ONGC: Co Gets Auction Boost, but Subsidy Still Weighs

The government’s decision to finally sell 5% of its stake in ONGC through the auction mechanism has boosted the scrip to a 9-month high. The oil exploration company’s stock has been under pressure over the past one-and-ahalf years on talks of a follow-on public offer or FPO. A successful auction could help ONGC’s market valuation in the near term, although concerns over subsidy-sharing remains.
Since the December 2010 quarter, the government has been toying with the idea of divesting part of its shareholding in ONGC through a follow-on public offer. The offering got postponed a few times, but whenever talks of an FPO started doing the rounds, the share price would stagnate. This was because a typical FPO would be offered at a discount to the prevailing market price with a further discount to retail shareholders.
Investor interest in the company dwindled due to the FPO hangover. Since May 2011, the average monthly turnover in ONGC stock has steadily declined till January 2012, when it was just 35% of what it was in May 2011. In contrast, February has seen a sudden jump in average turnover, which was over 2.5 times that of January 2012 — as it became clear the government would choose the auction route for divestment.
The FPO hangover also meant that in the past one year the scrip didn’t react to developments which otherwise would have had a sizeable positive impact on the stock — bonus issue and stock split in February 2011 and a favourable resolution of the royalty payment issue for the Rajasthan block.
Even though the news of auction has boosted ONGC share price, the scrip remains substantially undervalued. The key reason is the ad hoc nature of subsidies, which makes it impossible to forecast ONGC’s profits.
For example, in the first two quarters of FY12, the company’s subsidy burden was set at around 30% of the industry’s overall under-recoveries. However, for the December 2011 quarter the method was suddenly changed and ONGC’s subsidy burden was calculated at $56 per barrel of oil sold for the entire nine month period, April – December 2011. This meant a steep rise in the burden in a single quarter.
Unfortunately, there is no assurance that the method wouldn’t change again.
ONGC is hoping to increase crude oil production to 28.75 million tonnes in FY13 and to 32 million tonnes in FY14 from the current 27.3 million tonnes. Another positive about the auction process is the setting of a floor price. For a long-term investor the floor price of Rs 290 is surely attractive and there is a possibility that the bidding could take it even higher. A higher price in the auction will boost ONGC scrip in the secondary market.