Credit Suisse: RIL-OUTPERFORM- Continues to price in low return expectations

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��



● EPS (and return) estimates for RIL have steadily been falling over
the last 20 months, on margins and gas volume estimates.
● On CS HOLT®, RIL implies cost of capital returns if real assets
grow 8% (half of 20-year median, some of which will happen just
through cash accumulation). Conversely, with 0% asset growth,
return expectations (6.5%) are below 20-year median of 7.5%.
● Falling gas production has been an overarching concern recently,
but the decline should reverse with time. There are few signs yet
of any material downgrade to reserves / peak production at D6.
● Meanwhile, potential refining / petchem margin strength can help
improve returns. Global oil demand has surprised positively and
should outstrip refining capacity growth in 2011. Effective ethylene
utilisation rates are up on demand / shut downs, helping margins.
● Clarity on gas production outlook can then be a significant catalyst
for the stock, correcting the low / falling return expectation. While
difficult to time, the importance of gas to India and RIL means the
ambiguity should not sustain for very long. Maintain
OUTPERFORM.

Downgrades have lowered return expectations for RIL
Earnings estimates for RIL (FY11E and FY12E) have been falling
steadily over the past 20 months. They were perhaps too high to
begin with (hangover of the bull markets / high margin environments?)
and more recently due to disappointments in oil and gas production
volumes at KG D6. The RIL stock has lagged the market as a
consequence, and has traded at about 14x one-year forward EPS
since mid-2009. Due to the continuous downgrades, one-year forward
EPS estimates have been around Rs70-74 since September 2009.

Yet, expectations in the stock today are still fairly low
We use CS HOLT® to examine return expectations implied by the
stock today. If real assets for RIL grew 8% (half of 20-year median,
and some of which will happen simply through cash accumulation),
the stock implies returns will fall to cost of capital levels in five years.
Conversely, with 0% asset growth, return expectations (6.5%) are
below 20-year median of 7.5%.


Returns for a large part of EBITDA could improve
Refining and Petchem represented about 60% of EBITDA in 2Q FY11,
and will remain material even as gas / oil volumes increase. Global oil
demand has surprised on the upside (see CS note Raise to $85/bbl
on Better Demand, $80 LT, dated 13 December 2010) and should
outstrip refining capacity growth in 2011; spare capacity, though high,
should fall, beginning to help margins. Consensus estimates of RIL
GRM increase in FY12 over FY11 may not see large misses. Global
ethylene utilisation rates are high on strong demand / capacity shut
downs and have led to recent margin surprises. High cotton prices are
helping polyester segment margins. Petchem EBITDA run rates for
RIL are most likely above consensus estimates.

Clarity on gas volumes can be a significant catalyst
Falling oil / gas production at KG D6 have been a significant concern
recently – yet the company maintains LT peak production guidance of
89 mmscmd (D1/D3 + MA gas). Clarity on near-term gas production
outlook can then be a significant catalyst for the stock, correcting the
low / falling return expectation today. While difficult to time, the
importance of gas to India and RIL means the ambiguity should not
sustain for very long. Maintain OUTPERFORM.