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Oil & Natural Gas Corp. (ONGC.BO)
Return Potential: 24% Equity Research
Improving fundamentals and regulations, still inexpensive; CL-Buy
Source of opportunity
We revisit our positive investment view on ONGC by taking a deep dive
into the improving fundamentals, regulatory tailwinds and valuation of
individual segments. We believe the following trends provide attractive
investment opportunities over the medium term at inexpensive valuations:
1) rising domestic production from the increased JV share, IOR/ EOR gains
and marginal field developments, 2) transparent subsidy-sharing
mechanism that is likely to help ONGC’s cash flows, 3) increased
production overseas improving overall realization as oil prices stay robust
4) likely natural gas price hikes by govt. to incentivize further investment.
1) Higher-than-expected overseas production, 2) continued improved
performance in mature, domestic fields as EOR/IOR projects show results,
3) likely implementation of a formal subsidy-sharing mechanism, which
would reduce uncertainty around cash flow, 4) likely increase in consensus
earnings as subsidy burden declines in new mechanism, 5) Rajasthan
royalty and cess issues could be settled in favour of ONGC.
We reiterate Conviction Buy on ONGC with 12-m EV/GCI vs. CROCI-based
TP of Rs340, implying 24% upside. A US$1/bbl change in net oil price
realization has a 1.8% impact on FY12E EPS and a US$1/mmbtu change in
natural gas prices has a 6.6% impact. With FY12E EV/1P reserves of
US$7.1/boe, it is one of the most inexpensive stocks globally. Despite low
operating and F&D costs, reasonable reserve replacement , high reserve
life and attractive returns, ONGC is trading at FY12E EV/DACF of 5.5x vs.
an 8-yr historical range of 4.0x-9.5x. The SOTP valuation is Rs365 per/sh.
1) Delay in the transparent subsidy mechanism; 2) high subsidy burden, 3)
lower volume from legacy fields, and 4) overpaying for acquisitions.
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