Harshad Borawake (HarshadBorawake@MotilalOswal.com); +91 22 3982 5432

20 March 2014

Update | Sector: Oil & Gas

ONGC CMP: INR315 TP: INR385 Buy

Investors are advised to refer through disclosures made at the end of the Research Report.

Upbeat on gas price hike; ongoing policy reforms Likely production increase, lower subsidy to drive earnings

We met ONGC to get an update on operational outlook as well as ongoing policy reforms. Management continues to remain upbeat on scheduled gas price hike as well as ongoing diesel reforms and likelihood of subsidy reduction.

Ongoing diesel reforms (under-recoveries set to halve by FY16), proposed gas price hike (from 1 April 2014) and >4% CAGR (FY14-16E) in group production over the next two years are key positives, in our view.

If ONGC’s expectation of full gas price pass-through materializes, our base case EPS CAGR (FY14-16E) of 13% could reach 21%. Maintain Buy; our SOTP-based target price of INR385 implies 22% upside.

Upside potential to our FY15 gas price assumption: Scheduled doubling of gas price from 1 April 2014 to ~USD8.4/mmbtu will boost ONGC’s FY15E EPS by ~30%. Of the additional revenue from gas price hike, the government receives ~50% through levies and taxes. Hence, any additional subsidy burden on ONGC is unlikely. However, with clarity yet to emerge, we conservatively model gas price of USD6.3/mmbtu (only 50% pass through) from FY15 in our base case scenario to factor in likely subsidy towards Power/Fertilizers. If the full gas price benefit is passed to ONGC, then our FY15E EPS will further increase by ~16%.

Production to increase in near term; KG-DWN-98/2 to take gas production to 100mmscmd: ONGC expects standalone oil production to increase from 22.6mmt in FY14E to 24.9mmt, led by IOR/EOR and redevelopment of fields like D-1, B-193 and Cluster-7. ONGC has filed DoC (Declaration of Commerciality) for this field and is hiring consultants to file the FDP by end-2014. It expects gas production in 2017/18 from this field, with an estimated peak of ~30mmscmd, taking overall ONGC’s domestic gas production to 100mmscmd.

Gujarat royalty to be provided in balance sheet as deposits: In its interim order, the Supreme Court (SC) has directed ONGC to pay royalty to the Gujarat government on pre-discounted basis from 1 February 2014 (we estimate recurring impact of Gujarat royalty at ~INR1.7/sh) and has granted two months time to all respondents to file their responses. ONGC strongly believes that it is not liable to pay the royalty on gross basis. However, it would be paying the royalty in accordance with the SC’s interim order. Until the SC’s final ruling on the issue, ONGC would recognize this amount in its balance sheet as ‘deposits’.

Maintain Buy: We remain positive on ONGC due to the following: (1) likely increase in net realization due to lower subsidy, driven by continued diesel price hikes, (2) significant beneficiary of scheduled gas price hike from 1 April 2014, and (3) attractive valuations. The stock trades at 8.8x FY15E EPS of INR36. Our SOTP-based target price is INR385. Buy.

BSE Sensex S&P CNX 21,740 6,483

Stock Info Bloomberg ONGC IN

Equity Shares (m) 8,556

52-Week Range (INR) 353/234

1, 6, 12 Rel. Per (%) 9/1/-1

M.Cap. (INR b) 2,695

M.Cap. (USD b) 44.0

Financial Snapshot (INR Billion) Y/E March 2014E 2015E 2016E

Sales 1,793 1,947 2,032

EBITDA 593 674 750

Adj. PAT 260 311 337

Adj. EPS (INR) 30.4 36.0 38.9

EPS Gr. (%) 8.6 19.3 8.5

BV/Sh.(INR) 197 219 243

RoE (%) 16.4 17.3 16.9

RoCE (%) 14.3 14.8 14.6

P/E (x) 10.4 8.8 8.1

P/BV (x) 1.6 1.4 1.3

Shareholding pattern (%)

