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Stocks to Buy Now: ONGC May Bring Upside Thanks to Rising Govt Investment and A Push to Privatise

Professor of Financial Economics and Part-time Value Investor, Transfin.
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Oil and Natural Gas Corporation (ONGC) is India’s largest Government-owned oil and gas exploration and production company. The "Maharatna" operates under the aegis of the Ministry of Petroleum and is responsible for 74%/80% of India’s annual crude oil/natural gas production respectively.

As a global energy player, the company engages in both upstream Exploration & Production (17.9% revenue) segment and downstream Refining & Marketing (82.1% revenue) business.

Its 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).

ONGC discovered new sites in Assam, the Cambay basin (Gujarat) and the Eastern coast. In the 1970s, the PSU went offshore with Mumbai High.

Its history can be traced back to 1955 when the Government of India announced its intentions to develop India’s oil and natural gas resources. To this end, an “Oil and Natural Gas Commission” was constituted and later elevated to a statutory body with a mandate to explore possible crude reserves. Post-liberalisation, the "Commission" became a "Corporation" (in 1993, the Union Government first divested 2% of its stake through competitive bidding).

Here are 5 reasons why ONGC’s stock may bring significant upside.

  1. Tailwinds Favouring the Sector

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 450 MMT over the next decade.


  1. Domestic Reforms and Initiatives

The Government plans to invest $2.86bn in upstream oil and 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 ₹1Lcr ($13.46bn) 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, GoI’s privatisation drive is coming for ONGC. That said, the company’s tryst with the private sector is an old one. In 1991, for instance, it took a $450m loan from the World Bank on the condition that discovered oil fields would be developed as JVs with private and foreign players.

Besides its divestment ventures, the PSU is constantly pushed by GoI to sell its fields to private players to offset declining outputs. In 2017, for example, the Directorate General of Hydrocarbons identified 15 fields with a collective reserve of 791.2 MT for handing over to private firms. (This plan didn't see the light of day due to strong opposition from ONGC.) But two years later, the Cabinet decided to bid out 64 marginal fields of the ONGC. However, the market response was lukewarm at best, leading to the PSU retaining 49 fields. But GoI attached a condition - that the performance of these fields would be strictly monitored for three years.

In April 2021, MoP devised a seven-point action plan titled "ONGC Way Forward" to streamline the PSU's operations and raise oil and gas production by one-third by 2023-24. This plan included suggestions to sell stakes in maturing fields, privatising "non-performing" marginal fields and invite foreign participation in gas-rich blocks. Also touted was the suggestion of creating separate entities for drilling, well services, logging, workover services and data-processing entities. Furthermore, in June 2021, the Government announced its openness to auction ONGC and OIL’s unmonetised 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.


  1. Sound Balance Sheet and Low Leverage

ONGC’s revenue jumped from ₹3,25,666cr ($43.35bn) in FY17 to ₹4,24,961cr ($56.57bn) in FY20, registering a CAGR of 9.28% for the period. COVID-19 knocked some steam out in FY21 with revenues at ₹3,60,572Cr ($48bn). EBITDA margins have nonetheless 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 ₹14,993cr ($2bn) as of FY21. Revenue for Q2FY22 stood at ₹2,30,165cr ($30.64bn), a +57.5% jump YoY, while EBITDA was at ₹36,624cr ($4.88bn) in Q2FY22.

ONGC has a significant capex outlay, and plans to invest ₹15,500cr ($2bn) in major lump sum turnkey projects (c. 7% of FY20 revenues vs. 1-3% historically), of which ₹13,600cr ($1.8bn) will be on services, and ₹2,250cr (299.5m) on material procurement in FY22.


  1. 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 Ccomps 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 as 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.

The Union Government holds 60.4% of outstanding shares, however FII/FPIs have increased their stake from 8.06% to 8.08% recently.


  1. Hedge Against Rising Crude Oil

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. However, market volatility over the US Federal Reserve’s impending tapering of loose monetary policy and geopolitical concerns surrounding the Russia-Ukraine crisis and Middle Eastern instability have resulted in a consistent uptick in crude prices over the past few weeks.

ONGC, which receives strong support from the Government, 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.


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