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Getting back in the saddle again

* We reiterate our Buy rating and OW stance on ONGC on the back of buoyant oil prices and potential overhaul in nominated block (APM) gas pricing. Brent prices have risen to USD65/bbl, driven by demand recovery, OPEC+ cuts, stimulus and extreme cold weather.

* Arrival of summer-driving season in US-Europe and shift to personal mobility should support oil prices further. Hence, there is upside risk to our USD55/bbl Brent assumption for FY22. Subsidy risk based on Union Budget and LPG price hikes is low in our view.

* ONGC management has remained upbeat on the government agreeing to remunerative gas pricing, which should at least cover the USD3.5-3.7/mmbtu cost of production. Every USD1/mmbtu rise in APM rate implies Rs2.6/sh EPS increase for the company.

* We value ONGC at 4x FY23E EV/EBITDA to arrive at Rs130 TP, assuming USD2.3/2.7 APM prices for FY22/23. Under a blue sky scenario - USD60/bbl Brent, USD3.5/mmbtu gas price and KG-DWN-98/2 ramp up, FV comes above Rs170/sh.

Oil prices at USD65/bbl, aided by fundamentals, stimulus:

Brent prices have recovered to USD65/bbl as demand recovery and strict output-cut compliance by OPEC+ have led to a supply deficit and inventory destocking. Further, large Covid-19-led stimulus announcements and recent extreme cold conditions in Texas affecting operations have also weighed in. With the arrival of summer driving season and personal mobility preference, higher gasoline demand should support prices ahead. For every USD5/bbl increase in oil realization, ONGC’s EPS would grow by Rs3/sh. Our Brent assumption for FY22/23 is conservative at USD55/56 per barrel. With the government budgeting Rs282/125bn of subsidy and LPG price hikes also continuing, upstream subsidy burden risk is low, up to USD60/bbl+ Brent.

Management maintains narrative of remunerative APM gas pricing:

Management reiterated that it is only a matter of time before the gas pricing anomaly is set right. ONGC seeks remunerative rates. Cost of production is USD3.5-3.7/mmbtu and USD1.5/mmbtu+ of ROI, implies realization at USD5/mmbtu+. Our calculations suggest, cost of production of USD3.2/mmbtu (NCV), based on USD1.3/mmbtu of cash opex and levies (variable)+DD&A of USD1.9/mmbtu. For every USD1mmbtu rise in gas prices, ONGC’s EPS grows by Rs2.6/sh. We build in USD2.3/2.7 NCV for FY22/23E, hence USD3.2/mmbtu realization in FY22 implies Rs2.3/sh or 20% upside to our EPS estimate.

KG-DWN-98/2 ramp up, improving OPaL and gas foray other positives:

ONGC has also indicated 98/2 output ramping up from current 0.3mmscmd to ~3mmscmd by May’21, 8- 9mmscmd in FY23 and 15mmscmd peak by FY24. Other positive factors include improving OPaL performance, consolidation of downstream entities OMPL-MRPL-HPCL and subsequent synergies, foray into gas marketing (cleaner sunrise sector) and GST in gas.

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