Buy ONGC ; target of Rs 342: Edelweiss

Edelweiss Research report on ONGC

ONGC reported in line Q1FY16 numbers with PAT at INR54.6bn, up 14% YoY and 39% QoQ. Earnings were driven by a sharp 25% YoY surge in net realisation to USD59/bbl, highest in 4 years, as under-recovery further fell by ~25% during the quarter (down ~85% YoY). Direct benefit transfer (DBTL) on LPG allowed upstream companies to absorb only one-third of the subsidy (54% in Q1FY15). While oil production was flat YoY, gas production dipped 4%. Subsidy scenario now looks comfortable, following diesel deregulation and benign oil prices while DBTL on LPG will significantly reduce upstream contribution. We believe oil prices have bottomed and an expected recovery will translate into significant earnings resurgence for ONGC (10% rise in oil improves earnings 15%). We have revised our FY17 oil price assumption to USD68/bbl (USD72 earlier) and reduced upstream subsidy contribution to 30% (40% earlier), effecting a 9% cut in FY17E EPS. However, after a sharp 20% correction in 3 months, valuations look attractive, discounting USD55/bbl long-term oil price. We, therefore, upgrade to ‘BUY’ with a revised target price of INR342 (INR367 earlier).

Production flat, surge in realisation Crude production from ONGC’s nominated blocks was at 5.23MMT (up 1% YoY), while that from JVs fell 4% YoY to 0.91MMT. Gas production, at 5.8bcm, dipped 4% YoY and VAP sales plummeted 8% YoY. While gross realisation declined sharply by 42% YoY, net realisation surged 25%. OVL’s total oil & gas production declined 3% YoY.

Outlook and valuations: Subsidy comfort; upgrade to ‘BUY’Post diesel deregulation, domestic retail reforms continued with implementation of DBTL on LPG, which is likely to reduce under-recovery by INR83bn (refer our note, Good progress on LPG reforms going unnoticed-June 15, 2015). The government has announced further rationalisation of subsidy share (cap kerosene subsidy pay-out at INR12/litre), which will further rationalise upstream’s contribution. As oil prices crashed, ONGC stock has taken a toll, falling 30% YoY, and is currently trading at attractive valuations of 9x FY17E PER and at a 30% discount to global peers (Table 3). As the stock is currently pricing in the worst, we upgrade to ‘BUY/SO’ from ‘HOLD/SP’ with a target price of INR342.For all recommendations, click here Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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