ONGC a potential hedge against rising crude oil
Being the largest upstream player in the country, ONGC is expected to directly benefit from the expected increase in government investments within crude oil exploration and production.
Oil and Natural Gas Corporation (ONGC) is the country’s largest government owned oil and gas exploration and production company.
The public sector undertaking (PSU) is responsible for 74%/80% of India’s annual crude oil/natural gas production respectively.
As a global energy player, ONGC engages in both upstream Exploration & Production (17.9% revenue) segment and downstream Refining & Marketing (82.1% revenue) business.
Product portfolio comprises Crude Oil (70.6% revenue), Natural Gas (16.8% revenue), Liquefied Petroleum Gas (4.7% revenue), Naphtha (3.8%) and Ethane (1.4% revenue)
Sectoral Growth and domestic demand bode well as tailwinds
Upstream segment potential: global energy demand as per OPEC is expected to rise annually by 28% till 2045 – with crude oil holding the largest share in the pie (28%). India will contribute the most towards incremental oil demand globally, adding 6.5m b/d between 2020 and 2045. Crude oil would (the narrative on renewables aside) be responsible for satiating c. 45% of the country’s total energy requirement, along with natural gas.
Downstream market potential: India is Asia’s second largest refiner with a total oil refining capacity of 246.9 MMT. The country is expected to double its capacity to 450MMT in the next decade.
Domestic Reforms and Initiatives
The govt. plans to invest US$ 2.86 billion in upstream oil & gas activities to double natural gas production to 60bcm and drill more than 120 exploration wells by 2022. In September 2021, oil and gas projects worth Rs. 1 lakh crore (US$ 13.46 billion) were approved in Northeast India. Considering ONGC is the largest upstream player in the country (with sizeable presence in Northeast) – it is expected to directly benefit from these investments.
Moreover in June 2021, the government announced its open-ness to auction ONGC and OIL’s unmonetized large oil and gas fields in the future.
The government’s India Hydrocarbon Vision 2025 plan identifies natural gas as the preferred fuel for the future (consumption growing 3x vs. crude oil) and several options are being explored to increase its supply capacity including build-up of facilities to handle imports of liquefied natural gas (LNG) and setting up of pipelines from major gas producing countries.
Sound balance sheet and low leverage de-risk the investment profile
ONGC’s revenue jumped from INR3,25,666Cr in FY17 to INR4,24,961Cr in FY20, registering a CAGR of 9.28% for the period.
Covid 19 knocked some steam out in FY21 with revenues at INR3,60,572Cr. EBITDA margins have improved to 16.30% in FY21 vs. 14.40% in FY20.
Leverage is accommodative with debt-to-total assets of 0.20x resulting in 6.55x interest coverage as at FY 2021.
Cash Flow generation looks strong with FCFF of INR14,993cr as at FY21.
Revenue for Q2FY22 stood at INR2,30,165Cr, +57.5% yoy, while EBITDA is at INR36,624Cr in Q2FY22.
ONGC has a significant capex outlay, and plans to invest INR15,500cr in major lumpsum turnkey projects (c. 7% of FY20 revenues vs. 1-3% historically), of which INR13,600cr will be on services, and INR2,250cr on material procurement in FY22.
Valuation on absolute and relative terms looks fairly attractive
The company currently trades at an attractive 5.7x P/E and 4.30x EV/EBITDA on FY21 figures.
Close Comps RELIANCE trades at 31.9x PE and 16.5x EV/EBITDA but commands a significant premium due to its telecom and digital footprint.
OIL which is trading at 5.8x P/E and 4.8x EV/EBITDA on FY21 and HINDOILEXP at 51.0x P/E and 20.5x EV/EBITDA (high debt) serve as more like-for-like stocks, albeit with a much smaller asset base and monopoly power.
Government holds 60.4% of outstanding shares however FII/FPIs have increased their stake from 8.06% to 8.08% in previous quarter.
Risk and Mitigants and Our Position
There is uncertainty around crude oil’s short term price outlook until the impact of Omicron fully manifests. The market would likely place a significant discount to the stock till then.
ONGC receives strong support from the Govt, is well positioned to benefit from investments in E&P and its pivot towards natural gas. Moreover, ONGC can serve as an effective hedge in a post pandemic rising crude oil price paradigm in a commodities heavy portfolio.
Disclaimer: The views expressed above are the views of Arkvega Partners LLP, and are subject to change at any time based on market and other conditions. This is neither an offer nor solicitation for the purchase or sale of any security, and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. We strongly advise you to do your own research and consult an accredited investment advisor before investing based on what you read in a newsletter. Arkvega Partners LLP or its employees may have exposure in the financial instrument discussed above and can close positions in the future without prior intimation.