India's ONGC Will Have Solid Operating Cash Flow To Support Higher Investments S&P

Jun 3, 2022 03:00 pm

Oil and Natural Gas Corp. Ltd. (ONGC) should have a solid base to increase investments over the next 12-18 months, thanks to a healthy earnings outlook. Improved cash flow continues to support the rating on the India-based company (BBB-/Stable/--). S&P’s rating on ONGC remains constrained by the sovereign credit rating on India (BBB-/Stable/A-3).

ONGC will direct more than 60% of its improved cash flows to capital investments over the next few years. We expect the company to spend Indian rupee (INR) 550 billion-INR600 billion in fiscal 2023 (ending March 31, 2023) compared with less than INR450 billion that it has spent annually for the past two years in view of challenging business conditions. Of this, ONGC intends to spend INR310 billion over the next three years on exploration activities, compared with close to INR210 billion for the last three years. This increase will offset the decline in the company's recent production to 43.4 million metric ton of oil equivalent (mmtoe) in fiscal 2022 from 48.25 mmtoe in fiscal 2020. We anticipate these investments will also aid earnings resilience if prices start to decline.

ONGC is also likely to maintain healthy shareholder distributions, in our view. The company paid about INR130 billion in dividends in fiscal 2022, equivalent to about 30% of its free operating cash flows. ONGC has shown good flexibility in the past when it scaled back dividends to about INR30 billion in fiscal 2021 due to the challenging business conditions. However, given the healthy earnings outlook, we expect the company to maintain its stated financial policy of returning 40%-50% of net income to shareholders.

Favorable crude oil prices will support ONGC's earnings over the next 12 months and underpin the increased investments. We have revised our Brent crude oil price expectations for the rest of 2022 to US$90 per barrel and US$75 per barrel for 2023. This compares with about US$76 per barrel that ONGC realized in fiscal 2022. The recent increase in India's natural gas price will also boost earnings. The formula-determined price increased to US$6.1 per million British thermal unit (mmbtu) for the first half of fiscal 2023 from the earlier US$2.90 per mmbtu. Crude oil and gas contribute almost equally to ONGC's overall production volumes. We expect ONGC's earnings will increase 20%-25% in fiscal 2023 over fiscal 2022. We also estimate the company's ratio of funds from operations to debt will remain 55%-60% in fiscal 2023 compared with our estimate of 50%-55% in fiscal 2022.