Analyst Corner: ONGC downgraded to ‘hold’, target price at Rs 66

By: |
March 14, 2020 8:23 AM

Brent has collapsed by 34% from levels before the OPEC+ meeting on 5-6 Mar’20 to = $34/bbl; OPEC+ was unable to reach a deal to cut output to reduce supply to match the demand fall due to coronavirus.

Saudi Arabia, UAE and Russia have indicated that they would boost output by over 3.9m b/d in Apr’20.

Brent has collapsed by 34% from levels before the OPEC+ meeting on 5-6 Mar’20 to = $34/bbl; OPEC+ was unable to reach a deal to cut output to reduce supply to match the demand fall due to coronavirus epidemic and a market share war has ensued.

Saudi Arabia, UAE and Russia have indicated that they would boost output by over 3.9m b/d in Apr’20. Unless OPEC+ reaches a deal to cut output, we estimate supply surplus of 4.9m b/d in Q2 and 1.6-2.0m b/d in Q3-Q4FY20 and have therefore cut our brent forecast to $40/bbl from $60/bbl earlier.

This has led to cut in FY21E EPS of Oil and Natural Gas Corporation’s (ONGC) by 59%. We are now valuing ONGC at 10x FY21E EPS at `66 vs `182 based on 1xFY20E P/BV earlier. We downgrade ONGC to ‘hold’ from ‘buy’.

We expect brent to collapse to $25/bbl on large supply surplus and to gradually recover from $30/bbl in Q1FY21E to $50/bbl in Q4 as US oil production declines due to low oil prices and demand recovers after coronavirus epidemic is contained.

We have also cut ONGC’s target price to `66, which is now based on 10x FY21E EPS vs `182 earlier, which was based on 1x FY20E P/BV. ONGC’s fair value based on DCF of its oil & gas reserves assuming brent at $50/bbl in FY22E and long-term brent of $60/bbl works out to `169/share.

Likely further fall in oil prices and likely cut in gas price to levels, at which ONGC will lose money, is likely to hurt investor sentiment. We are therefore valuing ONGC now on 10x FY21E EPS instead of at 1x FY20 P/BV or on DCF basis like we did in the past.

In FY19 ONGC’s EPS was up 40% YoY, but its share price was down 10% due to large GoI divestment by way of ETF, which has been an overhang. Sentiment in ONGC has also been hit by an unfavourable gas pricing formula, which links its price to prices in four countries, three of which are net exporters.

Under this formula, gas price is likely to decline by 35% YoY to $2.5/mmbtu in FY21E. However, deregulation of gas price with realised price being at $3-4/mmbtu would boost ONGC’s FY21E EPS by 17-50% to `7.7-9.9. Any OPEC+ output cut deal that balances the market is likely to lead to swift recovery in oil price and ONGC’s share price.

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