Expectations vs ground realities

The ONGC stock’s sharp under-performance versus the Sensex reflects mismanaged expectations of volume growth, concerns about subsidies, a worrying decline in oil production and issues with OVL’s (ONGC Videsh ) production. However, the stock’s inexpensive valuations provide a big margin of safety. We upgrade ONGC to Buy from Add with a target price of R300, noting a favourable risk-reward balance. Catalysts include restart of production from South Sudan, steady share of subsidy similar to that over FY2011-12 and a hike in APM (administered pricing mechanism) gas price.

Concerns about subsidy, operations valid but not so much: We believe ONGC’s inexpensive valuations reflect excessive concerns about volumes and subsidies, after a 15% under-performance versus the BSE Sensex over the past three months.

Assuming a mid-range P/E (price-to-earnings multiple of 10x(times), the stock is discounting 12-month forward EPS (earnings per share) of R25. This implies (i) 45% subsidy on upstream companies versus 39-40% over FY11-12, (ii) $35/bbl of net realised crude price for ONGC versus $54-56/bbl over FY10-12, and (iii) 6% decline in oil volumes from its own fields.

Our FY13e EPS of R30 for ONGC is based on (i) 40% subsidy sharing, (ii) $44/bbl of net realised crude price and (iii) 4.5% decline in oil volumes from its own fields.

Mismanaged expectations of volumes and ground realities: We are surprised by the Street’s initial excitement about production growth on the basis of management guidance and subsequent disappointment on

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