ONGC-HPCL deal: a cozy arrangement

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The Oil and Natural Gas Corp. Ltd (ONGC) and Hindustan Petroleum Corp. Ltd (HPCL) deal has left the government with a big smirk on its face. After all, the deal consideration of Rs473.97 per share, amounting to Rs36,915 crore that ONGC will shell out for a 51% stake in HPCL, will help the government comfortably achieve its divestment target for this fiscal. The transaction is expected to close by the end of this month.

The acquisition price is at a 13.8% premium to HPCL’s closing share price on Friday. Still, ONGC investors are likely to heave a sigh of relief. That’s because the Street was expecting a significant premium compared to what has come through and by that logic, it’s a disappointment for HPCL shareholders.

Secondly, ONGC will not have to make an open offer, which will reduce the additional stress on its pockets.

It’s crucial how ONGC funds the deal, details of which are not yet out. ONGC has the option of monetizing its stakes in Indian Oil Corp. Ltd (IOCL) or Gail (India) Ltd. Still, consolidated debt is expected to increase.

As of 31 March, ONGC’s consolidated debt stood at Rs55,681 crore, translating into debt-to-equity of 0.25 times. IDFC Securities Ltd estimates ONGC group debt (including the $1.2 billion for Gujarat State Petroleum Corp. Ltd’s Krishna-Godavari assets and $2.2 billion for Russia’s Vankor field) could rise substantially if it buys the 51% stake in HPCL by raising debt and by not monetizing its ~14% stake in IOCL. The adjacent chart has details.

On a standalone basis, the deal is expected to turn its net cash balance sheet into net debt one.

Nevertheless, analysts expect the deal to be earnings accretive for ONGC. This column wrote earlier that for integrated oil companies, a lot depends on oil price levels and how best companies are able to hedge against price movements. For example, there have been times when refining companies have been able to perform comparatively better when crude oil prices dropped, as refining margins remained sturdy. ONGC could look to potentially reap benefits from such instances.

HPCL will not see much of an impact owing to this deal. “For HPCL, specifically, the transaction changes little on ground, with the company retaining its independent identity and only direct ownership changing hands,” pointed out Probal Sen of IDFC Securities in a report on 21 January.

What of the stocks?

ONGC shares have been suffering from the overhang of this deal and also fears about rising subsidies. With the deal price at a lower than expected premium, some of those worries are likely to recede. What this means is investor focus will now shift to earnings and firmer crude prices mean outlook on that front is rosy. Investors would do well to follow the production trajectory as well.

For HPCL, recent pressures on marketing margin may weigh on sentiment. Plus benchmark Singapore refining margins have been sequentially lower during the December quarter. In the last three months, the HPCL stock has fallen by a tenth.livemint