We upgrade ONGC to Buy from ADD with target price of Rs 185 post the recent sharp correction in the stock, which is now ascribing 8.5 X P/E multiple to recurring earnings under a worst-case scenario of sharing subsidies at spot crude price and exchange rate. A gradual recovery in crude price led by plausible balancing of global supply-demand and further increase in domestic gas price may augur well for ONGC’s earnings. Inexpensive valuation at 0.7X BVPS provides
adequate margin of safety.
Stock trading at 8.5X EPS under bear-case subsidy-sharing scenario
Our analysis suggests that the ONGC stock is now trading at 8.5X recurring consolidated EPS (including HPCL), under a scenario of the government putting the entire burden on upstream PSUs over and above the Budget provision at current levels of crude price (~$60/bbl) and exchange rate (`70/$).
We note that the recent sharp correction in global crude prices may act as a blessing in disguise for FY2019, specifically if the government exempts upstream PSUs from sharing subsidies.
Gradual recovery in global crude prices, domestic gas price may augur well
ONGC’s earnings are positively leveraged to global crude prices (and exchange rate) as earnings benefit from higher realisation on (i) crude production from nominated, JV and OVL’s fields and (ii) value-added products, more than offset the incremental subsidy burden on cooking fuels. We rule out further material correction in global crude prices. On the other hand, we do see a plausible recovery over the next 6-9 months. We also expect ONGC to benefit from expected increase in domestic gas price to ~$4.3/mn BTU in the next revision on April 1, 2019 from $3.7/mn BTU currently.
Inexpensive on long-term metrics
We find the reward-risk balance favourable post the sharp 20% correction in ONGC’s stock price over the past three months. The stock is trading at an inexpensive 0.7X forward book value per share and a low 0.5X EV/GCI for sustainable RoEs and CRoCIs of 9-10% across global crude cycles, which provides adequate margin of safety. The unanticipated 5.6% decline in crude production during 7MFY19 is certainly a worry; however, this may likely reverse in FY2020. Gas production has grown by 3% in the current year versus 6-9% in FY2017-18 and is expected to accelerate.
Kotak Institutional Equities