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KG D-6 production under pressure
As per recent media reports, Reliance Industries Ltd (RIL) is struggling to maintain
its gas production at its guidance level of 60 million standard cubic meter per day
(mmscmd; including 8mmscmd of associated gas from MA oil field) from its flagship
Krishna Godavri (KG) D-6 field. Due to reservoir complexities the production level
has now declined to 46mmscmd, which is 21% lower than the Q2FY2011 production
level of 58mmscmd. RIL is evaluating the reservoir characteristics and clarity on
the KG D-6 production ramp-up will come over the next two-three quarters.
Impact analysis: Earnings downside risk of 2.5% in FY2011 and of 2% in FY2012
On account of pressure on sustainability of the KG D-6 gas production, we see risk
to our FY2011 and FY2012 earnings estimates. We estimate a downside risk of
2.5% in FY2011 and that of 2% in FY2012 to our earnings per share (EPS) estimates
for RIL on the assumption of lower gas production in FY2011 (of 55mmscmd; below
RIL’s guidance of 60mmscmd) and FY2012 (60mmscmd). We maintain our current
estimates as we await further clarification on the production guidance before
reducing our gas production estimate for the KG D-6 block.
Moreover, the continuous decline in KG D-6 gas production is a cause of concern
and has raised issues with regard the timely ramp-up of the gas production level
to 80mmscmd. This would further affect the gas supply scenario in India, as KG D-
6 is the major contributor to incremental supply of gas in India.
Sustainable petrochemical margins; GRM to improve
gradually
In the last few quarters RIL has positively surprised with
its strong performance in the petrochemical segment
(earnings before interest and tax [EBIT] margin of 14.6%
in Q2FY2011). We believe that RIL would sustain its
petrochemical EBIT margin on the back of strong margins
in the polyester chain business and a strong domestic
demand. The refining margins are also expected to witness
a gradual improvement mainly due to healthy light-heavy
crude price differentials at $3.5 per barrel.
RIL’s stock price has under performed the Sensex (RIL share
down by 11% versus Sensex declining by 8%) since
November 09, 2010 on the account of 1) media reports of
lower than expected KG D-6 gas production at 46
mmscmd, 2) pressure expected on petchem margin due
to excess ethylene capacity addition in the Middle East
and China and 3) overhang of selling of treasury shares
by the company. On the back of above uncertainties, we
do not see any near term trigger for the stock and hence,
we maintain our Hold recommendation on the stock with
a price target of Rs1,190 despite 21% upside to our target
price. At the current market price, the stock trades at a
price/earnings ratio of 13.6x FY2012 earnings and an
enterprise value/earnings before interest, depreciation,
tax and amortisation of 7.3x FY2012E.
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