in the mix.
  • There are alternative energy projects being considered which might lead to some alternative sources of income - shale, coal bed methane, underground coal gasification, geothermal, Wind, and Kinetic hydro power. 

2. Risks

  • Under recoveries are at the whims and fancies of the government
  • Political risk or unrest in ONGC Videsh in the foreign assets
  • New discoveries not found or found with very expensive technology or expensive imported technology

3. Financials

  • Net importer by about 10.8K Crores. Most of the imports are capital equipment 17.7K Crores
  • No ESOPs
  • 5 year cash flow from operations (CFO) exceeds net income due to large depreciation and interest payments in the past
  • Exceptional items are small
  • Inventory % of sales is 7.6% and debtors % of sales is 9.1% - both of which are very healthy
  • Debt to EBITDA on a consolidated basis is 0.37 which is excellent
  • Net margin is at 14.2% - which is artificially low. Without the under recoveries it would be have been 24%+.
  • ROIC is 13.7% after under recoveries which would have been 30%+ without the under recoveries
  • Net working capital is massively negative to the tune of -12% of sales which shows an excellent operation
  • Dividend % of earnings stand at 39.3% - which is fairly healthy

4. Soft factors

  • Government of india owns 69.23%
  • FIIs only hold 6.27%
  • Not much insider trading reported
  • Director shareholding seems to be minimal although only a few directors have disclosed (new chairman being appointed, and directors up for re-election)

5. Pricing

  • This is a great business which is being used to subsidize consumer petrol and diesel costs.
  • Overall given the history of the company and the attitude of the government towards it - the net income growth will be capped by 5% to 6% by adjusting the under-recoveries. If the profits fall they could - but given the world's eternal fear of running out of oil a fall in genuine profitability would be only if they are unable to find oil & gas fields in unexplored areas of India. At that growth the right price to own it would be around 7 times earnings. Currently its trading at 13.55 times earnings. That said it is a safe stock and will probably rally in flights to safety during panic situations but not a value investment.
  • 2 big points to note:
    • If ever the under-recovery system is changed this might be an interesting stock to look at
    • The other exploration and production businesses in the private sector could be amazing to look it where there might not be subsidies involved

BSE: 500312|NSE: ONGC|ISIN: INE213A01029

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