The government’s continuous disinvestment of its stake has also taken a toll on sentiment for the stock
Lower oil prices will mean that ONGC’s price realizations will suffer
Shares of Oil and Natural Gas Corp. Ltd (ONGC) fell around 1.5% on Wednesday to touch a multi-year low, while the Nifty 50 index gained 6.6%.
“ONGC’s one-year forward EV/ Ebitda is currently two standard deviations below its 12-year average. Such low valuations were last seen during the global financial crisis in 2008," said Amit Shah, head of India equity research at BNP Paribas India. Standard deviation measures the variations from average in a data set. EV is enterprise value. Ebitda is earnings before interest, tax, depreciation and amortization.
On Tuesday, Moody’s Investors Service downgraded ONGC’s local and foreign currency issuer ratings from Baa1 to Baa2. The agency said the downgrade indicates that the company’s credit metrics will weaken beyond the tolerance level for its ratings if oil prices remain low.
The concerns are not unfounded. So far in 2020, Brent crude prices have dropped 59% to $27 per barrel. The worry is that a quick recovery in crude prices appears difficult in the near future, considering that global oil markets are expected to clock a surplus. Additionally, the Covid-19 outbreak is affecting oil demand.
Lower oil prices will mean that ONGC’s price realizations will suffer. Accordingly, analysts are trimming earnings estimates for FY21. Of course, the extent of the earnings impact depends on how long oil prices remain low.
“In our view, a rebound in global crude prices and/or review of domestic gas pricing formula will be crucial for any improvement in earnings visibility and stock performance in the near term," said analysts at Kotak Institutional Equities in a report on 17 March. According to the broker, ONGC’s stand-alone earnings from domestic businesses, including other income, break even at a crude price of $32-33 per barrel.
Further, the earnings outlook is not the only worry for ONGC investors. The government’s continuous disinvestment of its stake has also taken a toll on sentiment. “Apart from the sale of the 7th tranche of the CPSE Exchange Traded Fund (the CPSE ETF sales for ONGC has been one of the biggest factors for shareholder value erosion in our opinion) ONGC reported weak production numbers for 3QFY20," said a BNP Paribas report on 25 March.
Moody’s Investors Service said: “ONGC’s cash reserves, which provided protection against an oil price decline in 2016, have been depleting over the last three years because of high dividends, share buyback in 2019, and its acquisition of Hindustan Petroleum Corp. Ltd."
Against this backdrop and despite lower valuations, triggers in favour of an outperformance appear limited for the ONGC stock.