The share price of government-owned ONGC, India?s largest upstream player, has declined 11% since September 21 (Sensex up 3% over the same period) due to changes in the subsidy-sharing formula. The market?s main concern has been the ad hoc mechanism of the subsidy that ONGC must provide to oil marketing companies to partly fund their losses on sales of transportation and cooking fuel below the international price.
But the market is missing that earnings are remarkably resilient. We believe ONGC?s earnings are comparable to those of other international oil companies, such as IOC. The company?s net profit per unit of oil and gas produced has been largely in line with its peers? despite the ad hoc subsidy-sharing. Our analysis indicates that earnings will remain largely flat over a range of oil prices at the current level of subsidy-sharing, cushioning ONGC against oil price volatility.
Operational parameters are comparable to IOC?s. While ONGC?s finding costs over five years, at c$4.33/boe (barrel of oil equivalent), are only marginally above the c$4.20/boe peer average, its finding and development costs, at c$12/boe over the same period, compare favourably with IOC?s c$18/boe. Therefore, we expect ONGC?s capex plans to remain intact.
Gas price hike is a significant potential catalyst. We think ONGC?s gas price is set for a revision in 2014. We believe the government may be forced to provide price visibility earlier than expected so that the industry, particularly private sector companies, can plan expenditure for deep-water gas development in the face of declining domestic production. This could be a significant trigger for the ONGC share price.
We upgrade the stock to ?overweight? and raise target price to R310. We continue to value the company at 9.3x FY14e EPS, in line with the historical trend, but at a 25% discount to peers.
The lift to our target price results from our increased earnings forecasts. Our FY14 and FY15 EPS estimates are now 1.5% and 2% ahead of consensus. The key downside risks to our view are higher subsidy, a sharper decline in ONGC?s production and higher royalty or cess burden than we estimate.
HSBC
