ONGC’s June quarter performance to keep already-low valuations in check

For state-run Oil and Natural Gas Corp. Ltd’s (ONGC’s) investors, the fact that the stock’s valuations are inexpensive, is perhaps, the only bright spot. The shares have declined about 20% so far this fiscal year.

In comparison, the Nifty 100 index has declined at a slower rate of 5.5%. As such, the company’s valuations at around five times estimated earnings for FY20 are terribly low.

However, with prospects appearing dull, lower valuations by itself are unlikely to enthuse investors. Analysts from Emkay Global Financial Services Ltd said in a report on 13 August: “We are underweight on ONGC due to lack of triggers, weak oil output, commodity volatility and a significant divestment overhang.”

Having said that, the undemanding valuation is one reason why many analysts have a positive view on the ONGC stock. Even as the stock may be pricing in the worst, the recently announced June quarter results aren’t bringing any brownie points.

In the June quarter, revenues fell by 2% year-on-year to ₹26,555 crore, lower than the consensus estimate of ₹27,440.60 crore. This was driven by a 7% drop in net crude oil realizations to $66.3 per barrel. Crude oil production declined by 5.6% and this was disappointing considering that the output had fallen by 4.7% in FY19 already. Even as gas production increased by 3.7% year-on-year, it declined by 2% compared to the March quarter.

Overall, earnings before interest, tax, depreciation and amortization declined on a year-on-year basis, thanks to higher operating expenses. Net profit fell by 4% to ₹5,904 crore.

Post-June quarter results, some analysts have trimmed their earnings per share (EPS) expectations. “We had cut EPS by 8-10% earlier in July, therefore, and trim FY20-21E EPS by another 2-4%,” said analysts from Jefferies India Pvt. Ltd in a report on 13 August.

The sharp decline in the share price suggests investors are baking in the concerns adequately. ONGC’s shares traded at a new 52 week low on Tuesday, ahead of its June quarter earnings announcement. Investors will do well to keep a tab on crude oil prices hereon, as realization remains relatively more crucial from the earnings point of view. Unfortunately, outlook on prices appears tepid. “We recently reset our second half of 2019-2020 Brent forecasts down to $58-60 a barrel amid softer demand-supply outlook,” pointed out Jefferies India. It also expected domestic gas prices to fall 10% in the second half of FY20, weighed down by lower prices in Europe.

In sum, ONGC’s valuations may be compelling, but its earnings outlook remains far from inspiring, and that should ensure the muted valuations sustain from a near- to medium-term perspective, at least.