The Budget brought cheer to upstream oil and gas companies such as Reliance Industries Ltd (RIL) and Oil and Natural Gas Corporation (ONGC) on multiple fronts. While moving the oil and gas exploratory activities from the profit-sharing to a revenue-sharing model and expedition of shale gas exploration activities is positive, the Street is awaiting clarity on the investment recovery under the proposed revenue-sharing system. The mention of a review in gas prices is also positive for both companies (Rangarajan Committee has recommended to raise it to $8 per mbtu from around $4.2 prevailing). Implementation of all these measures should improve both revenues as well as profit growth trajectories of both RIL and ONGC, believe analysts, most of whom are bullish on these stocks, given reasonable valuations.
Gas price revision finally
While the gas price rise will be a positive for all players and make production more lucrative, it should also attract more investments in the sector. "If the recommendations of the Rangarajan committee are implemented in toto, it could imply an increase in domestic Administered Price Mechanism (APM) and KG-D6 gas prices to $8 per mbtu and would be earnings-accretive for ONGC, OIL (Oil India Ltd) and RIL. Every $1 per mbtu rise in gas price increases the EPS of ONGC and RIL by Rs 2.4 and Rs 2 per share, respectively," says Ballabh Modani, oil and gas analyst at Religare Capital Markets. For ONGC, the gains are huge as gas accounts for a fifth of its standalone revenues and APM gas accounts for most of its total gas production.
"We estimate a net benefit of 29 per cent in ONGC's FY14 estimated earnings, if gas prices go up to $8 per mmbtu. Building in a higher share for upstream in subsidies (40 per cent) and higher respective shares for ONGC, the net upside is 19 per cent. Thus, ONGC's valuation can go up by Rs 54 per share," says Prakash Joshi, analyst at IDFC
Securities. For RIL, analysts estimate that gas price hike to $8 will positively impact its earnings by 10-12 per cent.
Another comforting factor for ONGC was that the government created reasonable provision for fuel subsidies for both FY13 (raised to Rs 97,000 crore) as well as FY14 (Rs 65,000 crore).
While analysts are estimating FY14 under-recoveries at Rs 113,200 crore, the exact amount could be lesser as diesel prices are being increased gradually. Thus, the government's fuel subsidy estimates for FY14 appears reasonable, believe analysts, who do not expect upside risks to ONGC's share of the subsidy burden. Also, diesel price de-regulation will push up ONGC's net crude realisations. Every dollar/ mbtu rise in net crude realisation will boost ONGC's earnings by about two per cent. Outlook
The ONGC stock is trading at reasonable valuations of 1.6 times FY14 estimated book value versus the five-year average of 1.9 times. Regular increase in diesel price (to bring it in line with market rates) and higher gas prices will act as key catalysts for the stock, going forward. However, uncertainty over domestic and international oil and gas production will be a key concern in the near term, believe analysts. While the company's production from KG basin is expected to grow meaningfully only by FY16, its international production from Sudan and Syria (26 per cent of overall production) remains uncertain due to political problems.
On the other hand, at 1.3 times FY14 estimated book value, RIL is trading at about 30 per cent discount to its historical average valuations. Apart from the expected rise in gas prices, RIL will also gain from higher capex in its core business of oil and gas exploration.
The core business' share in total capex is up from 35 per cent in FY11 to 80 per cent in FY13 so far. RIL is expected to spend about $28 billion (Rs 153,000 crore) in core business during FY13-17. As the core business enjoys higher margins and return on equity (compared to cash lying in the bank), this should boost its earnings, as well as return on equity over the next few years. While earnings growth in FY14 is expected to be around 10 per cent, analysts expect growth rates to pick up thereafter (earnings are estimated to grow 15 per cent annually over FY13-17).
"RIL's operating environment is improving across its core businesses, which should spur a renewed earnings upgrade cycle. RIL's refocus on capital employed, its lagging share price, and an all-time low foreign portfolio ownership prompts our upgrade to overweight," said Vinay Jaising, analyst at Morgan Stanley Research, in a recent note.