Buy ONGC; target Rs 1100: Citigroup

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Buy ONGC; target Rs 1100: Citigroup

Citigroup Research has recommended buy rating on ONGC with a target price of Rs 1100 on account of greater confidence in adherence to a subsidy-sharing formula.

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Citigroup Research has recommended buy rating on ONGC with a target price of Rs 1100 on account of greater confidence in adherence to a subsidy-sharing formula and the company's recent successes in driving volume growth and potential improvement in reserve replacement.

Citigroup Research report on ONGC:

4Q was disappointing, but expected - ONGC's pre-exceptional standalone net profit at Rs 22.1billion in 4QFY07 was disappointing as higher subsidy share (Rs 46.7 billion) took its toll. However, profit contribution from the subsidiaries increased significantly to Rs 21.3 billion in FY07 vs. Rs 9.7 billion in FY06 - thus helping ONGC post a consolidated EPS of Rs 83 during the year.

Lots of one-offs, but net impact was neutral - ONGC accounted for one-off staff costs of Rs 12.9 billion during the quarter. However, it was offset by booking of other income of Rs 11.6 billion from the surplus in Gas Pool account, to partly compensate for higher price for richer fractions supplied to GAIL since July-05.

Contribution from subsidiaries kicks in, finally - OVL and MRPL contributed Rs 10 i.e., 12% to the consolidated EPS vis-à-vis 6% in FY06. Bulk of the improvement came from OVL, which benefited from the commencement of production from Sakhalin-I (Exxon Mobil).

FY08 subsidy sharing may hold positive surprises - Given the low chances of retail auto fuel price hike, upstream's subsidy share could revert back to 33- 35% (from 40% in FY07). Meanwhile, the widening positive spread between Bonny Light prices (benchmark for ONGC) and the headline WTI would offset the impact of rupee appreciation. Undemanding valuations, increasing contribution from OVL, likely improvement in subsidy share, and possible exploration success make ONGC a good value pick. Maintain Buy/Medium Risk.

Company description

ONGC is India's largest E&P company. Through its subsidiary ONGC Videsh, the company has invested in overseas crude equity. It has ventured downstream, picking up a majority stake in Mangalore Refineries, and it intends to set up a petro-products retailing network.

Investment thesis

We rate ONGC as Buy/Medium Risk (1M) with a target price of Rs 1100. Despite near-term uncertainties on subsidy payouts, ONGC's asset valuations have improved with higher net realizations and greater confidence in gas price deregulation. The present subsidy-sharing mechanism reduces the gains for ONGC in the short term; however, stable and range-bound crude of USD 50- 60/bbl indicates a sweet spot for ONGC as the subsidy burden will become manageable at lower crude prices. Meanwhile, domestic gas prices have been on an up-move and the structural market forces will reflect in higher realizations for ONGC's APM gas in the next 2-3 years. OVL's past acquisitions will also start bearing fruit in FY2007-08 and beyond as they become a meaningful portion of ONGC's total production. ONGC remains reasonably priced among the Asia- Pacific E&P universe - both on traditional valuation multiples as well as asset valuations (EV/boe). This, coupled with dividend yield of 4.0%, makes ONGC a good value pick.

Valuation

Our target price of Rs 1100 is based on a PER of 11x FY08E P/E (previously 10x) on account of greater confidence in adherence to a subsidy-sharing formula and the company's recent successes in driving volume growth and potential improvement in reserve replacement. The new target price imputes EV/EBITDA of 5.5x FY08E. This is at the higher end of historical trading ranges - PER of 2.1x to 11.3x and EV/EBITDA of 0.8x to 5.6x - but in-line with regional peers. In terms of asset valuation, ONGC's implied target EV/boe of USD 6.9 is at a discount to peers.