Friday, October 21, 2011

>ONGC: 2QFY12 oil realisation to improve significantly; Buy

Rising net realization and production growth on the horizon; reiterating Buy
We expect ONGC’s oil net realization to jump by 60% QoQ to US$78/bbl in
2QFY12 versus the last four years' average of US$52/bbl, driven by duty cuts and
fuel price hikes implemented by the Government of India in June 2011. Moreover,
ONGC’s newly elected Chairman has indicated production growth of 15% in oil
and 58% in natural gas over the next five years. ONGC’s stock price is currently
implying an upstream subsidy sharing of 50% going ahead, as against 31-42%
historically. Reiterating Buy.

Net realization to rise by 60% QoQ, to US$78/bbl, on lower subsidies
We estimate ONGC to report robust INR73.2bn net profit (+36% YoY, +79% QoQ)
for 2QFY12, on higher net realization of US$78/bbl (+24% YoY, +60% QoQ) and
lower royalty payments for the Rajasthan block RJ-ON-90/1. The sharp increase in
net realization is a result of lower estimated gross under-recoveries (INR204bn, -
53% QoQ), driven by fuel price hikes and duty cuts by the Government of India in
June 2011, as well as seasonally weaker diesel sales. ONGC’s average net
realization has been US$52.4/bbl the last 17 quarters. We assume an upstream
subsidy sharing of 38.7% (in line with FY11), vs. 33% in 1QFY12.

Expected production CAGR of 4.3% in oil and 3.6% in gas in the next 4 years
ONGC’s newly elected Chairman Mr Sudhir Vasudeva recently indicated
production growth of 15% in oil, to 28m tonnes, by FY14, and 58% in natural gas,
to 100mmscmd, by FY17. This is likely to come from the development of marginal
fields (G-1, GS-15, G-4-6, etc.), and the Daman Offshore and KG DWN 98/2 blocks.
We believe production start-up from KG DWN 98/2 is likely to be delayed. We
have built in a production CAGR of 4.3% in oil and 3.6% in gas in FY11-15E.

DCF-based value of INR365/sh; uncertain subsidy sharing the key risk
We value ONGC at INR365/sh, based on DCF, assuming a 12.9% WACC, based
on Deutsche Bank’s CoE assumptions for India (rfr 6.7% and risk premium 8.1%),
and a beta of 0.85. Key risks are vagaries in government policy on fuel pricing and
subsidies, a further increase in oil prices and a fall in oil & gas production.

To read the full report: ONGC