BNP Paribas on Reliance Industries: In underperformance limbo

Re-rating some time away
In early 2010 we switched to a market weight position on Reliance Industries (RIL) after being sellers of the stock for a large part of 2009. Since our upgrade to HOLD in our report “Refining Bottom in
Sight”, dated 17 February 2010, shares of RIL have gained 1.2% vs Sensex’s 25.1%
gain and BSE Oil’s 0.6% gain. While we did not expect any outperformance, the
magnitude of underperformance has surprised us. We believe the
underperformance started with the forayinto telecom and further weighed on the
stock due to the INR10.21b investment in EIH Ltd and delays in KG-D6 gas production. We still do not recommend an overweight position on the shares and believe a good time to revisit
RIL could be towards the end of the year or early next year as we get to
see some drilling results from D3 and D9. We continue to expect a
refining recovery in the second half of next year and reiterate that while
we believe that refining has bottomed, we see little reason for it to move,
barring the occasional spikes.
We lower our 2QFY11 EPS estimates by 4%
Our 2QFY11E EPS declines by 4% to INR15.10 (PAT of INR49.4b) as a
result of a shutdown in gas production at the Panna-Mukta field, sudden
decline in MA oil production and also slight weakness in refining post the
strength in July-August 2010. We expect blended refining margins at
USD8.00/bbl, slightly below our previous estimate of USD8.25/bbl. Our
checks with Middle East petrochemical producers indicate that pricing
may not decline at the same pace as expected, as supply remains
staggered. We believe consensus estimates will come down as delays in
gas production and an indifferent refining environment continue.
Range-bound in the near term; good for accumulating in
phases for long-term value
We reiterate our HOLD rating on RIL and retain our SoTP-based TP of
INR1,077/share. Our FY11E EPS estimates decline by 2.3%, adjusting
for lower PMT gas and MA oil production. We recommend investors to
accumulate the shares on dips (from a long-term perspective) as we see
limited downside from current levels. However, we do not expect material
outperformance in the near term as the delay in gas production and
continued flatness in the refining environment, combined with increasing
petrochemical capacity, will likely weigh on the shares. Downside risks:
Weaker-than-expected petrochemical business and further diversification
into non-core areas.