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(Delayed) Spark Capital : ONGC: Worst Of Subsidy Priced In; OVL’s Turnaround To Drive Upside In Near Term; Upgrade to Buy




Spark Capital Advisors(India) Private Limited


10 Dec 2012





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Worst Of Subsidy Priced In; OVL’s Turnaround To Drive Upside In Near Term; Upgrade to Buy ONGC’s stock price has declined by 10% over the last 2M on rising subsidy worries and tepid domestic volume growth outlook amidst falling OVL earnings. We (and seems market as well) never bought into the aggressive production growth guidance. However, optimism on FY13 subsidy burden faded away with rising fiscal concerns. Given the current correction we reviewed all the moving parts and concluded that the worst on subsidy is being priced in with valuations implying realisations of $50-$55/bbl for entire reserves – This is ultra conservative. Further, the worst of OVL is behind us and production growth in OVL can surprise in FY14E. Ex-cash, market seems to be valuing ONGC at Rs. 180/share (@8x FY13E core EPS) and OVL at Rs. 28/share (@8x FY13E EPS). We expect revival in OVL earnings in FY14E to drive an upside of Rs. 25-30/sh. Further, gas price hike (in FY15E), modest volume growth and lower subsidies would support domestic earnings growth of 18% CAGR FY13E-15E. We increase our OVL FY14E EPS by 34% and roll forward valuations to FY14E. Upgrade to Buy with TP of Rs. 314 Investment Thesis OVL turnaround: After ~20% production decline in FY13E, production growth would revive in FY14E due to South Sudan production resumption (1QCY13), recent acquisitions, and new projects (Carabobo-Venezuela, A1/A3-Myanmar and Block 06.1-Vietnam). This would lead to OVL production growth of 33% CAGR FY13-15E and earnings growth of 39%. While we have not yet incorporated Kashagan acquisition pending approvals, we see this as a positive step Modest volumes – well factored in: ONGC reduced its oil production guidance by 1%/8% for FY13/14 and moved its 28mmt target to FY15 due to delays in marginal field projects. We expect only 25.5mmt by FY15 as further delays are likely in B22, B193 and Cluster 7 projects. Nevertheless, this is better than a 2% CAGR decline seen in the last 5 years Worst of subsidies priced in: We expect upstream burden of Rs. 600bn in FY13E ($56/bbl or 40%) which could slightly drop to Rs. 525bn on softening of crude, full benefit of LPG cap and diesel price hike. Expect ONGC’s net realisation of ~$48/$55/bbl in FY13E/14E which implies limited downside risks. Valuations price in reserves based on perpetually low realisation of $50-55/bbl and any improvement in subsidy would provide fillip to the stock Gas price hike bonanza: While there is no set review period for APM Gas prices, we expect a $2/mmbtu hike to $6.2/mmbtu (base case) in 1HFY15 after KG D6 price review in April’14. Already, ONGC is allowed to sell gas from new fields at market determined prices ($5.2-$5.7/mmbtu) which provides basis for atleast $2 hike in APM gas. This would provide an additional PAT of Rs. 50bn in FY15E and valuation upside of ~Rs. 50/share (@9x)

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