Wednesday, May 6, 2009


Downgrade to Hold on rich valuations post recent rally

No positive catalysts; subsidy concerns may revive
We downgrade ONGC from Buy to Hold as the stock offers a 6% total return to our INR787/sh TP. The stock has risen 28%YTD (Sensex up 14%) and now implies US$70/bbl Brent assuming subsidy sharing. The stock will likely be capped by concerns about the subsidy burden in H1FY10, following the Q4FY09 reprieve and the lack of visible catalysts.

Lacklustre volumes, policy concerns dampen FY09-11 earnings outlook
The adhoc government subsidy policy and ONGC’s inconsistent track record in volume growth remain a concern. Our higher subsidy assumptions are based on i) the recent rise in global fuel prices and ii) cuts in domestic fuel prices on petrol, diesel and LPG – a setback for ONGC’s earnings outlook for the next two years.

Our Hold rating reflects a neutral risk/reward
The positives are Deutsche Bank’s rising oil deck from CY10E and likely positive newsflow on EoR/new initiatives and new acreage/reserves. Key negatives: i) an uncertain growth outlook; ii) revival of subsidy worries as India is electing a new government; and iii) rich valuations and a contracting oil demand outlook.

Volatile oil price/newsflow poses 10-15% rise/fall to the stock
We retain our DCF-based TP for ONGC at INR787/sh (over FY10-15E, nil terminal growth) using Deutsche Bank’s India WACC assumption of 13% and EV/2P reserves for OVL. Upside risks: new oil finds, gas price deregulation and subsidy reform. Downside risks: a sharp collapse in oil demand/prices, policy concerns, execution/political risk in domestic/overseas projects, and lack of transparency in its overseas arm OVL. (See pp. 5-6 for more on valuations and risks.)

To see full report: ONGC