As on Dec-13 Sep-13 Dec-12

Promoter 69.2 69.2 69.2

Domestic Inst 10.5 10.6 11.2

Foreign 6.8 6.6 5.8

Others 13.5 13.6 13.8

Stock Performance (1-year)

200

250

300

350

400

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

ONGC Sensex - Rebased

ONGC

20 March 2014 2

Production to increase in long term as well as near term ONGC expects the standalone oil production to increase from 22.6mmt in FY14E

to 24.9mmt led by IOR/EOR and redevelopment of fields like D-1, B-193 and Cluster 7. We model domestic oil production (incl. JV) CAGR of 3.4% and gas production CAGR of 3% over FY14E-FY16E period, driven by IOR/EOR, redevelopment and new fields' development.

Key Fields which would lead the production increase in FY15 include 1. D-1 in Mumbai High (Oil): Production to increase from 18kbpd to ~32kbpd

and later to 60kbpd 2. B-193 cluster fields (Oil + Gas): Production to increase from 6kbpd to

24kbpd 3. Cluster 7 fields (Oil + Gas): Production to increase from 7kbpd to 17kbpd

KG-DWN-98/2 to take ONGC’s gas production to 100mmscmd by 2018 ONGC has filed DoC (Declaration of Commerciality) for this field with DGH and is

hiring consultants to file the FDP (Field Development Plan) by end-2014. Company expects gas production in 2017/18 with an estimated peak of

~30mmscmd, thereby taking overall gas production to 100mmscmd (v/s current production at ~65mmscmd).

In-place gas reserves are currently estimated at 200bcm (7tcf) and in-place oil reserves at 100mmt and development capex is estimated at USD9-10b.

The northern area discoveries (Oil + Gas) can be developed with available resources, but technological help will be required to develop southern area discoveries (primarily gas). We currently do not assign any value to this block.

Multiple successes in KG-DWN-98/2: Technological tie-ups and remunerative gas pricing would be critical for full monetization of the block

Source: Company FY13 Presentation, MOSL

ONGC

20 March 2014 3

Expect meaningful reduction in subsidy burden We expect the continued diesel price hikes will reduce the under recoveries by

~50% by FY16 to ~INR880b and in turn should lower the subsidy burden. While the management expects meaningful reduction in the subsidy, we

conservatively model reduction in subsidy by ~6% v/s 50% reduction in the under recoveries by FY16.

High subsidy burden and lower net realization makes many fields uneconomical. Hence, ONGC and Oil India has requested government to increase the net realization as it would also lead to higher production.

Further, we understand that the government is also working on a mechanism so as to provide higher realization to ONGC/Oil India. (Media reports of increasing net oil retention price to USD65/bbl v/s USD45/bbl now).

Despite likely ~50% reduction in the under recoveries, we conservatively model lower reduction in upstream subsidy

Source: Company, PPAC, MOSL

M&A focus to continue to reach production targets While OVL’s earlier deals have given significant returns partly helped by

significant rise in the oil prices, its recent acquisition performance is mixed with under performance in Imperial Energy but positive surprise in Mozambique through reserve upgrade (up 15%) post the purchase.

ONGC’s perspective plan targets 60mmtoe production from overseas assets with an interim target of 20mmtoe by 2020. Its recent buys in Azerbaijan and Mozambique are in-line with this target and expect the M&A focus to continue.

OVL Reserve Trend: While the 3P reserves have almost doubled since FY04, 1P reserves are largely flat (mmtoe)

Source: Company, MOSL

OVL Capex + Acquisition Trend: Expect recent discovered asset buys to increase 1P reserve numbers for OVL (USDb)

Source: Company, MOSL

ONGC

20 March 2014 4

Valuation and view We remain positive on ONGC due to (1) likely increase in net realization due to

lower subsidy driven by continued diesel price hikes, (2) significant beneficiary of scheduled gas price hike from April 1, 2014, (‘c) attractive valuations.

