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Oil and Natural Gas Corp.
Cheap, defensive play on upstream
Event
We upgrade ONGC to Outperform from Neutral due to compelling valuations,
following an 8% MoM decline in the stock price. We believe that a sustained
revival in the reserve replacement ratio (RRR) and JV production is likely to
arrest the domestic volume decline, while a sharp 30-60% fall in shallow water
rig rates may further enhance its globally competitive finding and development
(F&D) costs. We increase ONGC’s TP to Rs295 from Rs293.
Impact
Resurging RRR may arrest domestic volume fall: Increasing overseas and
domestic JV production has enabled ONGC to marginally grow its total
production, despite a fall in domestic volumes. Over the past 4 years, ONGC
has revived 1P RRR to exceed ~1x. Coupled with continuing EOR/IOR efforts
in existing fields, a higher RRR should arrest the fall in domestic volumes.
Modest operational matrix. ONGC’s domestic exploratory success rate has
declined over the past 3 years, but it is aiming for increased drilling in FY12.
Its F&D costs of US$5.2/bbl are among the lowest globally (global average is
~US$14/bbl) and are poised to fall given a sharp drop in shallow water rig
rates as previous 3-year contracts get renewed. Gas production could show
mild growth in the period FY12-14 as marginal fields are put into production.
Royalty gains: Cairn India is in the process of getting shareholder approval
to allow royalties to be cost recoverable for the Barmer (Rajasthan) block. We
estimate that ONGC is likely to gain Rs11/share, or US$2.1bn.
Strong balance sheet: ONGC has significant cash on its balance sheet. Its
aggressive capex plans can be easily funded by internal accruals and cash.
Its dividend payout is 30-40%, enabling a significant dividend yield of 3-4%.
Subsidy concerns continue in a high crude price scenario, but a 38.8% share
by upstream (FY11) is as bad as it can get, in our view (typical share is 33%).
Countercyclical: Although ONGC is a crude oil producer, higher crude oil
prices are detrimental given a higher share of under-recovery (subsidy). We
believe US$80-90/bbl is the inflexion point at which ONGC’s profits will once
again become directly sensitive to crude oil prices.
Earnings and target price revision
We reduce our FY12-14E earnings by 2-4% on minor adjustments to volume.
FY12E one-time gains from Rajasthan royalty are incorporated, thus FY12E
reported PAT may increase by ~1%. TP increased to Rs295 from Rs293.
Price catalyst
12-month price target: Rs295.00 based on a Sum of Parts methodology.
Catalyst: Subsidy swings, volume growth and finds, gas pricing.
Action and recommendation
Compelling valuations: ONGC’s EV/1P reserves of US$6.3/bbl compares
with global average of US$15/bbl. We attribute US$11bn or ~20% of ONGC’s
value to its overseas subsidiary OVL, which seems likely to grow further. We
believe that the current risk-reward is favourable, as the stock is more than
adequately factoring in subsidy risks and a lack of near-term volume growth.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Oil and Natural Gas Corp.
Cheap, defensive play on upstream
Event
We upgrade ONGC to Outperform from Neutral due to compelling valuations,
following an 8% MoM decline in the stock price. We believe that a sustained
revival in the reserve replacement ratio (RRR) and JV production is likely to
arrest the domestic volume decline, while a sharp 30-60% fall in shallow water
rig rates may further enhance its globally competitive finding and development
(F&D) costs. We increase ONGC’s TP to Rs295 from Rs293.
Impact
Resurging RRR may arrest domestic volume fall: Increasing overseas and
domestic JV production has enabled ONGC to marginally grow its total
production, despite a fall in domestic volumes. Over the past 4 years, ONGC
has revived 1P RRR to exceed ~1x. Coupled with continuing EOR/IOR efforts
in existing fields, a higher RRR should arrest the fall in domestic volumes.
Modest operational matrix. ONGC’s domestic exploratory success rate has
declined over the past 3 years, but it is aiming for increased drilling in FY12.
Its F&D costs of US$5.2/bbl are among the lowest globally (global average is
~US$14/bbl) and are poised to fall given a sharp drop in shallow water rig
rates as previous 3-year contracts get renewed. Gas production could show
mild growth in the period FY12-14 as marginal fields are put into production.
Royalty gains: Cairn India is in the process of getting shareholder approval
to allow royalties to be cost recoverable for the Barmer (Rajasthan) block. We
estimate that ONGC is likely to gain Rs11/share, or US$2.1bn.
Strong balance sheet: ONGC has significant cash on its balance sheet. Its
aggressive capex plans can be easily funded by internal accruals and cash.
Its dividend payout is 30-40%, enabling a significant dividend yield of 3-4%.
Subsidy concerns continue in a high crude price scenario, but a 38.8% share
by upstream (FY11) is as bad as it can get, in our view (typical share is 33%).
Countercyclical: Although ONGC is a crude oil producer, higher crude oil
prices are detrimental given a higher share of under-recovery (subsidy). We
believe US$80-90/bbl is the inflexion point at which ONGC’s profits will once
again become directly sensitive to crude oil prices.
Earnings and target price revision
We reduce our FY12-14E earnings by 2-4% on minor adjustments to volume.
FY12E one-time gains from Rajasthan royalty are incorporated, thus FY12E
reported PAT may increase by ~1%. TP increased to Rs295 from Rs293.
Price catalyst
12-month price target: Rs295.00 based on a Sum of Parts methodology.
Catalyst: Subsidy swings, volume growth and finds, gas pricing.
Action and recommendation
Compelling valuations: ONGC’s EV/1P reserves of US$6.3/bbl compares
with global average of US$15/bbl. We attribute US$11bn or ~20% of ONGC’s
value to its overseas subsidiary OVL, which seems likely to grow further. We
believe that the current risk-reward is favourable, as the stock is more than
adequately factoring in subsidy risks and a lack of near-term volume growth.
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