Lower expenses was a positive surprise for ONGC/Oil India in 1H/1QFY17, some of which is likely to continue. Regular kerosene, LPG price hikes could also benefit upstream cos, particularly if continued beyond 10 months. Crude price recovery remains a catalyst. As a result, we maintain Buy on ONGC despite concerns on production, gas price and corporate action. Maintain Hold on Oil India due to risk of continued crude production decline and royalty issue.
Lower expenses, LPG/SKO price hikes lead to a surprise
ONGC and Oil India have outperformed the Nifty by 15-20% over the last 3-6 months despite no significant movement in crude price and downward revision in domestic gas prices. We believe there are two reasons for this: (i) expenses have declined sharply y-o-y in 1H/1QFY17, leading to positive surprises in quarterly earnings; (ii) since July-16, the government has allowed Oil Marketing Companies (OMCs) to hike retail prices of subsidised LPG and kerosene in small increments.
Continued kerosene hikes would be a key positive
Since July, net benefit of kerosene price hikes has been R0.35/l per month on average and R0.5/ l in November. These are significant hikes and can eliminate the government contribution of R12/l in 2-3 years. However, we understand that the mandate is only for 10 hikes as of now. By comparison, the LPG price hike of R2 per cylinder per month is a relatively small number amounting to only $3.5/bbl per year.
Production issues, gas price, royalty & adverse corporate action are concerns
ONGC’s management has guided for growth in both crude and gas production going forward, with fairly aggressive targets for 2HFY17 but we believe continued misses against targets are likely and build more modest increases into our estimates. While Oil India’s gas production has increased over the last 12 months, steady decline in crude production with no visibility of trend reversal is a major concern. Gas price is likely to remain low for at least the next 12-18 months. Payment of royalty on pre-discount crude price since February 2014 and potentially from April 2008 is a material impact for Oil India’s net worth in particular. There are also reports of an acquisition of stake in GSPC’s Deendayal field by ONGC, which could be value erosive.
Prefer ONGC to Oil India
We raise our EPS estimates for ONGC and Oil India to reflect lower expenses. Despite concerns, we believe risk-reward is still favourable for ONGC especially given our expectation of a gradual upward trend in crude price. We maintain our Hold rating on Oil India, mainly due to risk of continued decline in crude production and the royalty issue.