Key things to watch: (1) Continuance of diesel reforms, (2) Clarity on benefit of gas price hike, (3) Subsidy sharing and (4) Visibility on production growth.

Upside potential to our FY15 gas price assumption: We model gas price of USD6.3/mmbtu from FY15 v/s likely new gas price of USD8.4/mmbtu, to factor in likely subsidy towards power/fertilizer sector. However, if the full gas price benefit is passed to Oil India then FY15E EPS will further increase by 16%.

ONGC currently trades at ~40% discount to its global peers on EV/BOE (1P basis) and timely execution of diesel reforms and passing on of benefits of gas price hike could lead to stock's re-rating.

Implied dividend yield of FY15E dividend stands at ~4%. The stock trades at 8.8x FY15 EPS of INR36. Our SOTP-based target price for ONGC stands at INR385/sh. Buy.

ONGC: Key Assumptions Year End: March 31 (INRm) FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Exchange Rate (INR/USD) 45.8 47.5 45.7 47.9 54.5 60.6 61.0 60.0

APM Gas Price (USD/mmbtu) 2.0 1.9 3.9 4.2 4.2 4.2 6.3 6.3

Brent crude price (USD/bbl) 84.8 69.7 86.5 114.5 110.6 108.5 105.0 105.0 Production Details (mmtoe)

Domestic Oil Production (mmt) 27.1 26.5 27.3 26.9 26.1 26.2 27.4 28.1 Domestic Gas Production (bcm) 25.4 25.6 25.3 25.5 25.3 25.0 26.0 26.5

Domestic Production (mmtoe) 52.6 52.1 52.6 52.4 51.5 51.2 53.4 54.6 OVL Production (mmtoe) 8.8 8.9 9.4 8.8 7.3 8.3 8.9 10.0

Group Production (mmtoe) 61.3 60.9 62.1 61.2 58.7 59.6 62.3 64.6 Subsidy Sharing (INRb) 282 116 249 445 494 577 549 465

Oil Price Realization (USD/bbl) Gross 88.0 71.7 89.4 117.4 110.7 108.5 105.0 105.0 Upstream Discount 39.1 15.7 35.6 62.7 62.9 67.3 61.0 51.3

Net 49.0 56.0 53.8 54.7 47.8 41.2 44.0 53.7 Cons EPS Break-up (INR/sh)

EPS (Standalone) 18.9 19.6 20.4 26.8 24.5 25.1 29.0 30.9

EPS (OVL) 3.3 2.4 3.0 3.2 4.6 5.5 5.9 6.6 EPS (MRPL & Others) 0.9 0.6 1.1 0.4 -0.8 -0.1 1.1 1.4

EPS (Consolidated) 23.1 22.7 24.5 30.4 28.3 30.4 36.0 38.9

Source: Company, MOSL

SOTP based fair value at INR385/sh USDB INRB INR/sh Valuation method ONGC Domestic 36 2,258 264 DCF Based, WACC of 11.5% OVL 15 921 108 2P reserves @ USD5/boe (same as ONGC) Cairn India 2 109 13 DCF based; 25% discount Net (Debt) / Cash -6 -371 -43 Mozambique Block 4 269 31 At investment value

Listed Investments 2 109 13 MRPL, IOC, GAIL & Petronet LNG; 25% discount to our target/market price

Target Price 53 3,294 385

Source: MOSL

ONGC

20 March 2014 5

ONGC: Story in charts

Despite ad-hoc subsidy, last 10 yr EPS CAGR at ~10% (INR)

Source: Company, MOSL

Impressive RRR of >1 in last eight years

Source: Company, MOSL

Many of the development projects set to complete in coming quarters

Source: Company, MOSL

ONGC’s IOR/EOR projects are largely on track

Source: Company, MOSL

Expect domestic production uptick in coming years (mmtoe)

Recent acquisitions to lead OVL’s production growth (mmtoe)

