Oil & Natural Gas Corp. (ONGC): Dry wells drill into profit:: HSBC

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Oil & Natural Gas Corp. (ONGC)
N: Dry wells drill into profit
 Production of oil and gas largely in line with Street and our
estimates, but profit lower due to dry wells
 Proportionate share of subsidy a tad lower q-o-q, further
reflecting ad hoc nature of fuel subsidy sharing mechanism
 Reiterate Neutral rating with target price of INR1,469


ONGC reported net profit of INR54bn, +47qoq, +6%yoy, which was 15% lower than
our estimate due to a higher charge for dry wells. The sequential increase in profitability
stemmed largely from lower subsidy payment, INR30bn vs. INR55bn in 1QFY11, and
higher gas revenue, as ONGC recorded the first full quarter of higher gas prices from its
nomination blocks after the government increased the price from 1 June 2010.
Subsidy sharing proportionately lower. ONGC contributed to c80% in Q2FY11 (82.4%
in Q1FY11) of the total subsidy borne by government-owned upstream companies. This
further underscores the ad hoc nature of the fuel-subsidy sharing mechanism.
Investment view and valuation. We believe that ONGC’s reserves are attractively
valued; however, we also believe that the market is unlikely to focus on this due to the
policy overhang related to funding of under-recovery. We value ONGC shares at a
forward PE multiple of 11x (based on the last three-month average PE) on FY12e EPS,
resulting in our 12-month target price of INR1,469. We rate the stock Neutral.
Risks, in our view, include a higher share of the subsidy and higher or lower long-term oil
and gas prices. Catalysts that we see include reforms in retail fuel pricing, new
discoveries, and possible overseas acquisitions.