ONGC Rating ‘Hold’; Downside risks to oil price a concern

HSBC’s global oil & gas team sees near-term downside price risks to oil prices. This is alluded to in an anticipated conservative OPEC+ agreement supporting prices in the short term, but there is still much more spare capacity in OPEC+ than there is likely demand growth. There will be a need for continued OPEC+ restraint through the balance of 2021 and probably beyond, in our view. This may prove challenging if prices stay firm, while the group may face difficulty absorbing at least 1.5mbd more Iranian exports in the event of sanctions being lifted.

Much will continue to depend on Saudi oil policy but its leverage will remain high—even without the voluntary cut, its spare capacity should still be c2.5mbd in Q22021. Our 2021/2022 Brent forecasts remain at $56/b and $60/b. A $1/bbl change in the oil price from our current assumption impacts our FY22 earnings estimates by c3%.

Gas segment to drive growth in profitability: While growth in oil output is likely to remain subdued, we expect c7% CAGR during FY21-23 in gas output, driven by KG DWN 98/2, WO 16, Vashistha and other fields. We also expect APM gas prices to have bottomed out and as global prices have increased, we expect it will impact APM gas prices with a lag. Also, the new gas is market linked and with its share increasing, blended gas realisations for ONGC will likely also rise. A $1/mmbtu change in the gas price impacts our FY22e earnings by 20%.

Maintain Hold; raise target price to `130 (from `70).The stock currently trades at about 8x FY22e EPS which is the 10-year historical mean for ONGC, leaving limited upside for multiple expansion given possible risks to oil demand and any supply-related relaxations by OPEC+. However, ONGC can be a good dividend yield play as it offers an attractive dividend yield of 6.0% (FY22e-based). This should also provide downside protection to the stock price.

We value ONGC using a multiples-based sum-of-the-parts approach. We value ONGC’s core EPS at a 2022e PE of 8.0x (earlier 6.0x). Our new target multiple is based on the 10Y mean PE multiple (versus -1sd from the 10Y mean before), given reduced COVID-19-related risks and a recovery in oil prices. We value ONGC’s listed investments at a holding company discount of 25% to market value to factor in market volatility. We raise our TP to Rs 130 (from Rs 70) due to higher earnings from FY22 and our higher target valuation multiple.

Key upside risk: a sharp increase in crude price. Key downside risk: a fall in production.