Buy ONGC; target Rs 1025: CLSA

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Buy ONGC; target Rs 1025: CLSA

Research firm CLSA has recommended buy rating on ONGC with 12 months target price of Rs 1025.

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Research firm CLSA has recommended buy rating on ONGC with 12 months target price of Rs 1025.

CLSA report on ONGC:

ONGC's 4Q results were marked by a slew of exceptionals on the other income, staff and recouped costs and gains on insurance-claims. Stripped off these, 4QFY07 were ahead of estimates on the back of higher than expected other income driving full year standalone profits up 8%YoY. The uncertainty on subsidy sharing remains the key overhang for standalone profit outlook but ONGC Videsh holds the key for core performance over FY08-10CL. We were positively surprised by FY07 when OVL registered an Rs 16.6 billion net profit driving up ONGC's consol EPS 13.6% higher to Rs 83 per share (+15%YoY). Valuations remain undemanding at 10x PE. BUY.

A slew of exceptionals in 4QFY07

ONGC's 4QFY07 standalone results were marked by a slew of one-offs. While other income was boosted by the Rs 11.6 billion gas pool money transferred from Gail, recouped costs were also Rs 1.8 billion higher on account of a review of abandonment costs. Staff costs included prior period arrears and exceptionals related to post retirement benefits, pay-arrears and pension-funding (Rs 13.6 billion). Together with the Rs 4.75 billion extraordinary income from the insurance claims related to the mid-2005 BHN fire and a minor reversal of other income, however, these cancelled each other out in 4Q.

Standalone 4Q profits drop 13% but ahead of estimates

Even adjusted for these one-offs, ONGC's 4Q profits (Rs 26.8 billion, down 13%YoY) came in higher than estimates boosted by higher other income (up 60%YoY to Rs 10.6 billion) taking standalone FY07 profits up 8%YoY to Rs 73 per share (pre-excep profit growth of 18%). Sharply higher subsidy sharing (Rs 46 billion) was the key reason for the YoY/QoQ lower profitability for ONGC in 4Q as the government allocated a sharply higher burden on upstream companies in FY07 (41.5%). We are building in 40% upstream sharing in FY08 but this may be prove too high; the government is looking to revert back to the status-quo (one-third subsidy sharing for upstream) and may also be lenient towards ONGC on account of the appreciating rupee (1% appreciation = 1.4% impact on EPS).

Consol EPS rises 15%YoY in FY07 driven by an 85% rise in OVL profits

The uncertainty on subsidy sharing aside, ONGC's core performance over FY08-10CL will be contingent on the performance of the overseas assets housed in 100% sub ONGC Videsh (OVL). OVL's FY07 profit of Rs16.63bn (+85%YoY, much ahead of estimates) is encouraging in this regard driven by higher crude prices (Sudan), M&A (Syria, Colombia) and the commissioning of the profitable Sakhalin project. Consol profits rose 15%YoY as a result to Rs 83 per share (13.6% higher than standalone).

Core performance trajectory moving upwards

The outlook for subsidy sharing formula holds the key to near term performance for ONGC but its core performance trajectory is improving. OVL s gaining greater salience (30 projects in 16 countries), domestic exploration efforts are beginning to show some results (reserve accretion at 1.4x in FY07) and concrete steps are being taken to monetise marginal fields (600mboe of recoverable reserves). We remain BUYers.