Reliance Industries: UW: Results in line but valuations stretched: HSBC

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Reliance Industries (RIL)
Down to UW: Results in line but valuations stretched
􀀗 Earnings broadly in line with our and consensus estimates
􀀗 We see gradual conversion of RIL from a growth stock to a
refining and chemical margins-driven cyclical stock
􀀗 Downgrade to UW from N, while increasing TP to INR1084
from INR1058


2QFY11 results were broadly in line with our estimate. Reported PAT of INR49.2bn
(+28%yoy and 1.5%qoq) was broadly in line with our estimates. However, investors who
were expecting some kind of corporate announcement are likely to be disappointed.
Refining margin was a tad lower at USD7.9/bbl versus our estimate of USD8/bbl. Robust
polyester chain performance riding on poor cotton produce from China and Pakistan
contributed to sequential growth of 7% in petrochemicals chain profit.

Qualitatively, the results point to downstream margins as future driver of the stock.
With uncertainty continuing on further ramp-up from the KG-D6 gas fields, we believe
investors will no longer consider RIL a defensive stock. We expect RIL to gradually turn
into a cyclical stock, which would be driven more by refining and petrochemical margins.
We estimate RIL will earn USD8.5/barrel refining margin over the rest of FY11 and FY12
(USD7.6/bbl in 1HFY11). Our petrochemical margins are in line with the latest CMAI
forecasts. Therefore, we believe our estimates reflect adequate optimism on business
fundamentals. However, we are 8-15% below consensus.

Valuation. We continue to value the E&P business on DCF for producing properties and
reserves multiple for discovered fields. We also continue valuing the refining &
petrochemical segment on the average of EV/EBITDA and PE and investments on actual.
We are not changing the multiples. However, we have increased contribution of the
petrochemicals business to total EBDITA from 24% to 27% while decreasing that of E&P
from 37% to 34% due to lack of clarity on further ramp-up, while our total EBITDA
remains unchanged. Our new TP of INR1084 implies 1% potential return and we are
downgrading our rating to Underweight.

Risks and catalysts: Refining and petrochemical margins, gas production ramp-up from
D6 block and USD/INR exchange rate. If production from KG-D6 remains at current
levels, we find our target price would come down by INR60. A USD1/barrel change in
refining margin would change our TP by INR70, while a 10% change in petrochemical
margins would change it by INR30.