Improving outlook for ONGC

The company is set to benefit from diesel price regulation, likely increase in price of domestic gas, though the stock partly captures these positives

Oil and Natural Gas Corporation (ONGC) disappointed the Street as its net profit was hit by higher provisions and dry well write-offs. However, most analysts remain bullish on the company and expect it to gain from fuel price reforms, going forward. “We expect ONGC to benefit from lower subsidies, increase in domestic gas prices and higher oil and gas volumes. We maintain our ‘Buy’ rating with a revised target price of Rs 385 (Rs 375 previously)”, says Sanjeev Prasad, oil and gas analyst at Kotak Institutional Equities.

ONGC’s net realisations are likely to gain from lower subsidy burden, diesel price de-regulation and potential increase in domestic gas prices. Analysts expect its net crude oil realisation to gradually grow from $48 a barrel in FY13 to $63.7 a barrel in FY16. Analysts believe the government will also increase domestic gas prices from $4.2/mBtu (millions of British thermal units) currently to $6-7/mBtu in the next 12-15 months.

ONGC’s consolidated production volumes are also likely to pick up over the next couple of years due to ramp-up in production at the Rajasthan block, higher production of own fields and pick-up in OVL’s production (due to incremental volumes at fields in South Sudan, Myanmar). The key risk though, remains a sudden and unfavourable change in the subsidy sharing arrangement. For example, adoption of export parity pricing policy could hit ONGC if the upstream companies are asked to bear part of the losses borne by OMCs.

The ONGC scrip has outperformed the broader indices in 2013 so far, which means significant upsides from current levels might not come immediately. Thus, one should use any dip in the share price to buy the ONGC scrip, which is currently hovering around Rs 334.

Weak March quarter
ONGC’s poor show in the March 2013 quarter was largely a function of high dry well write-offs (up 33 per cent year-on-year to Rs 4,740 crore) and provisions (Rs 1,585 crore for octroi/VAT and Rs 1,850 crore towards employee superannuation benefits). This led to a 40 per cent fall in net profit to Rs 3,389 crore. This more-than-offset the gains on account of lower subsidy burden (down 13 per cent to Rs 12,310 crore).

ONGC also reported a drop in both oil (down one per cent to 5.87 million tonnes or MT) and gas (down 5.2 per cent to 4.95 billion cubic metres) sales volumes in the quarter, impacted by lower production. “We highlight that despite more ultimate reserves (3P) being added than production, the declining oil production trend continues. ONGC’s domestic oil production has declined each of last six years, and FY13’s decline of five per cent is steepest”, says Anil Sharma, oil and gas analyst at Nomura Equity Research. ONGC’s international subsidiary - ONGC Videsh Ltd (OVL) too, reported fall in crude oil production volumes in the quarter due to issues in Sudan, Syria and lower production across various fields. While OVL’s oil production volumes fell 23 per cent to 0.99 MT, natural gas production volumes grew 21 per cent to 872 million cubic meter, boosted by higher production in Vietnam.

However, this trend in declining volumes should change, going forward, given the expected increase in output from various fields and geographies. Kotak’s analysts expect ONGC’s total sales volumes (oil equivalent) to rise from 48.8 mt in FY13 to 51 mt in FY14 and further to 53.1 mt in FY15.