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Strong crude shores up earnings

Our view

ONGC’s 2QFY22 operating profit at Rs 125.3bn, stood slightly below our and street estimates. The miss on our estimates stemmed primarily from lower than estimated crude production and realization. The PAT at Rs 183.5bn, nevertheless stood above our and street estimates on account of reduction of Rs 85.4bn in deferred taxes, on introduction of section 115BAA of IT act. We believe that recent rally (+123.3% in 12M & 35% in 3M) in ONGC’s stock prices is largely fueled by high crude oil and natural gas prices, even as its production is on decline and capital expenditure on the rise to sustain the falling production. Additionally, the sharp rally in crude oil prices while spectacular, but is most likely unsustainable. Normalization of supplies, in the near term and a push for sustainable renewable energy, in the longer run would act as dampener for crude oil prices. Maintain REDUCE, with a target price (TP) with Rs 145/sh.

Result Highlights

* 2QFY22 Profitability: Operating Profit and PAT stood at Rs 125.3bn (+80% YoY; +14% QoQ) and Rs 183.5bn (+346% YoY; +323% QoQ). The operating profits improved QoQ and YoY, despite 4% YoY drop in crude and 6% YoY drop in natural gas production, on account of 68% YoY and 6% QoQ higher crude oil realization

* Crude Oil Production: Crude oil production continued to slide and stood 4% YoY lower at 4.9mmt for ONGC -SA and 5.47mmt (-3.8% YoY) along with JV. The drop in production was primarily on supply disruption from Cluster-8 & Mehsana Asset and loss of production from Ratna and R Series. The production is likely to get a leg-up with start of crude oil production from KG -98/2 (40000-50000 bbl/day), even as ageing fields continue to decline.

* Natural Gas production: Like the trend seen in crude oil production, ONGC’s NG production as well declined by 6% YoY during the quarter, clocking in at 57mmscmd (vs 61.2mmsmcd in 2QFY21). The decline in production was attributable to a) delay in gas production from UI field of KG 98/2, and b) lower production from Tapti Daman block and c) less than envisaged production from Dahej & Gandhar fields. The outlook for NG production, however, appears better with 2nd well in KG-98/2 commissioned leading to a production of 0.65mmscmd, and the same shall ramp up to 1mmsmcd with commissioning of a third well.

* OVL: The crude oil and NG production for OVL stood at 2.17mmt (+4% YoY) and 0.98bcm (-8% YoY). The revenue at Rs 46.3bn, stood higher by 16% aided by higher crude oil prices, but EBITDA at Rs 28bn (+7% YoY) were impacted by higher costs due to force majeure in Mozambique.

* Capex: ONGC has a planned capex of Rs 320bn for FY22 and FY23; also has plans of infusing Rs 50bn in OPAL.

Valuation

We maintain our REDUCE rating on ONGC, with a TP of Rs 145/sh, as we model for a crude oil realization of USD 65/bbl and INR/USD exchange rate of 75 in our projection period. Our TP of Rs 145/sh comprises of a) Rs 113/sh for the stand-alone domestic business, valued on DCF basis (Terminal value : Rs 0; WACC: 13%) , b) Rs 3/sh for OVL on EV/EBITDA of 4x FY23e and c) Rs 32/sh for investment in listed equities, valued at 20% hold-co discount to 3M average market price.

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