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Energy
India
It may not be so bad in the end. We see continued lack of clarity on the subsidysharing
mechanism in a rather adverse macro-environment, led by (1) higher crude price
and (2) a weakening Rupee, impacting valuations of upstream oil companies. However,
we believe ONGC/OIL stocks offer a favorable risk-reward balance given (1) a fairly
bleak scenario of net crude realizations, discounted by current stock prices, (2) attractive
valuations of 7-8X FY2012E EPS and (3) potential upside to earnings from a weakening
Rupee. We maintain our BUY rating on ONGC/OIL stocks given large potential upside of
35% to our target price of `355 for ONGC and 46% to our target price of `1,720 for
OIL.
Subsidy-sharing prophesy remains a mystery…
The lack of clarity on the subsidy-sharing mechanism for FY2012 and beyond continues to impact
investor sentiment for upstream companies, given an adverse macro-environment. We see (1) a
prolonged period of high crude oil prices and (2) a steep weakening of the Indian Rupee against
the US dollar, resulting in sharply higher under-recoveries of over `1.3 tn in FY2012 (assuming
Dated Brent crude price of US$110/bbl and average exchange rate of `48.7/US$) versus `814 bn
in FY2011. We admit risks to upstream companies from a higher subsidy burden given (1) a
difficult fiscal situation for the government and (2) lower earnings potential for downstream oil
companies in the light of weak refining margins and large foreign exchange losses.
…but stocks discounting a fairly bleak scenario
However, we highlight that current stock prices of ONGC and OIL are discounting a bleak scenario
in terms of subsidy burden to be borne by upstream companies. Our reverse computation exercise
reflects ONGC stock price is currently discounting net crude price realization at US$44/bbl, which
is significantly lower than US$53.8/bbl in FY2011 and US$55.9/bbl in FY2010. The same exercise
for OIL stock price implies net crude price realization of US$50/bbl versus US$58.5/bbl in FY2011
and US$56.2/bbl in FY2010. For the purpose of this exercise, we assume (1) crude oil (Dated Brent)
price assumption of US$90/bbl and (2) exchange rate assumption of `50/US$.
Higher crude realizations in Rupee terms to offset higher subsidy losses
We note that upstream oil companies benefit from the depreciation in the Indian Rupee against
the US dollar, given higher crude prices and APM gas realizations in Rupee terms. However, the
positive impact on earnings is partly offset by higher subsidy sharing by upstream companies,
given an increase in under-recoveries for the industry, assuming upstream companies bear 45% of
gross under-recoveries in FY2012E and 40% in FY2013-14E. We discuss the impact of a
weakening Rupee in detail later in the note.
Revised earnings to reflect weaker Rupee assumptions and lower production from OVL
We have revised our earnings estimates for ONGC to `33.7 (-1.9%) in FY2012, `38.2 (+0.8%) in
FY2013 and `39.1 (+2.3%) in FY2014 to reflect (1) weaker Rupee assumptions, (2) lower
production from OVL fields in Sudan and Syria and (3) other minor changes. We have revised our
earnings estimates for OIL to `154.5 (-1.1%) in FY2012, `186.9 (+0.2%) in FY2013 and `192
(+2.3%) in FY2014 to reflect our weaker Rupee assumptions. We have revised our exchange rate
assumptions for FY2012, FY2013 and FY2014 to `48.7/US$, `52.5/US$ and `51/US$ respectively
from `47.3/US$, `49.75/US$ and `48.5/US$ previously.
Impact of a weakening Rupee on upstream companies
We give a detailed explanation of the impact of a weakening Rupee on all pertinent
variables pertaining to upstream companies.
Impact on revenues. The weakening of the Rupee is positive for revenues of upstream
companies as it results in higher crude price realization. In addition, the gas price for
ONGC and OIL is fixed in US dollars, resulting in higher realizations from a weakening
Rupee. We compute FY2013 revenue for ONGC and OIL to increase by 1.6% and 2.7%
respectively for every `1/US$ depreciation in the exchange rate assumption.
Impact on gross under-recoveries. A weakening Rupee against the US dollar would
result in higher gross under-recoveries as domestic prices of diesel, LPG and kerosene are
regulated. A `1/US$ depreciation will result in additional gross under-recovery of ~`74 bn
for the industry on an annualized basis (at US$100/bbl). Exhibit 1 shows gross underrecoveries
for FY2013E at various levels of exchange rate assumption. We estimate gross
under-recoveries at `1.2 tn in FY2012, assuming (1) crude oil price at US$100/bbl,
(2) exchange rate at `52.5/US$ and (3) no change in retail prices.
Impact on subsidy burden to be borne by upstream companies. We highlight that a
weakening Rupee will result in a higher subsidy burden to be borne by upstream
companies, given higher gross under-recoveries. We compute subsidy burden for ONGC
and OIL to increase by 6% for every `1 weakening of the Rupee against the US dollar.
We highlight that our exercise assumes (1) subsidy burden for upstream companies
remains unchanged at 40% of the gross under-recoveries, (2) crude oil price at
US$100/bbl and (3) no change in retail prices.
