India Oil & Gas sector - Elara Capital

Subsidy sharing: Upstream to bear 1/3rd

Inevitable reversion to age-old sharing method comes in

The Oil Secretary, Government of India, has given some clarity on the subsidy sharing system post the de-regulation last month. As we argued in our note post the de-regulation, 'Some justice, finally', the Oil Ministry has gone back to its old sharing mechanism - upstream sharing one-third of the total under-recoveries and the Government accounting for at least 50%. However, there is a lack of clarity on the remaining burden. We believe the switch to the old sharing was unavoidable after the last month's de-regulation reforms as petrol and diesel would have had minimal losses for the upstream to bear. In that case, cooking fuel losses for the Government would have been unchanged, making the de-regulation a non-event for itself. Thus, passing on a portion of cooking fuel losses to upstream players was expected. The Oil Secretary has also pointed at FY11 under-recoveries of INR520bn while our estimate stands in-line at INR524bn.

Our Q1FY11 estimates to see 15-17% upside

Though, for the entire FY11, we had assumed the upstream to bear one-third of the total losses, for our quarterly estimates, we had factored in the upstream to bear auto fuel losses - mentioning that there will be a 15-17% upside to the bottom line of ONGC and Oil India (in case they share one-third of the losses). Despite this upside, we believe that Q1FY11 would be a weak start to a robust FY11 as Q1FY11 was subsidy heavy while the period - Q2-Q4 - would be a lot better due to much lower subsidies.

Medium term: Back PSU Oils, neutral on RIL, Cairn

For the next two quarters, we would recommend investors to back PSU Oils due to the Government's active stance on reforms. Though we see upsides of 5-7% for both ONGC and Oil India, considering broader market valuations, we would prefer Oil India over ONGC due to higher cash/market cap ratio and production growth prospects. For RIL, we do not expect any significant positive earnings surprise in the next two quarters. Thus the stock would stay subdued in the medium term, in our opinion. For Cairn, the CMP of ~INR316/share factors in crude prices of more than USD80/bbl, as per our estimates. Thus at such price and valuation levels, we would not be recommending any fresh positions for Cairn while we would be more comfortable around INR265-270/share levels as entry points.

Source : Equity Bulls

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