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CLSA bullish on ONGC – BUY Target of Rs930

November 16, 2006

CLSA’s Research report on Oil & Natural Gas Corporation Limited.

With the crude oil prices coming off by USD 20 per barrel, ONGC has underperformed the broader market by c.10ppt over the last three months. ONGC is a beneficiary of a softening crude price environment, however, as industry under-recoveries (which ONGC shares) will come off faster. After a flat USD 23-24/bbl net realisation over FY05-07CL, we see unit realisations increasing in FY08CL even after we build in an adverse change in the subsidy sharing. In addition, ONGC’s 2-year 5.6% volume growth cagr will support a 14% earnings cagr over FY06-08CL. BUY. “

ONGC has only marginally gained from rising crude in FY05-07CL

“Crude prices have risen by 50% over FY05-07CL with a leveraged impact on most E&P bottomlines. The subsidy burden on ONGC, however, has kept its gross realisations in the USD 43-45/bbl range over the last six quarters. In fact, adjusted for the fixed and variable production taxes, net crude realisations have stayed at USD 23-24/bbl over FY05-07CL. While higher crude prices have helped profitability in overseas assets (Sudan-GNOP) and for its VAP portfolio, ONGC’s 11% EPS cagr over the last two years has rested primarily on volume growth and the legacy gas price increase in FY06.”

It stands to benefit from a falling crude price environment

“Falling crude prices, however, may lead to an uptick in ONGC’s realisations. With auto fuels priced at USD 60/bbl, under-recoveries will disappear at this threshold and overall retail under-recoveries will come off by USD 7 billion YoY to USD 5.5 billion in FY08CL. Even after building in an increase in upstream subsidy sharing (from 33% to 50%) and an even larger burden for ONGC (from 87% to 95% of upstream share), we find that net ONGC realisations could actually improve USD 1.8 per barrel YoY even as Brent averages USD 7 per barrel lower from FY07 levels. A status quo on subsidy sharing norms will increase realisations by a further USD 5 per barrel creating room for a 15% earnings upgrade.”

“ONGC has underperformed the market by 10ppt in the last three months on the back of poor investor sentiment towards E&Ps as crude prices collapsed by USD 20/bbl. This will start to change over the next few quarters as ONGC delivers steady growth even in a falling crude prices environment on the back of higher overseas volumes and a rebound in domestic production. With most other E&Ps at risk of earnings downgrades (consensus crude estimates are USD 5-6 per barrel above current prices), the differentiation should become stark.”

ONGC is a value play. ONGC will stand out with steady earnings growth.

“At 9x PE and 4% dividend yield ONGC is one of the cheapest stocks in India and at USD 5/boe, one of the cheapest in the global upstream space. Our upgraded target price of Rs 930 per share indicates a 7% upside. BUY.”

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