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Our Take:

ONGC is the country’slargest oil and gas producer with a share of nearly 73% in India’s total production of crude oil and natural gas (including share of JVs). It is also a significant producer of value-added products such as liquefied petroleum gas (LPG), superior kerosene oil (SKO), naphtha and C2/C3. The company has developed significant onshore and offshore production facilities, subsea and land pipelines, gas processing, drilling and work-over rigs, storage facilities and other infrastructure located throughout the principal oil and gas-producing regions of India.

ONGC drilled 100 exploratory wells in FY21 as compared to 500 drilled in FY20. It produced 1.17mmboepd of O&G in FY21, had proved reserves of around 7.0 billion barrels of oil equivalent ((boe) including 4.5 billion boe in India) and reserve life of around 15 years. The government has proposed a detailed action plan to boost the dwindling oil and gas production of ONGC that includes hiving off noncore businesses into separate companies, monetizing existing infrastructure, decentralization of decision-making on operational matters and partnerships with private energy majors. ONGC could bring in technically sound private partners for about 66 major fields that contribute over 95% of the domestic production.

ONGC may explore creating separate entities for drilling, well services, logging, work-over services and data processing entities. In line with the Atmanirbhar Bharat policy, the government has decided to reduce India’s over-reliance on imported oil. It has set production targets of 40 million metric tons (MMT) of crude oil, and 50 billion cubic meters (BCM) of gas by 2023-24 where ONGC is tasked to contribute 70%. Thus, restructuring proposals could help to boost ONGC’s output. ONGC has completed various aggressive investment plans in the past and made E&P expenditure of about Rs 1,50,000crin last 5 years.

ONGC is planning for capex of Rs 29,800 crore in FY22 to boost oil and gas output. Capex in FY22 is expected to be funded partially from debt and internal accruals. The company expects to maintain its production dominance, contributing >65% of India’s projected output in next three years. ONGC is given a target to achieve 28 MMT of oil and 35 BCM of gas production by March 31, 2024. Oil prices have climbed on hopes of demand recovery as vaccine roll-outs pick up pace. Crude Oil (WTI) climbed sharply by 83.5% YoY and 11.6% MoM to US$ 73.3/bbl.

Higher crude oil prices lead to higher realization for ONGC and help shore up its profitability. Apart from this, Natural gas has rallied sharply in the last few weeks and momentum could be continue in the near to medium term. Natural Gas price is at US$ 5.02 /mbtu, which is up by 145% YoY and 30.2% MoM. The annual demand is expected to hit pre-pandemic levels in 2022, according to the International Energy Agency (IEA). This is spurred by the return of vehicular traffic in most of the major countries in the world as well as the improving overall economic outlook.

Also the CNG and piped cooking gas prices in cities such as Delhi and Mumbai may be hiked by 10- 11% next month which is a positive trigger for ONGC. The government, using rates prevalent in gas-surplus nations, fixes the price of natural gas produced by ONGC from fields given to them on nomination basis, every six months. The next review is due on October 1 and a big hike in APM gas prices is expected in Oct 2021 and in April 2022 which could benefit ONGC in a big way.

Valuation & Recommendation:

ONGC enjoys a dominant market position in the domestic crude oil and natural gas production business with large proven reserves, globally competitive cost structure, and stable performance of its subsidiary ONGC Videsh Ltd. (OVL). Any value unlocking from subsidiaries and other investments & lower holding company discount on investments can be positive for the stock.

The company also has excellent financial flexibility arising from its moderate gearing, large liquid investments, its significant sovereign ownership and strategic importance. However, subdued oil prices, low domestic gas prices and high dividend payout could impact its cash accruals going forward. Oil prices have recovered, trading at five year high levels and Gas prices are trading at 15 year high. ONGC is among the cheapest global upstream companies offering attractive dividend yield.

Every $1/barrel increase in crude oil prices could add Rs.4.5-5 per shares to the fair value and every $0.5/mmbtu of gas increase could add to Rs.8.5-9 per share. Investors could buy at CMP and add more on dips in Rs. 121.5-123.5. Base case fair value of the stock is Rs 149 (6.5xFY23E EPS plus current value of listed investments after 30% haircut) and the bull case fair value of the stock is Rs 163 (7xFY23E EPS plus current value of listed investments after 30% haircut) over the next 2 quarters. At the CMP of Rs 137.75 the stock trades at 5.85xFY23E EPS plus current value of listed investments after 30% haircut.

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