HSBC downgrades ONGC to ‘reduce’ on falling oil prices, operational challenges, predicts 22% fall to ₹230

HSBC has downgraded Oil and Natural Gas Corporation (ONGC) to ‘Reduce’ from ‘Hold’ on concerns about falling oil prices and operational setbacks that have exposed risks to the project’s earnings and profitability. The brokerage has set a target price ₹230 for oil and gas stocks, implying a potential downside of more than 22 percent.

HSBC cited various challenges, including falling production volumes, delays to key projects and increased capital expenditure on green energy ventures. These factors, combined with volatility in oil prices, led to a cautious outlook for the company in the near term.

Stock price trend

The stock is up about 60 percent over the past year and 44 percent in 2024 YTD. Oil and gas stocks lost more than 10 percent in September after falling 1 percent in August. They had previously risen 22 percent in July and nearly 4 percent in June. They corrected 6.5 percent in May after four straight months of gains. They were up 5.5 percent in April, 1.3 percent in March, 4.5 percent in February and 23.5 percent in January.

Currently listed on ₹295.35, the stock is more than 14 percent off its peak ₹344.60, reached in August 2024. Meanwhile, it has risen more than 64 percent from its 52-week low ₹179.80, recorded in October last year.

Main reasons for the rating downgrade

ONGC Earnings Concerns: According to HSBC, ONGC’s earnings are largely dependent on production levels rather than oil prices, as government policy limits the realization of oil prices to $75 per barrel and gas to $6.50 per mmbtu. As oil prices fall below this threshold, HSBC warns that ONGC faces significant downside risks. There is no lower bound on oil prices under current policy, making ONGC vulnerable to further price declines, which could impact the profitability of greenfield projects and enhanced oil production. This assessment is consistent with HSBC’s broader view of the global oil market, as noted in a previous report by analyst Kim Fustier.

Production problems and delayed projects: ONGC is also grappling with declining production volumes, especially from its old oil fields such as the Western High field, which was discovered in the 1970s.. Despite efforts to boost oil production, production continues to decline. In addition, the KG-DWN-98/2 field, considered one of ONGC’s most promising new assets, has faced delays and lowered production guidance. HSBC said ONGC has missed its production targets for next year, raising concerns about its ability to maintain steady production.

Increased investment and focus on renewable energy sources: ONGC’s capital expenditure is expected to increase, especially as the company shifts to renewable energy. In 2024, ONGC began its green energy transformation by acquiring PTC’s renewable assets and is currently bidding on Ayana Renewable Power. The company has committed ₹970 billion by 2030 to create 5 GW of renewable capacity. While this transformation marks a positive long-term change, HSBC has raised concerns about the potential strain on ONGC’s core business in the near term.

Poor results of subsidiaries: HSBC also noted weaker performance of ONGC subsidiaries, particularly Hindustan Petroleum Corporation Limited (HPCL) and Mangalore Refinery and Petrochemicals Limited (MRPL), which have historically contributed significantly to ONGC’s earnings. Declining refining margins at these subsidiaries could impact ONGC’s ability to pay dividends, a key value driver for the company.

Valuation and Dividend Focus

Despite the challenges, HSBC said ONGC remains relatively cheap compared to other state-owned subsidiaries (PSUs) and global oil giants. However, the brokerage attributed the discount to weak earnings growth expectations and high carbon emissions associated with ONGC’s traditional exploration business. HSBC believes ONGC’s pivot towards renewable energy justifies a higher valuation than before, although earnings growth is expected to remain sluggish in the near term.

HSBC has valued ONGC using a dividend discount model as the brokerage believes that the government’s actions have a major impact on the company’s cash flows and dividends. While the shift towards green energy is a positive long-term strategy, it is expected to take some time to materially boost earnings. In the meantime, dividends remain the most reliable indicator of ONGC’s value, making them a key factor in the company’s overall assessment.

ONGC’s downgrade by HSBC reflects the company’s challenges amid falling oil prices, falling production and rising capital expenditure. While the shift to renewable energy offers a glimmer of hope for long-term growth, the near-term outlook remains challenging. ONGC’s ability to navigate these headwinds, maintain dividend payments and navigate the transition to green energy will be key to its future performance.

Disclaimer: The views and recommendations presented above are those of the individual analysts or brokerage firms and not Mint. We recommend that investors consult certified experts before making any investment decisions.