Kotak Sec: Downgrade Reliance- target Rs 1015

FY2012 is a lot closer than FY2015. We would advise investors to focus on downside
risks from current weak refining and chemical cycles, which far outweigh potential
upsides from higher gas prices in FY2015E. Implementation of IFRS in FY2012E and
DTC in FY2013E may also spring negative surprises. We maintain our REDUCE rating
and SOTP-based 12-month target price of `1,015.


Refining margins remain dismal—US$1/bbl lower refining margin impacts RIL’s EPS by `6
Singapore complex refining margins have plunged into negative territory and were at –US$1/bbl in
the recent week (see Exhibit 1). We expect refining margins to remain subdued over the next
12-18 months given a comfortable global demand-supply balance. We see significant downside
risks to earnings from weaker-than-expected refining margins. We model FY2011E and FY2012E
refining margins at US$8.5/bbl and US$9.5/bbl versus 1QFY11’s US$7.3/bbl. A US$1/bbl lower
refining margin impacts RIL’s FY2011E EPS by `6 and FY2012E EPS by `6.3.
Chemical margins have plunged—US$50/ton lower chemical margin impacts RIL’s EPS by `3.5
We highlight that polymer margins have corrected by 9-30% versus the high margins seen in
February 2010 led by (1) restart of troubled plants in Japan and Saudi Arabia and (2) start of new
chemical plants in India, Singapore and Thailand. We expect large new capacity additions to
continue through CY2010-11E (see Exhibit 2), which will likely result in subdued margins. We see
significant risk to our assumption of reasonably strong chemical margins for RIL (see Exhibit 3);
US$50/ton lower chemical margin impacts RIL’s FY2011E EPS by `3.6 and FY2012E EPS by `3.5.
Minimal upside from a potential gas price hike; we already assume a price increase anyway
A section of the street has speculated about a potential increase in the price of KG D-6 gas.
We note that any revision in gas prices will be applicable from FY2015E when the current pricing
formula is due for a review. We already model US$5.25/mn BTU gas price for RIL (all blocks)
starting FY2015E. We see a modest upside of `10 to our fair valuation even if prices are increased
to US$5.5/mn BTU. We would also highlight related issues such as (1) burgeoning losses of state
electricity boards and (2) increase in fertilizer subsidy, which rules out an out-of-turn price increase
in the short term, in our view.
Several other potential negatives looming large
We do not rule out further downside risk to RIL’s earnings and valuations emanating from (1)
implementation of IFRS from April 1, 2011, (2) implementation of the new Direct Tax Code (DTC)
from April 1, 2012, (3) lower-than-expected production of oil and gas and (4) non-availability of
tax exemption on gas production