Action: Further downside for upstream PSUs; Reduce on ONGC, OIL
Upstream oil PSUs (ONGC, OIL and GAIL) have sharply underperformed relative to the BSE Sensex; these stocks have declined by 12-15% over the past three months and 19-28% YTD (year-to-date). Even as the three stocks currently trade near their three-year lows, we think the scenario could worsen in H1FY13F (forecast). Macro concerns remain elevated and we believe upstream oil PSUs are vulnerable to higher subsidy sharing. With the Indian government’s (GoI) priority on fiscal deficit control (amid revenue slippages) this year and likely doling out of populist measures in 2013 ahead of the 2014 elections, the outlook remains gloomy for upstream PSUs, in our view.
Catalysts: Direct cash subsidy–Intent good, but timing not We believe GoI is keen on implementing direct cash transfer from early- 2013, and intends to cover half the country by Apr-13. Even as the intent is good, with inadequate infrastructure and preparedness, we believe a hasty implementation could create confusion in the near term. With populism a priority, GoI is likely to rollback earlier tough/unpopular decisions (eg, after widespread criticism of the six LPG cylinder/household annual cap, it is considering raising the limit). We also believe that any benefit from a cut in under-recoveries would be enjoyed by GoI itself (by way of reduced cash payments to OMCs) and not lead to much payout cuts for upstream PSUs.
Not much to cheer operationally; the decline in volume continues: For both ONGC and OIL, production trends remain disappointing. Budget targets have been lowered, yet actual production still remains below budget. Even as GAIL keeps adding new pipelines, transmission volumes have seen sharp declines. With KG-D6 production decline continuing, we believe not much respite is likely soon. GAIL is seen as both an upstream and downstream company, but the company suffers-as an upstream company, the government makes it pay subsidies, and tariff orders of PNGRB, the downstream regulator, have not made things easy for GAIL.
Macro situation remains unfavourable: Oil and currency not in favour: High oil prices in INR terms are negative for Indian oil PSUs. In USD terms, oil prices remains high (FY13YTD Brent has averaged $110/bbl). A weak currency compounds the problems for oil PSUs. YTD in FY13, INR has weakened considerably (17% depreciation vs. the USD). In INR terms, oil prices remain close to the all-time high levels.
A sharp increase in fuel prices needed; unlikely soon: We highlight