11 February 2013

A 9-Year Case Study of an investment in ONGC & why it is available close to its historically cheapest valuations?

Some time back, we did a post on ONGC’s dividend history. Since, we hold this stock in our long term personal portfolio as well as Dead Monk’s Portfolio, we thought we could (or rather should) give it a deeper study. We were debating on how to go about it, when we came across a great post by Joshua (link) analyzing an investment in Starbuck’s IPO. We really liked the thoroughness with which the investment was analyzed. This prompted us to take a similar approach to evaluate ONGC.

ongc logo

Caution – This is a long and number intensive post.

ONGC’s IPO came sometime in first half of 2004. The prospectus is still available here. The price band was initially set as Rs 680 – Rs 750. And retail investors were offered a discount of 5%, i.e., shares were allotted to them at Rs 712.50 (non-adjusted as of today price). Retail category comprised of those who invested less than Rs 50,000. The proceeds of the share sale were going to Government of India and not ONGC.

This ONGC case study looks at following issues:

  • What a Rs 50,000 investment in company’s IPO would have turned into over a 9 year holding period? We look at all aspects including capital appreciation and dividends.
  • We also try simulating results of another approach where we make regular investment in ONGC’s stock over this 9 year period.
  • We also look at how ONGC has increased its book value per share over these years and how it can be used to make decisions about when to enter this stock for long term.
  • We also evaluated why the above approach might fail.

This is the first time we are trying to evaluate a company in this manner and would like to get your feedback and suggestions. Though this post took several hours, we think its result was worth it, atleast for us. J


What a Rs 50,000 investment in company’s IPO would have turned into over a 9 year holding period?

Suppose you had Rs 50,000 to spare in 2004. You decided to invest in ONGC’s IPO as a retail investor. The shares were sold at Rs 712.50 apiece to retail investors. You received a total of 70 shares (rounded for ease) for your investment.

First of all, after these 9 years, your 70 shares would have grown to 421 shares as a result of 2 bonuses (2:1 and 1:1) and a split (from face value of 10 to 5). At a market price of Rs 320 (at time of writing this post), your stocks would be worth Rs 1,34,737. To top it, you already know that ONGC is a generous dividend payer due to government’s mandate. This means that in past 9 years, you would have received 19 dividend payouts totaling a sum of Rs 30,035.

That means that between capital gains and dividends, your Rs 50,000 investment grew to Rs 1,64,772 in nine years.  That is a compound annual growth rate of 14.17%. Compare this with Sensex journey from 5600s to 19500s, i.e. a compound annual growth rate of 14.87%. Not bad for a dull and boring company like ONGC when compared to glamorous Sensex. J

(Edited to add): The Sensex returns would be higher than 14.87% if we also consider the dividends issued by the constituent companies.


investing in ongc ipo
Investment in ONGC IPO: Calculation of returns (including dividends paid in last 9 years)

This also means that in less than nine years, ONGC has returned more than 60% of the initial investment as dividends (that too pretty regularly: 19 times)!! It is here that one can truly understand John D. Rockefeller’s feeling when he said – ‘Do you know the only thing that gives me pleasure? It's to see my dividends coming in.’

ongc dividend history
Dividends Paid in last 9 years & comparison with initial investment in ONGC's IPO

Note – John D. Rockefeller was the richest man ever. More than 10 times richer than the current richest man!! You can read about him and his company Standard Oil’s story here.


What a Rs 10,000 investment every quarter (3 months) in ONGC’s stock would have turned into over these 9 years?

This approach is born out of our interest in disciplined investing. Suppose you decide to invest Rs 10,000 every three months in ONGC’s stocks. This can be considered similar to having a regular SIP (Systematic Investment Plan) in mutual funds. This approach would have resulted in you investing Rs 3,50,000 in last 9 years. Result?

First of all, after these 9 years of quarterly investments, you would own about 1656 shares of the company. At, current market price of 320, these shares would have a value of Rs 5,30,077. Apart from that, these shares would have earned a total of Rs 73,828 as dividend income. That is, your total investment of Rs 3,50,000 has turned into Rs 6,03,906.

regular investment in ongc
Quarterly Investment of Rs 10,000 in ONGC during last 9 years: Analysis of  total returns (including dividends)


What has been the trend in Book Value per share for ONGC in last 9 years and how this data can be used to decide when to invest in the stock?

