1. Credit Suisse upgrades ONGC to ‘Outperform’, raises target price to Rs 220

Credit Suisse upgrades ONGC to ‘Outperform’, raises target price to Rs 220

Despite delivery of reform, ONGC trades at a 25% discount to global peers on P/CF, higher than historical average (16%). Fundamentals continue to improve, with rising domestic gas/oil production.

By: | Published: May 19, 2017 4:39 AM
Higher overseas output (on acquisitions) helps EPS too.

We upgrade our rating on ONGC to ‘outperform’ (from Neutral), raising TP to Rs 220 (19% upside). We see the stock doing well as the market begins to fully appreciate the improving outlook on subsidies; government price increases are cutting retail losses by $1 bn/year (30% of FY18E). At $50/bbl oil, losses on kerosene/LPG could fall to zero by Dec-19 (vs $4.3 billion in FY16). Despite delivery of reform, ONGC trades at a 25% discount to global peers on P/CF, higher than historical average (16%). Fundamentals continue to improve, with rising domestic gas/oil production.

Higher overseas output (on acquisitions) helps EPS too. Continued demonstration of subsidy reduction is the key catalyst, which helps: Lower multiple discounts — as the magnitude of subsidy losses falls and cash flows become more predictable, raising maximum net realisations every year — more so in the back end of our field DCFs. Following 50% cumulative price cuts in domestic gas prices, we see momentum turning — and expect a 45% increase in the next two years, adding 15% to EPS.

Multiple domestic projects are also ramping-up, and ONGC’s volume trajectory (both gas and oil) has begun to turn. The delivery of ~10% gas volume growth over FY17-19 can help the stock as well. While ONGC has historically not been a crude play (realisations capped by subsidy), falling losses on LPG / Kerosene increases this leverage. In our base case ($65/bbl oil in FY19), we expect a 25% EPS CAGR.

If oil were to remain flat at $50/bbl, the stock would deliver an 8% EPS CAGR nonetheless; combined with inexpensive valuations and a 4+% dividend yield, we see risk reward as favourable. Given ONGC’s alternative for cash deployment (overseas M&A) and our positive outlook on HPCL’s core refining and marketing business, we don’t see potential investments in HPCL as a negative. We update models for falling subsidies, KG-basin volumes/capex (with a year delay) and overseas business outlook. FY18/19 EPS up 4%.

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