See relief rally, earnings upgrade for OIL, ONGC: Antique

In an interview to CNBC-TV18, Amit Rustagi, analyst, Antique Stock Broking says upstream companies like Oil and Natural Gas Corporation (ONGC) and Oil India should see a relief rally based on the government's nod to export parity pricing for petroleum products.

Rustagi says that with the government compensating almost one lakh crore, the upstream companies may see a five-seven percent earnings upgrade for FY13. Rustagi's optimism is not restrained to FY13 only. Based on the lower subsidy sharing put on upstream companies this year, Rustagi believes FY14 too will see some earnings upgrade. "Restricting the upstream subsidy compensation share to 37 percent for the full year or the next year, when under recoveries are falling, we may see upstream companies also benefiting to some extent now from the current levels. This is keeping in mind that we are seeing almost a 40 percent reduction in under recoveries. So, we are going to see an earnings upgrade for FY13 based on this new sharing mechanism. Also, we are going to see an earnings upgrade for FY14 based on the lower sharing put on upstream companies this year," adds Rustagi in an interview to CNBC-TV18. The government on Tuesday gave an in-principle nod to export parity pricing model for petroleum products. To know more, read here. Below is the edited transcript of Rustagi’s interview to CNBC-TV18. Q: Would you expect a relief rally for Oil and Natural Gas Corporation (ONGC) as well as Oil India based on what has come out? A: There should be a relief rally. If one looks at the last one-and-half months, there have been large speculations that government will undercompensate the sector because they won’t be paying compensation for trade parity pricing. Hence, all the people and infact the street too started expecting that now upstream has to bear that additional burden, whatever being the undercompensation from the government. Now, with the government compensation coming at almost Rs one lakh crore, which is much better than expectations and upstream share capped at Rs 60,000 crore, which was largely expected, we may see a five-seven percent earnings upgrade for FY13. This is not only about FY13. Restricting the upstream subsidy compensation share to 37 percent for the full year for the next year, when under recoveries are falling, we may see upstream companies also benefiting to some extent from the current levels. This is keeping in mind that we are seeing almost a 40 percent reduction in under recoveries. So, we are going to see an earnings upgrade for FY13 based on this new sharing mechanism. Also, we are going to see an earnings upgrade for FY14 based on the lower sharing put on upstream companies this year. Q: Say in FY13, the total under recovery burden was Rs 1.6 lakh crore out of which upstream was bearing Rs 60,000 crore. Now in FY14, the total under recovery burden is expected to come down perhaps Rs 80,000 crore, maybe Rs 1 lakh crore, but still from what the Finance Minister said when the reporters got hold of him, that the upstream would still bear Rs 60,000 crore in FY14, this is despite the total under recovery burden coming down. So, do you think you would be a bit concerned about the upstream space in FY14, if the government says that I will keep your subsidy burden unchanged so that I can take care of my fiscal deficit? A: Yes, I think that is one of the concerns. However, if one looks at what is changing in the sector, we had Rs 1,61,000 (one lakh sixty one thousand) crore of under recoveries in FY13. Now, we are looking at the under-recovery number of Rs 1 lakh crore even at elevated rupee level of 55 and assuming another three-four price hikes diesel, which is not that aggressive assumption. So, on that Rs 1 lakh crore number, even if we see upstream sharing Rs 45,000 crore and government paying Rs 55,000 crore, upstream shares will anyway move from 37 percent in this year to 45 percent in FY14. We are not building a great benefit to the sector as a whole. We are assuming that out of Rs 60,000 crore burden reduction for the sector, government will takeaway the majority of the benefit. They will reduce their share first. Hence, we are expecting only Rs 5,000 crore benefit coming to the upstream sector. In that sense, ONGC sharing 80 percent of that number, we may see a Rs 4,000 crore gross benefit to ONGC, which might translate into an additional earnings per share (EPS) of Rs 3 per share after paying the royalty and the taxes. With this, one will see that the standalone EPS of the company will grow to Rs 30 from Rs 27 now. ONGC Videsh (OVL), Mangalore Refinery and Petrochemicals (MRPL), contributes another Rs 5 per share for ONGC. _PAGEBREAK_ So, we might see an EPS to Rs 35 and that’s assuming no gas price hike. If