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 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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ONGC Dividend History

ONGC is an Indian oil exploration company majority owned by government of India, i.e. it’s a PSU. As a stock, it has a very long history of dividends. It’s a company with solid business model and has highly reliable cashflows. If you are an Indian investor focusing on dividends, it would be strange if you do not hold shares of ONGC. Ask anyone to name few great Indian companies which have paid generous dividends. We can bet that ONGC would definitely figure in such a list. We ourselves have chosen it for our Dead Monk’s Portfolio. We personally hold ONGC and another oil explorer Cairn Indiaas long term investments.

 
ongc logo
 
This post is about ONGC’s dividends, frequency of payouts, payout ratios and all related information.
 
Why are we doing this? As already mentioned, we hold ONGC in our long term portfolio for primary purpose of dividend income. We are doing this to reaffirm our faith in ONGC of being a good dividend stock to hold for years to come. J As far as capital appreciation is concerned, we believe Cairn India is a better stock in oil sector.
 
Dividend Rate (%)
 
ONGC is known to be a regular dividend payer and this notion is validated by data. It has been consistently paying dividends for more than 10 years. The table below shows the dividend rates (as % of face value). The great thing is that the dividends have been continuously increasing during the last 5 years.
ONGC's Dividend Payout Rates
ONGC’s Dividend Rates (%) : Last 10 years
Dividend Payout Ratio (%)
 
A company with high dividend payout ratio can mean two things: Either the company has no future investment plans OR high dividend payouts are temporary (due to some asset sale) and hence not sustainable. ONGC for last 10 years (!) has maintained a very stable payout ratio of 40% i.e. it shares 40% of its earnings with investors as dividends. This shows that company is balancing its growth (investment) plans and wealth sharing objective on a consistent basis.
ONGC’s Dividend Payout Ratio : Last 10 years
Dividend Policy
 
Company’s dividend policy (available on its website) has the following 2 highlights:
  • Factors to consider while deciding dividends: Future capital expenditure plans, profits earned during the financial year, cost of raising funds from alternate sources, cash flow position and applicable taxes including tax on dividends.
  • As per govt.’s guidelines, all profit-making PSUs in oil sector (like ONGC) should declare the higher of a minimum dividend of 30 % on equity or a minimum dividend payout of 30 % of post-tax profit.
Since company has maintained 40% payout ratio for last 10 years, it is safe to assume that same would be maintained in future too. Since great companies generally increase their earnings over years, it can be safely assumed that dividends would increase in years to come.
 
How many times ONGC pays dividend in a year?
 
In last 8 years, ONGC has paid dividends twice every year. Interim dividend (generally higher than final dividend)is paid in December. This is followed by Final Dividend paid in September. We have plotted all dividend payouts by ONGC in last 12 years. The same can be seen below. This dividend calendar is a good depiction of when (& how much) to expect as dividends from ONGC every year.
 
ONGC Dividend Calendar
Click to enlarge
Though we haven’t discussed ONGC’s future business prospects, we believe that being a mature company with ageing oil fields (except those owned by its subsidiaries ONGC Videsh Ltd), it would be wrong to expect it to become a multi-bagger in years to come. But what can be expected is a stable flow of dividend income, stability in portfolio and potential of positive surprises in case there are any bumper oil & gas discoveries.
All in all, we would stay invested in ONGC and keep investing as and when its prices fall substantially.
 
Disclosures: Hold Long term investments in ONGC, Cairn India.