Stake sale overhang a good opportunity to buy Coal India, ONGC

Accumulate the Coal India and ONGC stocks on any correction as both the companies have strong long-term prospects

The government's disinvestment plans have put Coal India Ltd (CIL) and Oil and Natural Gas Corporation (ONGC), among others, in the spotlight. The Centre is expected to sell 10 per cent of its stake in CIL and five per cent in ONGC in the near term. This could, however, be in multiple tranches. The sales are estimated to fetch about Rs 15,750 crore and Rs 11,500 crore, respectively. While the stake sale might help the government garner the funds required to keep its fiscal deficit under control, in the interim, the news could weigh on the share prices of the two companies. Analysts believe any correction will be a good opportunity to enter these stocks, given the strong long-term prospects of the two companies.

CIL, which saw a rally on hopes of reforms, touching an all-time high of Rs 423.85 in June, is now being traded at Rs 349.5. Factors such as lower e-auction volumes, lower volume ramp-up and the stake-sale overhang have led to the decline. These concerns could keep the stock under pressure in the coming days, too. While the government has been able to end the strike called by workers opposing the disinvestment, one will have to be watchful till the stake sale is completed.

A positive aspect is CIL's prospects are likely to improve in the medium- to long term. Analysts at Goldman Sachs have, however, lowered their FY15-18 estimate for profit after tax three-nine per cent, owing to lower sales and higher costs. They expect cost pressures to decline in the second half of FY15 on lower diesel prices. The analysts foresee significant gains on the operational front, given the government's focus on raising coal production. Therefore, despite lowering their target on a DCF (discounted cash flow) valuation basis, the analysts have arrived at a 12-month target price of Rs 470. CLSA, too, is said to have recently included CIL in its model portfolio.

Earlier, the government had said it planned to double CIL's output to a billion tonnes annually.

Meanwhile, CIL's production and sales numbers for October have been encouraging and have boosted its performance for the first seven months of this financial year. In the first half of FY15, CIL had seen tepid volume growth of 2.4 per cent (one per cent in FY14). But in October, it saw better output, with production/off-take at 40.2 million tonnes (mt)/39.1 mt, up 15 per cent and 10 per cent year-on-year, respectively. If the company sustains such performance, its near-term sales and e-auction volumes could also see an uptick.

Analysts at Nomura say the current disinvestment overhang notwithstanding, CIL remains a good long-term story. They expect 28 per cent returns, including five per cent dividend, from CIL, from Rs 359 levels. The consensus target price, according to analysts polled by Bloomberg in November, stands at Rs 376.

ONGC has corrected 14.5 per cent from its closing high of Rs 455 in September and the stake-sale overhang has aided to this, as the government is expected to give some discount on the prevailing share price. This is likely in the case of CIL, too.

ONGC's prospects have been improving. With low crude oil prices boding well and expected to reduce underrecoveries, the reforms being undertaken by the government will add to benefits. The lower crude oil prices will, however, hit the earnings of its subsidiaries OVL and MRPL. These entities, however, account for a small part of ONGC's consolidated revenue and profit (less than 25 per cent at the level of profit before interest, tax and depreciation). Lower underrecoveries will mean higher net realisations, which will boost ONGC's earnings.

Diesel prices have already been de-regulated and the government is contemplating on how to reduce subsidies on liquefied petroleum gas. It is believed administered-price-mechanism gas prices, raised from November 1, will raise ONGC's FY15 earnings per share by Rs 1.5. In this backdrop, any further correction in the stock could be used by investors to accumulate it. The consensus target price, according to analysts polled by Bloomberg after the announcement of the company's results for the September quarter, stands at Rs 456, against the current Rs 386. What's more, if the government brings in transparency in the subsidy-sharing mechanism, it might lead to a re-rating for ONGC.