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Higher oil & gas price to drive profitability

About the stock: Oil & Natural Gas Corporation (ONGC) is primarily engaged in exploration, development and production of crude oil and natural gas.

* ONGC’s crude oil production has been in the range of 54-63% of total domestic oil production in FY11-21

* ONGC is also a play on the refining sector via its subsidiaries

Key events:

* Domestic natural gas price was revised from US$1.8/mmbtu to US$2.9/mmbtu on a GCV basis from October 1. A sharp increase of 62% augurs well for realisation of upstream companies.

* Oil prices have also been on an upward trend for the last five quarters and are currently at nearly three-year high of US$83/bbl.

What should investors do?

ONGC’s share price has underperformed the benchmark over the past four years due to a decline in domestic oil & gas production. Due to lower production growth on a sustainable basis, despite cheaper valuations, we do not recommend that long term investors add the stock as it is a play on commodity prices.

* We retain our HOLD rating on the stock

Target Price and Valuation: We value ONGC at | 185 i.e. | 161 for core oil & gas business and | 24 for subsidiaries and other investments.

Key triggers for future price performance:

* Sustained higher crude oil prices and gas realisations can result in better profitability. If prices sustain at higher level, there is further upside potential to earnings and our target price

* Ramp-up in oil & gas production from newer fields

* Value unlocking from subsidiaries and other investments & lower holding company discount on investments

* High dividend yield and payout ratio

Key triggers for future price performance:

* Sustained higher crude oil prices and gas realisations can result in better profitability. If prices sustain at higher level, there is further upside potential to earnings and our target price

* Ramp-up in oil & gas production from newer fields

* Value unlocking from subsidiaries and other investments & lower holding company discount on investments

* High dividend yield and payout ratio

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