The cess on crude oil has been raised from R2,575 per tonne ($6.9/bbl) to R4,635 per tonne ($12.4/bbl) in the Budget. It means a cut in ONGC’s FY13-14 EPS by 11%. We have also cut ONGC’s purchasing order (PO) by 17% to R298 a share from R358 a share earlier. ONGC’s revised PO implies 9% potential upside. We downgrade ONGC to neutral given the hit from the rise in cess and also as hope of reforms are fading after the recent state election results.
Cess would increase on production from ONGC’s nomination blocks and the pre-NELP Rajasthan block. The increase in cess on crude oil by 80% means a cut in ONGC’s FY13-14 EPS by 11%. If there is no diesel price hike or only a modest hike, ONGC’s FY13 EPS is likely to be lower year-on-year. Share in subsidy of ONGC and its upstream peers is another crucial factor, which will influence its earnings outlook.
ONGC’s fair value is down by 7% to R332 a share due to the rise in cess on crude. ONGC trades at a discount to its fair value when there is no progress on reforms, there is uncertainty on subsidy sharing and earnings outlook is poor. We are sceptical on reforms in the remaining two-year term of this government. When there is no progress on reforms risk of adverse subsidy sharing also rises. We have therefore fixed ONGC’sPOat 10% discount to its fair value at R298 a share.
Hefty hike in subsidised products or a steep fall in oil price and favourable subsidy sharing will improve earnings outlook and make us bullish. Sharply higher oil price and adverse subsidy sharing would make us bearish on ONGC.
Upstream share in subsidy was 37.9% in 9M FY12.
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