Ris­ing oil prices to fuel ONGC, Oil In­dia earn­ings


Resource Digest - - CONTENT -

Ris­ing de­mand and geopo­lit­i­cal ten­sions have led to a rally in crude oil prices, which have touched two-year highs. With Brent crude oil at $59-60 a bar­rel, the prospects of up­stream public sec­tor oil pro­duc­ers such as Oil and Nat­u­ral Gas Cor­po­ra­tion (ONGC) and Oil In­dia Ltd (OIL) have got a boost. An­a­lysts had al­ready in­creased their earn­ings es­ti­mates about a month back, but with oil prices gain­ing fur­ther and the ru­pee slid­ing, there is more up­side for earn­ings. A weak ru­pee will in­crease realisations for the com­pa­nies.

Street sen­ti­ment for oil­pro­duc­ing com­pa­nies was im­pacted when Brent oil prices de­clined to lows of about $44 a bar­rel in June 2017, a sig­nif­i­cant fall from $58 a bar­rel lev­els in Jan­uary 2017. The share price of both ONGC and Oil In­dia had seen their one-year lows in June-july this year. How­ever, as the Brent started gain­ing there­after, Oil In­dia has seen a re­bound of al­most 37 per cent, while ONGC has gained 9-10 per cent from their re­spec­tive lows. The lower gain for ONGC can be at­trib­uted to some con­cerns re­gard­ing its ac­qui­si­tion of Hin­dus­tan Petroleum (HPCL), its fund­ing and po­ten­tial eq­uity di­lu­tion. But, these should ease go­ing for­ward as clar­ity emerges, as the ac­qui­si­tion is ex­pected to be earn­ings ac­cre­tive for ONGC.

The news is also pos­i­tive for Cairn In­dia, which is now a sub­sidiary of Vedanta. The dy­nam­ics for Vedanta, the nat­u­ral re­sources ma­jor, how­ever, are dif­fer­ent as it has been ben­e­fit­ting from ris­ing base metal prices too. Nev­er­the­less, with ris­ing crude prices, Cairn In­dia’s con­tri­bu­tion to rev­enues and op­er­at­ing prof­its of Vedanta at 12 and 6 per cent, re­spec­tively, dur­ing the June quar­ter can rise fur­ther. The share price gain could, how­ever, be re­stricted as the share-swap ra­tio for merger of Cairn with Vedanta has al­ready been fixed.

The im­pact, though, will be more pro­found for the two PSU oil and gas ma­jors. While ONGC and Oil In­dia re­main in a sweet spot with gov­ern­ment re­forms on fuel pric­ing lead­ing to re­duced sub­sidy bur­den, ris­ing oil prices will drive earn­ings fur­ther. For ONGC, the out­look has been im­prov­ing with ex­pected rise in oil and gas pro­duc­tion too. Though stand­alone do­mes­tic out­put from its own fields dur­ing FY17 was flat, the pos­i­tive news is that ONGC has re­versed the de­clin­ing crude oil pro­duc­tion trend. Gas pro­duc­tion, on the other hand, had in­creased 4.3 per cent to 22.09 BCM ( bil­lion cu­bic me­tre) dur­ing FY17, its first in­crease in past four years. An­a­lysts now ex­pect a 10-15 per cent per an­num in­crease in gas pro­duc­tion mov­ing for­ward. The June quar­ter has al­ready seen gas out­put rise 10.6 per cent year-on-year for ONGC.

Im­prov­ing prospects have led an­a­lysts to up­grade their earn­ings es­ti­mate for the com­pa­nies. Credit Suisse, for in­stance, had re­vised up­wards Oil and Nat­u­ral Gas Cor­po­ra­tion’s FY18/19 earn­ings by four and three per cent, re­spec­tively, on Septem­ber 7, on the back of higher vol­umes. The bro­ker­age said it stayed pos­i­tive on ONGC due to ro­bust vol­ume mo­men­tum, con­tin­ued sub­sidy re­duc­tion, and about 30 per cent in­crease in gas prices. With crude prices hav­ing moved up since then, Jef­feries on Wed­nes­day as­sumed cov­er­age on ONGC with a ‘buy’ rat­ing. The bro­ker­age ex­pects a 14 per cent com­pounded an­nual growth in the oil ma­jor’s earn­ings dur­ing FY18-21 as Brent rises to $65 a bar­rel. The HPCL ac­qui­si­tion, likely Eps-ac­cre­tive, is an over­hang, but with di­lu­tion to ONGC’S fair value be­ing mod­est and in any case, with the stock 20-50 per cent cheaper than peers, there is ad­e­quate cush­ion, it add. Jef­feries has a tar­get price of ~200 for the stock trad­ing at ~170 lev­els now.

For Oil In­dia, the trig­ger of im­prov­ing oil prices is cru­cial, con­sid­er­ing that it had been see­ing earn­ings cuts ear­lier due to prospects of flat­tish pro­duc­tion. An­a­lysts at Sharekhan had cut their FY18 and FY19 earn­ings es­ti­mate for Oil In­dia Ltd by 15 per cent in July look­ing at the oil price de­clines. Hence, the re­bound in crude prices bodes well for Oil In­dia. Jef­feries has also as­sumed cov­er­age on Oil In­dia, with a tar­get price of $65 for the stock that closed at $49 on Wed­nes­day. The bro­ker­age says that Oil In­dia (en­ter­prise value to Ebitda of 3.6x FY19) is 15 per cent cheaper than ONGC.

The only risk, apart from fall in oil prices, is if the gov­ern­ment tin­kers with oil pric­ing mech­a­nism and re­forms in an un­favourable man­ner.

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