Net impact on earnings. Exhibit 2 gives a breakdown of the overall impact of a
weakening Rupee on the earnings of ONGC and OIL. We compute FY2013E EPS for
ONGC to increase by 0.5% and for OIL to decline by 0.2% for every `1 depreciation in
the Rupee against the US dollar.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Energy
India
It may not be so bad in the end. We see continued lack of clarity on the subsidysharing
mechanism in a rather adverse macro-environment, led by (1) higher crude price
and (2) a weakening Rupee, impacting valuations of upstream oil companies. However,
we believe ONGC/OIL stocks offer a favorable risk-reward balance given (1) a fairly
bleak scenario of net crude realizations, discounted by current stock prices, (2) attractive
valuations of 7-8X FY2012E EPS and (3) potential upside to earnings from a weakening
Rupee. We maintain our BUY rating on ONGC/OIL stocks given large potential upside of
35% to our target price of `355 for ONGC and 46% to our target price of `1,720 for
OIL.
Subsidy-sharing prophesy remains a mystery…
The lack of clarity on the subsidy-sharing mechanism for FY2012 and beyond continues to impact
investor sentiment for upstream companies, given an adverse macro-environment. We see (1) a
prolonged period of high crude oil prices and (2) a steep weakening of the Indian Rupee against
the US dollar, resulting in sharply higher under-recoveries of over `1.3 tn in FY2012 (assuming
Dated Brent crude price of US$110/bbl and average exchange rate of `48.7/US$) versus `814 bn
in FY2011. We admit risks to upstream companies from a higher subsidy burden given (1) a
difficult fiscal situation for the government and (2) lower earnings potential for downstream oil
companies in the light of weak refining margins and large foreign exchange losses.
…but stocks discounting a fairly bleak scenario
However, we highlight that current stock prices of ONGC and OIL are discounting a bleak scenario
in terms of subsidy burden to be borne by upstream companies. Our reverse computation exercise
reflects ONGC stock price is currently discounting net crude price realization at US$44/bbl, which
is significantly lower than US$53.8/bbl in FY2011 and US$55.9/bbl in FY2010. The same exercise
for OIL stock price implies net crude price realization of US$50/bbl versus US$58.5/bbl in FY2011
and US$56.2/bbl in FY2010. For the purpose of this exercise, we assume (1) crude oil (Dated Brent)
price assumption of US$90/bbl and (2) exchange rate assumption of `50/US$.
Higher crude realizations in Rupee terms to offset higher subsidy losses
We note that upstream oil companies benefit from the depreciation in the Indian Rupee against
the US dollar, given higher crude prices and APM gas realizations in Rupee terms. However, the
positive impact on earnings is partly offset by higher subsidy sharing by upstream companies,
given an increase in under-recoveries for the industry, assuming upstream companies bear 45% of
gross under-recoveries in FY2012E and 40% in FY2013-14E. We discuss the impact of a
weakening Rupee in detail later in the note.
Revised earnings to reflect weaker Rupee assumptions and lower production from OVL
We have revised our earnings estimates for ONGC to `33.7 (-1.9%) in FY2012, `38.2 (+0.8%) in
FY2013 and `39.1 (+2.3%) in FY2014 to reflect (1) weaker Rupee assumptions, (2) lower
production from OVL fields in Sudan and Syria and (3) other minor changes. We have revised our
earnings estimates for OIL to `154.5 (-1.1%) in FY2012, `186.9 (+0.2%) in FY2013 and `192
(+2.3%) in FY2014 to reflect our weaker Rupee assumptions. We have revised our exchange rate
assumptions for FY2012, FY2013 and FY2014 to `48.7/US$, `52.5/US$ and `51/US$ respectively
from `47.3/US$, `49.75/US$ and `48.5/US$ previously.
Impact of a weakening Rupee on upstream companies
We give a detailed explanation of the impact of a weakening Rupee on all pertinent
variables pertaining to upstream companies.
Impact on revenues. The weakening of the Rupee is positive for revenues of upstream
companies as it results in higher crude price realization. In addition, the gas price for
ONGC and OIL is fixed in US dollars, resulting in higher realizations from a weakening
Rupee. We compute FY2013 revenue for ONGC and OIL to increase by 1.6% and 2.7%
respectively for every `1/US$ depreciation in the exchange rate assumption.
Impact on gross under-recoveries. A weakening Rupee against the US dollar would
result in higher gross under-recoveries as domestic prices of diesel, LPG and kerosene are
regulated. A `1/US$ depreciation will result in additional gross under-recovery of ~`74 bn
for the industry on an annualized basis (at US$100/bbl). Exhibit 1 shows gross underrecoveries
for FY2013E at various levels of exchange rate assumption. We estimate gross
under-recoveries at `1.2 tn in FY2012, assuming (1) crude oil price at US$100/bbl,
(2) exchange rate at `52.5/US$ and (3) no change in retail prices.
Impact on subsidy burden to be borne by upstream companies. We highlight that a
weakening Rupee will result in a higher subsidy burden to be borne by upstream
companies, given higher gross under-recoveries. We compute subsidy burden for ONGC
and OIL to increase by 6% for every `1 weakening of the Rupee against the US dollar.
We highlight that our exercise assumes (1) subsidy burden for upstream companies
remains unchanged at 40% of the gross under-recoveries, (2) crude oil price at
US$100/bbl and (3) no change in retail prices.
Net impact on earnings. Exhibit 2 gives a breakdown of the overall impact of a
weakening Rupee on the earnings of ONGC and OIL. We compute FY2013E EPS for
ONGC to increase by 0.5% and for OIL to decline by 0.2% for every `1 depreciation in
the Rupee against the US dollar.
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