CLSA retains buy on GAIL, sell rating on ONGC

Mumbai: CLSA has retained buy rating on GAIL and sell rating on Oil & Natural Gas Ciro as they believe volume growth, earnings surprise potential and return ratios are better for GAIL. The foreign brokerage has a target price of Rs 125 on GAIL and a target price of Rs 55 on ONGC. ET takes a look at reasons behind CLSA's 'sell ONGC, buy GAIL' recommendation:

1. Crude oil price: According to CLSA, both CLSA and GAIL are positively leveraged to the crude price but ONGC is pricing in an over $50 per barrel brent price even as futures suggest a sub-$45 per barrel price for the next two years. GAIL offers a 20% upside at a spot Brent of $41 per barrel.
2. Gas Price: The domestic gas price is set to be cut by 25% by September, which is a big negative for ONGC but GAIL is a consumer of this gas and will benefit because of lower input costs, said CLSA.
3. Volumes: CLSA said the start of new pipelines and a 50% increase in domestic gas production over the next three years will drive up volume for GAIL’s flagship gas transmission business. ONGC’s legacy field continues to see high decline rates and this will keep production growth highly uncertain in the near-term even as crude realisations are depressed, it said.
4. Earnings surprise potential: Gas trading is an area of concern for Gail but performance in the fourth quarter and commentary about the June quarter suggest GAIL’s hedging strategy should limit big losses in gas trading. CLSA said in ONGC's case, it is possible that consensus does not fully appreciate the upcoming gas price cut.
5. Return ratios: The brokerage expects ONGC's return on equity in FY22 to be below 4%, despite factoring in a crude price similar to the futures curve. The brokerage said GAIL's FY22 return on equity would be much better at 10%, even after ignoring the chances of upgrades on gas trading.
6. Regulatory reforms: CLSA said natural gas being brought under the ambit of GST will be a much smaller boost for ONGC but GAIL could benefit from increased demand for gas.
7. Equity share supply overhang: Fiscal challenges for the government may force more aggressive stake sales in PSUs via ETFs and the government has headroom to sell in ONGC (60.4% stake in ONGC vs 52.1% in GAIL) leading to a big equity share supply. On the other hand, GAIL has not been mentioned as a candidate for stake sale.
8. Valuations and Dividend: While GAIL is trading well below average valuation whereas ONGC is trading at over 1 standard deviation of its average on its EPS estimate. GAIL's dividend yield is much more attractive than ONGC's, said CLSA.