Declining crude production in its core asset is a major concern for Oil India in our view, especially since the reasons for the decline are now more operational in nature, being related to natural decline in its mature fields vs. external factors earlier. As a result, we downgrade Oil India to Hold. We cut estimates for ONGC to factor in lower crude and gas prices but maintain our Buy rating.
Crude production decline a major concern for Oil India: Oil India’s crude production has been declining steadily over the last four quarters from an annualised rate of 3.44MMT in Q3FY15 to 3.16MMT in Q3FY16. While Oil India’s production has been inconsistent in the past due to blockades and political disturbances in the region, this time the reasons for the decline (i) rise in water cut, (ii) permanent loss of production from select fields and (iii) less than planned contribution from work over and new wells, seem to be more operational in nature. Even management commentary seems to suggest that natural decline in many of its mature fields is not being compensated by work overs, EORs and contribution from new and marginal fields. While management expects production to stabilise at around current level of 3.2MMT in FY17, we remain concerned about medium to long-term prospects given the natural decline in its core asset.
Q3 results: Impairments start for ONGC; Beat in Ebitda for Oil India. ONGC’s Q3 Ebitda was largely in line. However reported net profit was significantly lower due to a R40 bn impairment provision taken on account of its Eastern onshore assets. Management said that it has completed impairment testing for all domestic assets using a crude price of $33-34/bbl for this year and going up to $50/bbl by FY20 as per the forward curve. We expect more impairments going forward due to (i) impairments in OVL assets (net fixed assets of over R800 bn) which are likely to be reported in Q4 and (ii) impairments in domestic gas assets once domestic gas prices are reduced to $3.5/mmbtu from April and possibly lower in October. Oil India’s Q3 Ebitda was 24% ahead of estimate primarily due to lower other expenditure.
Cutting estimates, fair value to reflect lower crude & gas prices; downgrading Oil India to Hold: We cut our FY16-18e EPS estimates for ONGC and Oil India by 16-44% primarily to reflect lower oil price assumptions of our global oil & gas team of $49/47/61 per bbl over FY16-18E vs. $54/65/75 earlier. We also cut domestic gas price estimates for FY17/FY18 to $3.4/mmbtu vs. $4.2/4.7 earlier and make adjustments to production estimates. We factor in lower cess at 10% of crude price vs. a fixed R4500/MT currently—we expect the government to announce this in the upcoming Budget. Our fair value for ONGC reduces to R250 vs. R345 earlier based on 9.2x FY18 P/E in line with historic median; similarly, our fair value for Oil India reduces to R354 vs. R502 earlier based on 8x FY18 P/E in line with historic median. We downgrade Oil India to Hold and maintain our Buy rating on ONGC.
Stocks pricing in $45-50/bbl crude price; low crude price could continue to hurt in the near term: Both ONGC and Oil India are factoring in $45-50/ bbl of crude price based on the historic median valuation against average Brent price of $32/bbl in Q4. As a result continued low crude prices could continue to hurt for some time. Any relief from the government in the form of customs duty hike on crude or higher domestic gas price are possible catalysts.