ONGC

20 March 2014 6

Source: Company, MOSL Source: Company, MOSL

ONGC: Story in charts Expect under recoveries to halve by FY16E (INRb)

Source: Company, MOSL

Leading to increase in net realization (USD/bbl)

Source: Company, MOSL

Domestic gas price sensitivity to FY15E EPS and SOTP

Source: Company, MOSL

Healthy Oil to Gas reserve ratio (mmtoe)

Source: Company, MOSL

ONGC 1 Yr Fwd P/B Chart: Trading attractively at historically low valuations

Source: Company, MOSL

Attractive dividend yield, average payout of 40% (%)

Source: Company, MOSL

ONGC

20 March 2014 7

Annexure 1: Gas pricing in India The government, through the Cabinet Committee on Economic Affairs (CCEA), has approved (long awaited) the Rangarajan Committee's gas price formula. Media reports indicate that the implied new gas price is ~USD8/mmbtu v/s the current USD4.2/mmbtu. The formula will be applicable from 1 April 2014 (FY15) and will be valid for five years. Further, gas price revision will be on a quarterly basis. Formula proposed by the committee: PAV = {PIAV + PWAV} / 2 PAV = Sales price for domestic natural gas sales in India PIAV = Netback FOB price of Indian LNG term imports (excluding spot imports) PWAV = Weighted average of prevailing gas prices in global markets, based on: Henry Hub gas price in the US and total volume consumed in North America, National balancing point gas price in the UK and total volume consumed in Europe and Eurasia, and Netback price of Japanese LNG imports and total volume imported by Japan.

Applicability of the formula of Rangarajan committee The pricing formula will be effective from 1 April 2014 for a period of five years

and will be revised quarterly. The price for each quarter will be the trailing 12-month average price, with a lag

of one quarter (the price for April to June 2014 will be calculated based on the averages for the 12 months ended December 2013). Netback price = A-B-C, where A = Imported LNG price on netback FOB available from World Energy

Intelligence B = Liquefaction costs at the respective loading port (source) C = Transport cost.

Domestic gas price to rise to ~USD8/mmbtu from April 1, 2014 (USD/mmbtu) (A) Net-back pricing for producers who export to India

In USD/mmbtu Volume

(mmscmd) FOB Price

Liquifaction Cost

Treatment Cost

Net-back Price

Qatar (Long Term) 33.2 11.3 3.0 0.5 7.8 Qatar (Medium-term/Spot) 3.9 14.0 3.0 0.5 10.5 Others 14.0 14.0 3.0 0.5 10.5 Weighted average by India imports (A) 51.0

8.7

(B) Net-back for Japan imports / Market pricing at gas hubs in US and Europe

In USD/mmbtu Volume

(mmscmd) FOB Price

Liquifaction Cost

Treatment Cost

Net-back Price

Henry Hub (US) 1,978

3.8 NBP (Europe) 2,816

10.7

JCC linked (Japan) 256 16.0 3.0 0.5 12.5 Weighted average by consumption (B) 5,051

8.1

Simple average of above two methodologies (A & B) in USD/mmbtu 8.4

Source: Company, MOSL

ONGC

20 March 2014 8

ONGC is the largest beneficiary of the gas price hike

Source: Industry, Rangarajan Committee report, MOSL

On the customer front, Fertilizer is impacted the most

Source: Industry, Rangarajan Committee report, MOSL

Of the incremental revenues, Government earns the most

Source: Industry, Rangarajan Committee report, MOSL

Central government earns 41% of incremental revenues

Source: Industry, Rangarajan Committee report, MOSL

Key Timelines for Gas Pricing in India

Source: Industry, Rangarajan Committee report, MOSL

Prevailing gas prices in India (USD/mmbtu)

Source: Industry, Rangarajan Committee report, MOSL

ONGC

20 March 2014 9

Financials and valuation

ONGC

20 March 2014 10

Financials and valuation

ONGC

20 March 2014 11

N O T E S

ONGC

20 March 2014 12

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