Investors with a two-to-three-year investment horizon can consider accumulating the stock of India’s largest oil and gas producer, ONGC, on dips. We believe the new gas pricing guidelines announced by the Government to be positive for the company. Besides, the additional crude and gas output from new fields, particularly its new well at Krishna Godavari basin, should help the company sustain healthy growth over the next two years. At the current price, the stock trades 5.1 times its trailing twelve-month earnings and about 0.7 times its book value. The stock, at the current price, offers an impressive dividend yield of 6.75 per cent.
We believe ONGC to be a good medium-term investment opportunity for three reasons.
First, ONGC commands leadership position in India’s oil and gas exploration industry, accounting for 68 per cent of the production — and for over two-thirds of the country’s total gas production. Similarly, on a stand-alone basis, without including joint ventures, it accounts for 66 per cent of the country’s crude oil produced as of April 2022-February 2023 production data released by PPAC (Petroleum Planning and Analysis Cell). ONGC’s production was at 16.88 million tonnes, as against total production of 25.49 million tonnes for the 11-month period ended February 2023.
The company also has the largest reserves of oil and gas in the country. As of April 2023, it has P2 reserves (proven and probable reserves) of 1221.48 million metric tonnes of oil and oil equivalent gas. In FY22, the company produced a total of 55.72 million metric tonnes. The current reserves are over 22 times its FY22 production. The company, through its subsidiary ONGC Videsh, has 32 projects ongoing in 15 countries and is looking to increase output from overseas assets from 15 million metric tonnes of oil equivalent to 40 mmtoe by 2040.
The new discovery of Vindhyan basin in 2022 will drive the long-term growth for ONGC.
Second, the new pricing guideline for domestic gas is expected to benefit the company’s natural gas business, by way of steady revenue and profit growth, over the medium term. Under the new policy, the gas realisation per mmbtu will be fixed at 10 per cent of the previous month’s average basket price of crude for India. Old fields of ONGC, also called as nominated fields, will have a floor of USD 4 per mmbtu and a cap price of $6.5 per mmbtu. This is positive for ONGC given that in the last 7 years, natural gas prices have been in the range of USD 1.9 to about USD 3.7 per mmbtu with an average of USD 2.8 per mmbtu.
Also, the company’s gas cost is estimated to be under USD 2 per mmbtu, and this should help consistent revenue and profit growth for the gas segment. Assuming total production of 22 billion standard cubic metre this year, the incremental revenue and operating profit accretion for every USD 0.5 increase per mmbtu, due to the new pricing guideline, will be about ₹3,630 crore.
Third, the new discoveries such as the KG-DWN-98/2 in the Bay of Bengal and the Cluster-8 marginal fields in the western offshore will add to the company’s gas production beginning FY23-24. ONGC is expecting incremental gas production of over 5 billion cubic metre by 2026, from the FY22 production of 20.9 billion cubic metre, which is an increase of about 25 per cent, over the next three years. Interestingly, it will be able to get a 20 per cent premium on the gas price from this field, under the new pricing guideline. ONGC is also implementing the fourth phase of the redevelopment of its 5-decade old Mumbai High oil and gas fields, which will further augment oil and gas production. It has set aside ₹31,000 crore, for shoring up its energy exploration over the next 2-3 years.
Besides this, the company is also actively pursuing opportunities in the renewables space – it has signed an MoU with Greenko ZeroC Pvt Ltd for setting up a 1 million tonne green ammonia plant. It envisages scaling up its non-renewable energy production from the current 204 MW to 10 GW by 2030.
Financials
The company’s strong balance sheet with a net debt to equity ratio of 0.42 times as of September 2022 lends more comfort and this has improved marginally from 0.44 times in March 2022. Being a consistent dividend payer, the stock’s current dividend yield of 6.75 per cent is attractive given the volatility in the market. For the nine-month period ended the company grew revenue by 29 per cent to ₹520,762 crore. However, the profitability of the company was impacted by the losses in the Oil marketing and refining subsidiaries – Hindustan Petroleum Corporation (HPCL) and Mangalore Refinery and Petrochemicals (MRPL) respectively, due to which the company reported a 27 per decline in net profit. While the standalone operating margin of ONGC is 55 per cent for 9MFY23, the consolidated profit margin was much lower at 12 per cent, thanks to the refining and marketing business losses.
Risks
ONGC holds 54.9 per cent stake in oil marketing major HPCL and 71.63 per cent stake in MRPL. HPCL’s performance has been a drag on ONGC’s profitability particularly over the last nine months, as the company reported a net loss of ₹14,696 over the April-December 2022 period. Despite sky-rocketing crude prices and record refining margins, the losses on marketing of petrol and diesel as the Government chose to kept prices unchanged, took a toll on HPCL’s performance. Now with the crude oil price in the USD 80 per barrel levels, any further increase in oil prices and inability to pass it on to consumers, can continue to strain HPCL’s profitability. That said, easing of inflation over the next few months and moderation in crude oil prices globally will be positive for HPCL. The windfall tax on crude which is currently a negative may be phased out should the crude prices moderate to USD 70 levels.
