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‘Buy’ ONGC shares as Indian rupee depreciation a positive, target price Rs 380, says Kotak

The company witnessed the worst quarter but we find risk-reward balance favourable at current levels

In-line results and probably weakest quarter for FY2014: Oil & Natural Gas Corp (ONGC) reported in-line net income at Rs 40.2 bn in Q1FY14 with higher other expenditure being offset by lower DD&A expenses. We believe that the recent sharp correction in ONGC’s shares reflects current abnormal conditions continuing in perpetuity. Q1FY14 may be the worst quarter for FY14 given likely higher crude oil prices and weaker rupee in subsequent quarters. We find the risk-reward balance favourable at current levels.

ONGC’s operating results marred by higher-than-expected other expenditure and staff costs: ONGC reported a sharp decline in Ebitda to R84.9 bn (-33% q-o-q,

-24% y-o-y), lower than our estimate of Rs 98.4 bn led by (i) higher other expenditure at Rs 45.8 bn (+39% q-o-q, +44% y-o-y) versus our expected Rs 34.2 bn and (ii) higher staff costs at Rs 5.9 bn versus our estimate of Rs 3.6 bn. The company has accounted one-off provision of Rs 12 bn for the conversion of post-retirement benefit scheme from defined benefit scheme to defined contributory scheme. However, net income (standalone) at Rs 40.2 bn (-6% q-o-q, -34% y-o-y) was in line with our estimate of Rs 40.3 bn led by lower DD&A expenses at Rs 39 bn versus our expected Rs 50 bn. ONGC oil sales volume increased 0.4% y-o-y to 5.93 m tonnes while gas sales volumes declined 3.6% y-o-y to 4.93 bcm.

Current valuations reflect high subsidy burden and no increase in gas price realisations: ONGC?s inexpensive valuations factor in (i) concerns on high subsidy losses and (ii) no increase in gas price realisations. We compute FY2015e (estimates) EPS (earnings per share) of Rs 33 for ONGC assuming current crude price and exchange rate in a bear-case scenario of (i) $56/bbl of subsidy discount, which implies $45/bbl of net realised crude price and 40% subsidy sharing for upstream companies assuming no further increase in diesel retail price and (ii) no increase in domestic gas price realisations. The stock is trading at 8.5X bear-case EPS and reflects no upside from higher net oil and gas realisation in perpetuity.

Indian rupee depreciation is a positive for ONGC?s earnings: We disagree with market?s tendency to treat rupee depreciation as a negative for ONGC?s earnings. Although a weaker rupee may result in higher under-recoveries, this is offset by higher rupee realisations for (i) domestic crude oil (assuming a fixed $56/bbl subsidy discount), (ii) domestic natural gas, (iii) value-added products, (iv) JV production and (v) OVL?s sales volumes. We note that Q1FY14 exchange rate was Rs 55.95/$ ?only?.

Fine-tune earnings; maintain BUY with a TP of Rs 380: We revise our FY14-16e (estimates) consolidated EPS estimates to Rs 29.50 (-12.2%), Rs 37.40 (-4.7%) and Rs 35.10 (-14.6%) to reflect (i) Q1FY14 results, (ii) weaker exchange rate forecasts, (iii) revised subsidy-sharing mechanism and (iv) other minor changes. We revise our 12-month forward target price to Rs 380 (Rs 400 previously) based on 10X 12-month forward EPS plus value of investments.

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First published on: 19-08-2013 at 03:21 IST
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