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Pricing strength more than offsets output worries

Despite a 5/4% YoY decline in oil/gas production, a sharp USD37/bbl YoY (USD8/bbl QoQ) increase in oil realization to USD65.6/bbl and a 1% YoY (23% QoQ) improvement in gas realization to Rs7.3/scm ensured a 96% YoY jump in EBITDA to Rs116bn and a sharper 8.7x YoY jump in net earnings to Rs43.3bn for ONGC. Earnings, however, were below estimates of Rs125bn EBITDA / Rs48bn PAT mainly due to the miss on production.

While production growth remains elusive in the near term, management has aggressive plans to augment output once Covid-related travel/logistics constraints abate. We see a very strong oil/gas price environment ahead to support earnings for both ONGC and OVL. Upgrade to BUY, with a TP of Rs156. The stock currently trades at just 6.7x FY23E EPS / 2.8x EV/EBITDA.

Production remains weak; outlook to get better

Oil output at 5.4mt (-5/-3% YoY/QoQ) and gas production of 5.3bcm (-4/-5% YoY/QoQ) both came below estimates of 5.5mt/5.6bcm. Management has pointed to (i) lower level of domestic exploration/development work, and (ii) the difficulty of arranging for technical equipment / experts from outside India to execute the KG 98/2 development (both due to Covid constraints) as the chief causes for the decline.

Outlook from management ambitious, however

Management has put in place plans to augment oil/gas output by as much as 5mt/12bcm over the next five years, which can materially alter ONGC’s operational scale even if executed partially. We note, however, that ramp up of KG 98/2 production, which is expected to add 3bcm in FY23 and another 2bcm thereafter, and also 2mt of oil, will be the key monitorable to achieve these numbers.

Oil realizations jump sharply; gas prices to also jump materially in H2FY22E

The USD36/7 per bbl YoY/QoQ jump in Brent crude prices reflects in a USD37/7.5 per bbl jump in net realizations for ONGC, with gas realizations improving 1/23% YoY/QoQ to Rs7.3/scm. Domestic gas prices are set to jump 50% (~US0.8-0.9/mmbtu) from 1 October 2021 and price trends suggest another USD0.4-0.5/mmbtu increase from 1 April 2022. Given a Rs30bn jump in standalone PBT for every USD1/mmbtu change in gas prices, this indicates a material delta for ONGC’s FY22/23E earnings.

Valuations – upgrade to BUY

We factor in a decline in production estimates offset by much stronger oil prices, and hence, we have increased our FY22/23E EPS by ~22% each, with gas price estimates also raised by 15-20%. While there is little to excite investors in the near term, current valuations of 2.8x EV/E FY23E and 6.7x PER FY23E are materially attractive, and the very strong earnings momentum + incremental earnings support from key subsidiaries (OVL/HPCL) is too strong to ignore, particularly at current stock levels. Upgrade to BUY with TP of Rs156, suggesting ~35% upside from here.

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