there is any gas price hike, like we are hearing from USD 4.2 to USD 6.7, then there will be a further upgrade in EPS by Rs 6. So, we might see that ONGC EPS will be upgraded from a consensus of Rs 33-34 for FY14 to Rs 30-40 for FY14 because of these changes. The Kirit Parikh committee is going to look at not only the export parity and trade parity pricing, but also look at the subsidy sharing mechanism between the upstream, downstream and government. If one looks at 2010 report of Kirit Parikh, they suggested the subsidy sharing formula for upstream based on oil prices. So, we may see a subsidy sharing mechanism linked to oil prices. That will be a big boost to upstream sector because right now despite earnings, companies are not giving multiple earnings because of the uncertainty. What Kirit Parikh recommendations will try to do is try to remove uncertainty from the sector with respect to the sharing mechanism. Q: Let's talk about the downstream companies or the oil marketing companies (OMCs) and this export parity pricing (EPP) overhang because quite clearly it now looks like from the kind of discussions we have also had that while for Q4 it wasn't implemented, but in some form it will be implemented in FY14. Will there be impact on OMCs and how would you position yourself in these stocks? A: If one sees the kind of impact that it can have on the financials of OMCs, as well as standalone refiners, we may see the entire profitability of these companies be wiped off. This is because if one just removes the trade parity pricing and moves to export parity pricing for diesel, the impact alone is around Rs 14,000 crore among all the companies in OMCs as well as standalone refiners. The point here is not moving towards a one particular system, but if one sees the earlier committee recommendations, they have clearly said that if the end product price is decontrolled like in the case of petrol, there is no question of a export parity or trade parity then OMCs are free to determine at what price they will buy from the refiners and with their own refineries also. I think a similar case exists for diesel also, wherein if diesel price is decontrolled, which can be achieved over next one and half years, then we might see that the price determination at the refinery gate will be left to OMCs. Whether they want to follow an EPP or a trade pricing that’s fine. But in between, till the time we are seeing the diesel prices being controlled, we may see a transition from trade parity towards export parity in the manner, right now we have 80:20 ratio for import to export parity while computing trade parity pricing, which might be reduced to 60:40 in the initial years and 50:50 maybe going forward. Basically, there should be a transition and as one has heard Kirit Parikh also stating that there are political compulsions for these OMCs to step refineries at the landlocked positions. This doesn’t mean that these companies should not be compensated for the decisions taken for the political benefit. So, I think balancing all those things we might not see an immediate shift towards EPP in the near-term. What we have to see is a transition from import parity pricing towards export parity pricing in a phased manner. Once the end product is decontrolled, then we might see that there is no question of an export parity and import parity, OMCs will be free to buy products from standalone refiners and from their own refineries at the competitive prices, which they are doing right now with petrol also.

Q: What about ONGC, Oil India? Oil India also comes out with numbers today because Oil India is cheaper, but ONGC has the bigger benefit of gas price hike if and when that happens. What would be your preferred pick among these two? A: Oil India is slightly cheaper. If we look at Oil India, there are certain exploration and production (E&P) exploration upsides, which are there for Oil India, which are difficult to measure for ONGC because of its size. Oil India is going to start exploration in one of its very prospective block K-G onshore, which they got in 2004. This block has a huge gas potential and once the exploration starts, they will be drilling around three-seven wells over next one year. If the prospectivity of this block is established then Oil India can play a major role in the gas markets apart from the North East market. So, we are bullish on Oil India from a production profile as well as exploration profile. But if we just look at the subsidy sharing mechanism, the reduction in the subsidy sharing mechanism benefits more to ONGC rather than Oil India. If someone is just playing this under recovery scenario then ONGC is a better play and if you want to play for a slightly longer term with respect to the E&P potential of the company, then Oil India is a better play.