The company has been growing its book value at a decent 13.6% (CAGR) for last 9 years. The great thing about this growth is that it has been uniform, i.e., all yearly increases have remained in the range 11-15%.

book value history ongc
ONGC's Adjusted Book Value Per Share (2004-2013) - (Note: 2013 book value is estimated)

book value trend ongc
ONGC Book Value Per Share & Annual Growth Rates

The above trend shows that the company has been successful in increasing its book value over the years. You may question this as the book value can be rigged. Also there are much better parameters available for valuing oil exploration businesses But lets just delay that discussion for a while. So, now what we have at our hand is a company (ONGC), operating in a capital intensive business of oil exploration, which has consistently grown its book value in last nine years.

So, now if we consider a very simple ratio: Price To Book Value Per Share (P/BV), can we find some trend which can actually help us in knowing whether it is a good time to invest in ONGC’s stock or not? Let’s first look at the graph below:

ongc book value
Price/Book Value Ratio: Lowest, Highest, Average - An indicator of when to enter the stock

The blue line is a plot of P/BV ratios of ONGC’s stock over the years. As we can see, the lowest which it has ever reached is P/BV=1.62. The highest it ever went was in late 2007 when it hit 4.14. The average in last nine years has remained at 2.51. So, when the stock was trading in the band 1.6-1.7 in late 2012, it was one of the cheapest multiple (P/BV) at which the stock could have been possibly bought!! Nevertheless, government’s deregulation news pimped up the stock and now you can see the abrupt rise in blue line near the end of graph. The stock is headed towards its mean. And this is a historical pattern. Any stock cannot remain far off from its historical averages for long durations. There is always a regression towards the mean. As far as our personal portfolio is concerned, we bought a few ONGCs near Dec 2012, when it was available at one of its cheapest valuations ever. J So is this the right method to decide whether to buy a stock like ONGC or not?

No...

Why?

Because there are many other factors which play an important role in deciding whether to purchase a stock or not. We look at a few which are relevant in this context.


Why the above approach should be taken with a pinch of salt? What are the possible loopholes in this approach?

A few immediate ones are as follows:
  • The above approach relies entirely on the stated book value of the share. And book values can be inaccurate because they do not always reflect the true networth of a company. This can be attributed to use of different accounting methods for items like depreciation, which can significantly affect the book value.
  • Oil exploration companies like ONGC offer a unique problem of valuation due to their large value based on oil reserves. There is also a large uncertainty in many of the assumptions, such as value and quality of their reserves. So, unless and until this data is taken into account, a comprehensive analysis of oil stocks cannot be done.
  • Other oil and gas specific metrics includes valuation based on barrel of oil produced per day, etc.
  • The above book value based approach does not give any weightage to the management team (appointed by Govt. of India in this case). Experience is crucial and ONGC has loads of it. But with ageing oilfields and increasing complexity of newer projects like ones taken up by ONGC Videsh (& its Imperial Energy fiasco), this aspect should be given its due importance.
  • Another issue with this approach is that it does not evaluate alternatives available within the sector. For example, there are other explorers like Oil India Limited and Cairn (India), which sometimes offer higher growth potential due to better reserve quality.
  • Its common knowledge that most of ONGC’s oil fields are ageing and in no position to increase their output. Such questions on future growth potential, in wake of lack of new oil finds, can also be attributed to lower P/BV multiple being assigned to this stock in last year and a half.


Last thoughts…

Oil & Gas companies are generally complex to value because of above mentioned limitations. But they offer solid investment vehicles for safety of principle, long term growth and consistent dividend payments. The above approach uses just one parameter P/BV to evaluate the stock. You as a reader, should remember that this is just a case study. Real life is much different from case studies. One should never invest based on just one parameter. This case should not be taken as an investment recommendation. Do your own due diligence before deciding about where to invest your hard earned money.

Disclosure: Long term positions in Cairn India & ONGC.

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10 comments:

  1. Hello. I have some doubt regarding this comment "Compare this with Sensex journey from 5600s to 19500s, i.e. a compound annual growth rate of 14.87%". While calculating the return of the market, don't we have to consider the dividend of Sensex companies as well? For example, if we had bought Sensex companies for the initial 50,000, we would also be getting the dividends of those companies. Considering that as well, the rate of return wont be that impressive for ONGC w.r.t Sensex.

