ONGC - Initiating Coverage - Poised for re-rating; Initiate with Buy ::Centrum

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Rating: Buy; Target Price: Rs425; CMP: Rs345; Upside: 23.2%



Poised for re-rating; Initiate with Buy



We initiate coverage on ONGC, with a BUY rating and a PT of Rs425
implying 23.2% upside. We believe the CMP factors in a continuation of
abnormally low crude price and the hitherto “fixed” high subsidy
burden of USD61/bbl, which we show is clearly illogical. Moreover, a
dissection of historical standalone EBITDA reveals that nearly 50% of
earnings are resilient to the vagaries of under-recoveries. There is a
realistic possibility of a jump in net realisations with adoption of a
simpler (read less ad-hoc) subsidy sharing formula. Our estimate of
0-1% CAGR in volumes is arguably conservative in the light of ONGC
graduating from arresting decline in output to expanding it.
Additionally, it is trading at a steep discount to peers, which caps
the downside.

$ Higher net realization – not a mirage: With de-regulation of diesel
prices and soft crude price regime for the forecast period, under
recoveries will dip by 44%/60% /50% vs Rs1.4tn reported in FY14. As a
logical outcome, the benefits of lower under recoveries will be shared
equally between the GoI and upstream companies. Hence, we are
confident that net realisation will be boosted by Rs100bn of annual
cess paid as part of the subsidy, the positive impact being USD12/bbl.
Under recoveries may dip further with long term benefit of direct
benefits transfer scheme roll-out from CY15 and probable price hike
for LPG in CY16.

$ Adverse impact of lower crude prices – Concerns overdone: The
present despondency over the impact of low crude prices on ONGC masks
the vital observation that ONGC’s net realization improves with
falling crude, as subsidy burden reduces or is relaxed by GoI. In
FY10, net realization had risen 17% despite 17% fall in gross
realizations. Also, linear correlation between crude and LPG/Kerosene
prices suggests that a drop of USD5/bbl in crude would lead to a
USD2.1/bbl drop in ONGC’s subsidy. This, coupled with cess of USD1/bbl
likely to be adjusted against subsidy payout, would limit the adverse
impact. For OVL, the impact is more pronounced in the current scenario
as every USD1 decline in oil price reduces EPS by Rs0.45, but OVL is
just 2% of our SoTP.

$ Conservative production growth built in: For the forecast period, we
have built-in 0.3 to 1% CAGR volume growth (FY14-17E) in production
and sales at standalone business. ONGC, in a bid to arrest the natural
decline in its maturing fields has credibly showcased its ability to
arrest the decline rate to a large extent. Our production estimates
factor in the natural decline and potential from key fields of Daman
offshore, B-193, B-22, G1-GS, W-16, C-26, D1 over FY16-17E and from
prolific KGDWN and Mumbai-High fields over FY18-19E. Hence, although
production may look to remain constant, a slightly long term outlook
stretching to FY18-19E looks very promising.

$ Valuation and Key risks: Our PT of Rs425 is based on Mar-17E,
derived by assigning EV/EBITDA(x) to standalone, PE(x) assigned to
OVL, MRPL valued at our PT and listed investments at our/consensus PT.
ONGC currently trades at a steep discount to its peers and near trough
levels, which caps the downside. Key downside risks are (1) Lower net
realizations; (2) Acquisition/Investment which are not EPS accretive
and (3) Payment of royalty on pre-discounted price, e.g. as per a case
going on with the Gujarat government.



Thanks & Regards