Why 2020 Could Be The Best Year For ONGC Stock In More Than A Decade

Shares of Oil and Natural Gas Corporation Ltd. are estimated to rise as much as 45 percent this year, according to the average of 12-month analyst targets compiled by Bloomberg. That will be the highest gains since 2009 and the best returns among its peers in the S&P BSE Oil and Gas Index.

To be sure, the stock hasn’t lived up to analysts’ expectations seven times in the last 11 years. And it declined in the last two years on concerns of having to share the government’s subsidy burden, falling crude oil prices, a decline in output, and an increase in debt after the purchase of the government’s stake in Hindustan Petroleum Corporation Ltd. There is also an overhang due to the possibility of ONGC participating in the Bharat Petroleum Corporation Ltd.’s divestment.

Yet, analysts remain bullish not only because of its lower valuation but also on the back of its strong fundamentals.

Here’s why analysts think ONGC may not disappoint in 2020:

Stable Crude Prices

A higher crude price aids ONGC’s fundamentals. In 2019, Brent crude averaged around $64.12 for a barrel, while in 2020 the prices are expected to remain stable at $65.14 per barrel, according to Bloomberg estimates. Crude is around $68 a barrel but, according to Goldman Sachs, ONGC’s stock is pricing in Brent at $45. That leaves room for the upside.

Easing Subsidy Concerns

ONGC hasn’t had to share the government’s subsidy burden since financial year 2015-16. Investors, however, remained concerned due to higher crude prices and lower budgeted petroleum subsidy. A shortfall in money earmarked for kerosene and liquified petroleum gas subsidy increases the risk of the explorer having to share it.

In FY19, when crude averaged around $70.86 per barrel, the petroleum subsidy stood at Rs 24,900 crore. For FY20, the government has budgeted Rs 37,500 crore even though crude has averaged lower at $64.4 per barrel for more than nine months. Prices of subsidised petroleum products—kerosene and liquified petroleum gas—also rose in the last six months, negating the possibility of ONGC shouldering the burden.

Expected Increase In Volumes

ONGC’s volumes contracted in the last eight quarters due to a high base, project delays and an extended monsoon which disrupts drilling activities. The explorer, however, expects the trend to reverse in the second half of the ongoing fiscal and in the next financial year. The pace of decline also slowed in the past four quarters.

Production volumes would grow on the back of contributions from new projects and post-monsoon pick-up in activity, the company had said in a conference call after the second-quarter earnings. Along with this, the KG-98/2 basin is expected to come on-stream from FY21, boosting gas volumes which had declined in July-September—the first time in 13 quarters. The gas will be eligible for deep-water pricing—nearly two times the current rates— increasing the company’s revenue.

Potential Deregulation of Gas Prices

The Indian government revises prices of the domestically produced gas every six months. The formula factors in market-linked prices of natural gas in the U.S. (Henry Hub), the U.K. (New Balancing Point), Canada (Alberta Gas) and Russia (Russian Natural Gas).

ONGC, according to ICICI Securities, would benefit if gas prices are deregulated. The stock would become a hedge against investment in city gas distribution companies as it would gain the most from free pricing, the brokerage said.

Improving Payout To Shareholders

In the last nine years, ONGC has on average paid 40 percent of its earnings as dividend. That could rise as analysts expect the company’s dividend yield—ratio of annual dividend to share price—to improve to 6.6 percent and 7 percent in the ongoing and the next financial year, respectively, from 5.2 percent in FY19.

The company, however, is yet to announce any dividend in FY20.

Cheaper Than Global Peers

Shares of ONGC declined 33 percent over 2018 and 2019 despite a growth in earnings. That has made the stock cheaper. It trades at 5.1 times its estimated one-year forward earnings—a discount of 39 percent to its five-year average. It also has the lowest valuation among global oil explorers with a market capitalisation is at least $10 billion.