Less loved, but hard to ignore behemoths: Investors often view ONGC & Coal India (CIL), India?s energy SOEs (state-owned enterprises), thro-ugh the same lens, focusing on policy concerns (subsidies, pricing, ownership) and core operating/financial metrics (volumes, returns, cash). This report aims to dispel investor concerns that CIL will suffer as much as ONGC in providing national service, by arguing that recent policy initiatives give ONGC an edge for the next one-two years, but longer term CIL would gain from volume growth and cash. Our India strategist is OW (overweight) on ONGC, MW (medium weight) on CIL.
Will CIL suffer ONGC?s fate? ONGC carries a huge subsidy burden and is pressed into national service often. Investors fear CIL may suffer the same ordeal and show prolonged underperformance. ONGC?s grea-ter pain has, however, been a function of India?s huge oil imports (13x of thermal coal), as India is only 20% self-sufficient in oil (80% in coal).
CIL going the ONGC way is not the answer: We believe that with CIL already doing its bit (albeit implicitly) with its large discounts to global prices, the government may have little to gain on a net basis by inflicting a greater burden on the company. With profitability largely hinging on about 20% of volumes (largely non-power), lowering prices could imply losses on volumes to power, denting the contribution to government coffers. Spreading the pain may not be optimal; higher production would.
Policy tailwinds give ONGC an edge: We believe FY13-16e earnings momentum from recent policy initiatives (on diesel and gas) and a potentially more favourable macro (read crude) tilts the balance in ONGC?s favour over one-two years. While volume growth should remain subdued, policy and pricing upside matter more, driving a 3-year EPS CAGR of 11% (vs. 0.8% for CIL).
Growth, cash make CIL compelling longer term: With potentially >40 years of reserves, rising demand (11% CAGR) and policy initiatives focused on volumes, CIL?s growth trajectory should pick up vs. ONGC?s (short-lived for oil, and challenging for gas). Less risk of pricing downside, strong free cash flow generation and higher payouts augur well for CIL, vs ONGC?s capex intensive growth options that are unlikely to leave it with net cash for long.
CIL a price maker, ONGC a price taker: While ONGC is effectively a price taker in oil with its minuscule contribution to global production, CIL can be a price maker given its ability to impact global trade balances by significantly scaling up production. Government policy (pricing, evacuation, environmental) would, however, have a pivotal role to play.
?Citi