UBS- Oil & Natural Gas Corp : Diesel price hike delay poses risk to our PT

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UBS Investment Research
Oil & Natural Gas Corporation
Diesel price hike delay poses risk to our PT


􀂄 Key catalyst for stock performance likely to be delayed
We upgraded the stock to Buy on 13 December on higher oil prices and
expectation of favourable government action on royalty payments for MBA fields.
A modest hike in diesel price is one of the key catalysts for the recent upgrade.
However, the expected diesel hike has not yet happened and given the rising food
inflation, we believe that the probability of a further delay has increased. Food
inflation has risen to a 10-week high of 14.4% and any hike in diesel prices (4.7%
weight in WPI) will translate into higher food prices.

􀂄 ONGC provides upside even in worst case scenario

The stock is down 4.7% since mid December. It has underperformed the Sensex by
8.5% over the last 3MTD. At these levels the stock provides a 20% upside in the
scenario when we assume no diesel price hike and no upside on royalty from the
Rajasthan fields (ONGC owns 30% of the block but pays royalty @20% for the
entire 100%). Our earlier PT of Rs1475/sh incorporated this scenario of no diesel
price hike and no change in royalty regime of Rajasthan field.
􀂄 Current stock price discounts negative news
We believe the stock has support from current valuations as the market has already
discounted the negatives. Therefore, any positive news on deregulation or price
hike should provide a sharp upside.
􀂄 Stock is trading at attractive multiples: maintain Buy and PT of Rs1,600
The stock is attractive at 10.2x FY12e EPS & 4.6x EV/FY12e EBITDA. The stock
provides a high div. yield of 4.9%. We value ONGC on a sum-of-the-parts basis.


High oil price is neutral if not followed by price hike
Higher oil prices will not translate into higher earnings for ONGC if there is no
price action by the government. Every US$1/bbl increase in crude raises underrecoveries
of the OMCs (Oil marketing companies) on the sale of petroleum
products by Rs38bn. Of this the subsidy on diesel forms the major chunk of
Rs30bn and LPG and kerosene account for the remainder. The reason for higher
under-recovery in diesel is 1) higher volume, and 2) higher taxes. Assuming
upstream pays out a third of this and 85% is by ONGC the additional payout by
ONGC due to a US$1/bbl of oil is Rs10.7bn which is roughly the same as the
positive impact of higher oil price to its consolidated pre tax earnings