ONGC’s Board approved the acquisition of GSPC’s 80% stake in KG-OSN-2001/3 block, including $1 billion for Deen Dayal West field and $200 million as ‘part consideration’ for six other discoveries, which will be adjusted against their valuation post approval of field development plan by DGH/management committee. We remain cautious on the acquisition given techno- commercial challenges and uncertainty on future prospects, even as the acquisition price seems to be lower than the amount invested by GSPC in the block. We maintain Sell on ONGC with a revised target price of R180 (R175 previously).
We note that the acquisition price seems to be lower than the amount of R136 bn (80% share of R170 bn until March 2015) invested by GSPC in the block. Nonetheless, we remain cautious on any value accretion from the block given techno-commercial challenges and uncertainty on future prospects, as pointed out by a recent Comptroller and Auditor General (CAG) report. We await further details to incorporate the transaction in our ONGC model.
Strategy of acquiring discovered assets may augment production but preclude value creation
We see limited merit in ONGC’s strategy of acquiring discovered/under-development or even producing upstream assets, even though it is in line with the company’s stated vision of augmenting oil and gas production in the long term. In our view, these acquisitions ($1 bn in ACG fields, $2.2 bn in Vankorneft and $1.2+ bn in GSPC’s block) may not create meaningful value, given their typical low IRRs versus likely higher IRRs from investment in exploration assets that result in potential hydrocarbon discoveries. Furthermore, the economics of certain acquisitions, such as $4.1 bn for 16% stake of Area 1 block in Mozambique, may have deteriorated meaningfully in a lower oil and gas pricing environment.
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Fine-tune estimates; reverse valuation implies stock is pricing in a recovery in oil and gas prices
We revise our FY2017-18E consolidated EPS estimates for ONGC to R6 (+6%) and R17.6 (+7%), factoring in benefit of nil subsidy burden in line with MOPNG’s recent statement, negative impact of likely applicability of service tax on royalty, full acquisition of 26% stake in Vankorneft and other minor changes. Our target price increases to R180 from R175 previously, as we roll forward to September 2018E EPS assuming 10X P/E multiple.
Our reverse valuation exercise suggests that ONGC is already pricing in a recovery in average Dated Brent crude price to $57/bbl and domestic gas price of $3.5/million BTU versus our calculation of $2.7/mn BTU for 1HFY18 and $3.2/mn BTU for 2HFY18. We remain wary on lower operating costs and exploration write-offs reported in the past two quarters and expect both to increase going forward. Also, ONGC’s oil production from own fields has declined 1.7% year-on-year and gas production has remained steady YTD, both falling short of planned targets.