Reliance Industries The re-investment conundrum; initiate with IN-LINE says Standard Chartered

We believe Reliance Industries’ (RIL) search for reinvestment
opportunities commensurate with its size is the
key factor constraining stock performance. We don’t see
that changing anytime soon despite the ongoing projects.
 The refining outlook remains subdued even as petchem is
impacted by capacity additions.
 We initiate coverage with below-consensus earnings and
IN-LINE rating with a price target of Rs1,100, based on
average of SOTP valuation and 14x FY12E EPS.


Lack of proportionate re-investment options – RIL has
outperformed during periods of high investment and underperformed
during cash-generation years. Most notable was
during FY06-09, which had negative FCF although stock
performance was also aided by the strong refining cycle.
Investors have rewarded RIL during the investment phase given
its track record of identifying large value-accretive projects and
executing them well. At times, it has also been aided by
innovative structuring, viz., Reliance Petroleum (RPL) listing.
This is absent now as RIL searches for “organic” investment
opportunities proportionate to its operating cash flow (US$24bn
over FY11-13E).
Refining: The long road – Given the capacity expansion
planned by Asian refiners and moderate demand recovery in
developed markets, we expect margins to remain below
average. Our Singapore gross refining margin (GRM) forecast
for 2010 and 2011 is US$4.00/bbl for both years. We estimate
RIL’s GRM at US$7.9/8.4/9.1 for FY11/12/13E.
E&P: Surprises have to come beyond D6 – We believe that
D6’s production profile and reserve upside (including D3) is in
the price. Any further discoveries (especially in MN-D4) will be
critical in providing further visibility as well as opening up reinvestment
opportunities (although development projects will
have long gestation periods).
Valuation: Price target of Rs1,100 – Our price target is based
on the average of SOTP valuation (Rs1,045) and PE of 14x
FY12E (ex-treasury), i.e., Rs1,144. Upside risks: discovery in
D4, D6 gas price revision and significant recovery in refinery
margins. Downside risks: rupee appreciation, cash deployment
in non-related businesses and downturn in petrochemicals.