ONGC, Oil India stocks rise: Post rally investors need to exercise caution

With the muted outlook for crude oil realisations and volumes, FY21 earnings may take a hit

ONGC and Oil India shares gained up to 1.7 per cent on Thursday as crude oil prices rose on the back of lower US oil inventories. The two stocks have gained 32-34 per cent from their March lows, as oil prices rebounded from under-$20 per barrel to over $40 now. Though market sentiment has improved and a recovery in oil prices bodes well for the state-owned oil and gas producers, investors need to be cautious.

The March quarter (Q4) performance has been weak, and the June quarter is likely to see the impact of the disruption caused by Covid-19. For FY21, too, analysts don’t expect significant growth in crude output, and are factoring in lower oil and gas prices. Hence, they expect a decline in earnings.

Though a global economic recovery bodes well for demand and, thus, oil prices, the risk of a second wave of Covid-19 can lengthen this recovery period. Moreover, production discipline among oil-producing countries holds the key for oil prices sustaining at higher levels.

 

 

For ONGC, valuations are still un-demanding, keeping some analysts positive, but others remain cautious. Kotak Institutional Equities believes the stock is already discounting crude prices recovering to $48. For Oil India, Nomura says, “While valuations are inexpensive, we do not see near-term catalysts, at present.”

ONGC, during Q4, had seen lower oil and gas realisations, a sharp jump in operating expenses, higher-than-expected DD&A (depletions, depreciation & amortisation) costs, and Covid-19 led impairments impacting its earnings. As its profit before tax declined 82 per cent, impairments worth Rs 4,899 crore led to a loss at the net level. Oil India, too, recorded impairments worth Rs 1,780 crore. While it reported a loss before tax, write-back of taxes helped Oil India post a profit at the net level.

For ONGC, crude oil realisations fell 21 per cent year-on-year to $49 a barrel in Q4 and the same may decline significantly in the June quarter, too. Analysts at Motilal Oswal Financial Services (MOFL) are factoring in the average Brent crude price of $40 (versus $61 in FY20) and expect production to remain at last year's levels in FY21. 

While analysts are positive on gas production rising 12 per cent, gas prices are 27 per cent lower than in FY20. Thus, analysts at Emkay, Kotak, Edelweiss, and Antique expect FY21 earnings for ONGC to decline by 26-63 per cent. For Oil India, too, HDFC Securities and MOFL expect a 52-54 per cent decline in FY21 earnings.