Risk, reward ratio favourable for ONGC

Attractive valuations and good dividend yields make ONGC and Oil India a good bet

Though the talks between key oil-producing countries from Opec and non-Opec groups in Doha may have failed to reach an agreement on freezing crude oil production, crude oil prices have not seen a major correction. Opec is the Organisation of the Petroleum Exporting Countries - created in 1960, by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Brent crude oil continues to trade $42-43 per-barrel and is almost 60 per cent up from lows in January and 18 per cent since start of March.

Analysts say near-term macro headwinds cannot be ruled out, but by year-end, demand-supply balancing should lead to higher crude oil prices. Analysts at Kotak Institutional Equities say, "We believe the ability of US shale producers to act as 'swing' suppliers will keep crude oil prices capped in the medium term, even while we expect a gradual recovery in prices as market balances out naturally by 2016-end."

This should be positive news for upstream companies and oil producers whose prospects are dependent on the movement of crude oil prices. Upstream companies find and produce crude oil and natural gas. With some bounce in prices, ONGC (Oil and Natural Gas Corporation) and Oil India, that had seen 52-week lows in February and March, now trade slightly higher at Rs 210 and Rs 315, respectively. Cairn India at Rs 150 has a higher beta (volatility) and trades 40 per cent higher from the lows.

Analysts remain positive on ONGC and Oil India as they feel that the downside is limited at current levels. Sachin Mehta at Centrum Broking says that at current levels, ONGC is factoring in crude oil prices at $35 a barrel. Hence, the ratio of risk to reward is in favour of upstream companies and the inching up of crude oil prices will add to it.

Analysts at Motilal Oswal Securities say that after the diesel de-regulation, and switching of cess to ad-valorem basis, ONGC and Oil India's earnings now correlate more directly to crude oil price movements. They have target prices of Rs 265 and Rs 421, respectively, for ONGC and Oil India due to attractive valuations and high dividend yields. This means an upside of 26 per cent and 34 per cent, respectively, for ONGC and Oil India.

For ONGC, analysts at IIFL have a nine-12-month target price of Rs 260, due to attractive valuations and strong dividend yield. For Oil India, analysts at HSBC have a target price of Rs 446. The Cairn India stock has a higher correlation to crude oil price movement; hence, any rise in crude oil prices will have a big impact.

The Street, however, will be looking for more. Factors such as production ramp-up, update on reserves, and extension of its production-sharing contract for its Rajasthan block are key. More importantly, the utilisation of cash is key, as Cairn is expected to be merged with Vedanta. Thus, analysts at Motilal Oswal Securities have a neutral rating, with a target price of Rs 147. Those at HSBC and Nomura have hold rating.