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  2. @google-c70e7c4c5ea9161f9f946387e9b817e9:disqus

    Thanks for pointing that out Ravi. The returns indeed would be higher than 14.87% for Sensex. Added the data to the post. :-)

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  3. Financial analysis of ONGC may looks attractive but not the business analysis. It takes 10 yrs from prospecting for new oil to commercial production. All its investments abroad gone wary. Its domestic oil wells are aging and day by day getting more diluted oil that requires elaborate processing. The key drivers the stock in last decade had been govt divestment, bonus, high dividends LIC bail out, recent fuel price hikes and deregulation of petroleum prices. The product output of the company more or less flat if not decreased. To me, this company looks like in retirement age surviving on pension (existing aged wells) and it needs steroids to get back on track. The excess government intervention is making the matters only worse. I would not invest my money on injured top player who won many grand slams earlier.

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  4. ONGC though a stable company suffers greatly from Geo-Political risks too. ONGC videsh's strategic as well as tactical moves overseas have been random at best. Paying over the odds & lack of due-diligence . Caught in dispute over a block in the South China Sea where China claims territorial rights over blocks originally allocated by Vietnamese oil company PetroVietnam, we all know who is going to be the winner. Imperial Oil fiasco is common knowledge.Production in Sudan block has been stopped since the partition of Sudan, more than an year back.After OVL invested more than half a billion dollars in Syria through ONGC Nile Ganga Corp - and got 0.8 million metric tonnes of crude out of it - the Syrian Petroleum Company, which operated the block, shut down production because of anti-government violence. These are just the heavily documented fiascos & there will surely be some others too. Unless ONGC sorts it out , we just have to rely on the old national assets of ONGC,which are boring but atleast stable source of revenues. In Oil sector, BPCL,GAIL look better bets for capital appreciation

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  5. @7dd725d55cff2451cd7ab546629d69c4:disqus

    True. As of now, ONGC is facing many issues. Most significant ones being the ONGC Videsh (OVL) related investments. ONGC has said that it expects most of its future growth to come from OVL and not its Indian operations. And as far as OVL’s international foray is concerned, most of them have not progressed as projected.
    So ONGC, as of now, can be said to be a wait and watch stock, unless there is a major correction and stock is available at deliciously cheap valuations. Because any drastic fall in stock price, would increase the yield considerably. And considering the cash flow rich nature of oil exploration and production business, ONGC would become an obvious stock to buy at distressed valuations & high dividend yields.

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  6. @facebook-760773427:disqus

    You have rightly mentioned that ONGC is continuously faltering with its overseas arm OVL’s (ONGC Videsh Ltd) investments. The problem is that ONGC’s management itself is expecting most of its future growth to come from OVL and not its Indian operations. And going by the past track record, future does not look encouraging. As an investment, one has many other ‘supposedly better’ options like Cairn India & GAIL.
    But, one shouldn’t write off ONGC. This would become a stock to buy if there is a major correction and stock is available at deliciously cheap valuations. This is because any substantial fall in stock price, would increase the yield considerably. And considering the cash rich nature of oil exploration and production business, ONGC would become a stock to accumulate at distressed valuations & high dividend yields.

    ReplyDelete
  7. A joke on oil industry :

    A banker calls in an oilman to review his loans. "We loaned you a million to revive your old wells, and they went dry," says the banker.
    "Coulda been worse," replies the oilman.
    "Then we loaned you a million to drill new wells, and they were all dry holes."
    "Coulda been worse," answers the oilman.
    "Then we loaned you another million for new drilling equipment, and it broke down."
    "Coulda been worse," says the oilman.
    "I'm tired of hearing that," snaps the banker. "How the hell could it have been worse?"
    "Coulda been my money," says the oilman.

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  8. @f4b6effd42613014e1643496008b91bc:disqus

    That was a good one :-)
    Would share it with our readers on social networks soon.

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  9. Hi.. the P/BV chart of ONGC and EPS/PE chart of Sail are very insightful. How does one get last 10 years charts for various scrips? Pls advice.

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  10. If I am to start a Recurring Deposit (RD) for 10 years and invest 10,000 quarterly (Rs. 3333 per month) @ 9% interest, I will have Rs. 6,45,000/- at the end of 10 years (gross calculations - have not discounted TDS).

    Comparing that against the calculations that are shown for ONGC from IPO days till date (for 9 years) does't seem to be so lucrative as it sounds.

    SIP Investment of Rs 3,50,000/- in ONGC vs. RD investment of Rs. 3,99,960/- fetches Rs. 6,03,906/- (including Dividends) in 9 years vs. Rs. 6,47,365/- (compounded) in 10 years

    Just taking a contrarian approach here to induce the thought that what may appear great may not always be so great as we may think !

    ReplyDelete

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