Gas pricing, subsidy sharing key triggers for ONGC: IDFC

Sonia: Since there is a sharp decline that is expected in the subsidy burden over the next couple of years, which are the stocks that you think could benefit from that which have not priced it in completely just yet? Which are the stocks that you would be positive on from the universe that you cover?

A: Upstream is the main sector which we think should be a beneficiary of lower subsidy payout. Out of the entire subsidy, the downstream which is the oil marketing companies did not bear any subsidy or it was fairly less, it was the government as well as the upstream. So, going forward if the subsidy starts to decline we think that should clearly benefit the upstream which is Oil and Natural Gas Corporation (ONGC), Oil India and Gas Authority of India (GAIL) and lead to a higher net realisation specifically for ONGC and Oil India.

Sumaira: For ONGC you think these recent positive newsflow, etc do you think it is not priced in and what will be the next key trigger for this stock? What is your rating on the stock?

A: There were two main triggers for ONGC in terms of government policy. One was the gas price which came through at 5.6; a bit disappointing I would think. Second is we are still not sure how the subsidy breakup will happen. The government has to come up with a formula in terms of what kind of upside or what kind of net realisation they want ONGC to get.

We don’t know whether subsidy will be one third sharing, whether it will be a fixed realisation and then take supernormal profits. So, that is probably what the market is looking for. I guess there is also the overhang of FPO which is why the stock has come off from its recent highs and therefore gives an opportunity to get in to make more returns.

Sonia: You were saying the other stock you are bullish on is GAIL. In the quarter gone by the profits for GAIL were boosted by this zero subsidy burden but the operational performance was quite muted for the company and that is what kept the stock under pressure. So, going forward do you think any kind of positives from the zero subsidy would be negated by the muted operational performance for the company?

A: You are right that GAIL has reported slightly disappointing numbers on the operational side but on the gas side the story is more a bit longer term. I do agree that what is going to drive is volume growth and that has been a bit of a disappointment because domestic volumes have not picked up and international LNG prices have been higher.

However, as we go forward, couple of policy measures, one is we have been hearing about gas pooling where the government says the stranded power plants, stranded gas power plants will get more gas. If that happens then we will need more LNG and that fills up the pipelines for GAIL.

The bottomline with GAIL, Petronet LNG, Jindal Steel and Power (JSPL), Gujarat Gas is that there is potential but there could be some slowdown in the first 6-12 months and then a pickup; that is how we look at it.

Sumaira: What about Reliance Industries, the gas price hike was lower than what was being expected and yet you don’t expect or rather you see just a limited impact on overall earnings. What is the basis on which you see this limited impact?

A: If you look at the EBIT contribution of gas for Reliance, it is about 8-9 percent maybe even lower and the large part is a global commodity call on refining and petrochemicals. Within petrochemicals we got to break it up between the polyester that is the aromatic and the polymers.

So, we think given the volume decline that we have already seen we are building in an increase in upstream maybe in the next three to five years. Therefore the contribution and the drivers will be the petchem refining and not really gas.

Therefore we think the gas price increase was a bit of a disappointment but we don’t see that impacting the company’s earnings too much in our estimates.

Sonia: I didn’t get your target price on ONGC; if you could just tell us that and how would you approach a stock like BPCL which has been the gainer this year? It is up about 108 percent, is this still a good time to accumulate or now would you start to be cautious on BPCL?

A: In terms of ONCG our price is around Rs 500 largely based on DCF. As we go forward we are looking for net realisation, longer term as well as FY16 onwards of around USD 60. So, the big estimate that we have taken is that net realisation will be in the range of USD 60.

In terms of Bharat Petroleum Corporation Limited (BPCL), we think the stock has done very well. It has been a star performer both in terms of operations, in terms of refining margins and the fact that it has a phenomenal portfolio in Mozambique. However, from these levels we would certainly think some amount of cautiousness is required largely on two counts. One is we think the market is extremely bullish in terms of marketing margins.

If you look at just standalone, you have to work that backwards but if you work the backwards way just the marketing business and maybe just the retail business of BPCL and HPCL they seem to be making returns upwards of 20-25 percent, maybe even higher. This will get in my view competition, one and two, diesel is still an important commodity and I am not sure whether they will continue to make these kind of margins.

The other point which I wanted to point out was that in Mozambique given that international prices are falling, it is a bit of negative. The value of Mozambique should start to decline on a spot basis if you will. So, from these levels we would prefer the upstream. Our call was to buy BPCL if you have to be in OMCs but from hereon I would take some profits.