ONGC: Concerns overdone

Analysts believe the share price fall provides an opportunity to accumulate the stock

The Oil and Natural Gas Corporation (ONGC) scrip has underperformed both the BSE Sensex and the BSE Oil and Gas indices since August 23 and has fallen about six per cent, against a 2.7 per cent fall for both indices in this period. The stock correction was on the Street's fears over a possible foreign currency loan to fund the $2.64-billion buyout in Mozambique, as well as a likely higher price for the acquisition.

However, analysts believe, these are not of significant consequence, and the share price fall provides an opportunity to accumulate the stock (now at Rs 259), which is quoting close to its lower band of Rs 240-360 seen in the past four years.

ONGC on Monday announced its plans to buy a further 10 per cent stake in Mozambique's Rovuma-1 offshore block from US-based Anadarko Petroleum Corp for $2.64 billion. In June, ONGC along with Oil India had purchased Videocon's 10 per cent stake in the same block for $2.475 billion. The latest deal price is about 6.7 per cent higher than the deal with Videocon.

Dayanand Mittal, oil and gas analyst, Ambit Capital, says, "I think the deal appears fairly valued. ONGC paid what the asset is worth for and the price factors in risks of any delay in production from the block. The Mozambique block is a good asset and will add to ONGC's reserves in the longer run".

Mayur Matani, oil and gas analyst at ICICI Securities, has a similar view. "The value paid by OVL works out to $4 a barrel of oil equivalent (BOE) of recoverable reserves, which we believe is a reasonable valuation. This acquisition would bring 19.2 per cent and 3.1 per cent additional 3P (proven, probable, possible) reserves (assuming 35 trillion cubic feet (TCF) of recoverable reserves). Cash outflow for the acquisition is Rs 19.7 a share for ONGC".

While some like Sudeep Anand, oil and gas analyst, IDBI Capital, believe the deal looks slightly expensive, given the recoverable reserve, production target of 2018 and risks attached, the long-term gains for ONGC are far more, given the production issues it is facing in India.

While ONGC's crude oil production fell in FY13 to 26.4 million tonnes (mt), it has also trimmed its FY14 domestic crude oil production guidance (forecast) by five per cent to 24.1 mt. In this context, the acquisition of stake in the Mozambique block (one of the world's most resource-filled assets) and, consequently, the addition to its reserves means better long-term visibility.

The company remains fairly confident and believes the increased stake will boost total production. "The acquisition would increase OVL reserve and resource base significantly. The project would also be an important milestone in reaching OVL's long-term production targets of 20 mt of oil and oil equivalent gas (mtoe) by FY18 and 60 mtoe by FY30," said ONGC. In the medium term, the pick-up in OVL production (due to incremental volumes at fields in South Sudan, Myanmar) will be a key positive. In the near term, timely ramp-up of production at its Rajasthan block (jointly owned by Cairn and ONGC) and other fields will be very crucial.

Among other reasons for the stock's recent underperformance is the rise in estimated gross subsidies to Rs 130,000-140,000 crore for FY14, compared to the Rs 80,000 crore estimated at the start of FY14. However, even at the revised levels, these are lower than the Rs 161,000 crore for FY13. Among upstream oil companies, ONGC had borne the highest burden (about Rs 48,000 crore) in FY13. Thus, even in the current scenario, the subsidy burden at worst is likely to come at similar levels. Additionally, the continuing fuel price increases, though in a staggered manner, will add to net realisations. Hence, on a net basis, ONGC should gain from fuel price reforms and higher domestic gas prices.

The key risk, though, remains a sudden and unfavourable change in the subsidy sharing arrangement.

On the other hand, since OVL (about 20 per cent of consolidated numbers) is not impacted by subsidies, the combined impact of higher volumes, higher realisations and weak rupee would boost its financials, thereby supporting ONGC's consolidated performance.