Reliance Industries, It takes three to tango. : Kotak Sec,

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Reliance Industries  (RIL) 
Energy 
It takes three to tango. We see downside risks to RIL’s earnings and valuation from
weaker-than-expected performance of the E&P segment. We believe the stock is
already pricing in significant improvement in chemical and refining margins but largely
ignoring the problems relating to the E&P segment. In our view, concurrent
performance of all three segments is critical for stock performance; the E&P segment
may be a drag on performance even if the other segments perform in line with our
expectations. We retain our REDUCE rating with an SOTP-based target price of `1,065

No structural improvement in refining cycle as yet; still an over-supplied market
We do not see the modest improvement in refining margins of the past few months as reflecting a
structural improvement in the refining cycle. The recent improvement in margins was led by a
phase-out of certain coal-based power plants for environment reasons in China that boosted
demand for diesel-based power generation. We highlight that Singapore refining margins
continue to be subdued (see Exhibit 1). More important, refining cycle may remain weak over the
next 9-12 months given continued global supply-demand imbalance; net refining capacity addition
of 1.6 mn b/d and incremental NGL supply of 0.6 mn b/d will offset incremental global oil demand
of 1.3 mn b/d in CY2011E

We already assume strong refining margins; downside risk exists
We model improvement in RIL’s refining margins to US$8.6/bbl in 2HFY11E and US$9.3/bbl in
FY2012E from US$7.7/bbl in 1HFY11. We see downside risk to our assumption given that margins
haven’t improved significantly in recent months despite strong demand for diesel led by forced
closure of certain coal-based power plants in China and subsequent use of diesel generators for
power generation. We note that Singapore refining margins are flat qoq in 3QFY11 (QTD),
although RIL will benefit from modest expansion in light-heavy differential

We model strong chemical margins as well
We already model very high chemical margins for FY2011E to align our estimates with RIL’s
reported petchem EBIT for 1HFY11 (see Exhibit 4). We note that global operating rates/capacity
utilization will still be quite low in CY2011E and CY2012E despite incremental global supply
lagging incremental global demand

Concerns on E&P segment persist
We see meaningful downside risks to our earnings estimates from (1) lower-than-expected gas
and oil production in KG D-6 block and (2) non-availability of tax exemption on gas production.
Our FY2012E and FY2013E EPS for RIL will decline to `70 (-4.2%) and `77 (-10.1%), if gas
production is at 60 mcm/d versus our estimate of 70 mcm/d in FY2012E and 88 mcm/d in
FY2013E.


Earnings revision for lower oil and gas production and weaker rupee
We have fine-tuned FY2012E and FY2013E EPS by +0.5% and +0.8% to `73 and `86 to
reflect (1) lower oil and gas production (-ve) and (2) a weaker rupee assumption (+ve). We
now model FY2011-13E US Dollar-Indian Rupee exchange rate at `45.5/US$ versus
`44.5/US$ previously. Our revised SOTP-based fair valuation is `1,065 (`1,050) previously.
Exhibit 6 shows our SOTP-based fair valuation of RIL based on FY2012E estimates.
Downside risks to earnings of E&P segment persist
` Downside risks from lower-than-expected D-6 gas production. We are concerned
about the recent decline in KG D-6 gas production to ~54 mcm/d. Our FY2012E and
FY2013E EPS for RIL will decline by `3.1 (-4.2%) and `8.6 (-10.1%), if we assume gas
production at 60 mcm/d instead of our higher base-case estimates. We model a rather
benign scenario of KG D-6 gas production increasing to 70 mcm/d in FY2012E and 88
mcm/d in FY2013E.

` Downside risks from lower-than-expected MA-1 oil production. We note the decline
in oil production from MA field to~21,700 b/d from the peak level of over 36,000 b/d
achieved in 1QFY11. The management had earlier guided to ramping up production to
40,000 b/d by end-FY2010. We note that our FY2012E and FY2013E EPS would decline
by `0.9 (-1.2%) and `2.5 (-2.9%), if oil production is at 22,000 b/d. We model oil
production at 25,000 b/d in FY2012E and 30,000 b/d in FY2013E.
` Non-availability of tax exemption on gas production may further erode earnings.
We assume that RIL will continue to avail of income tax exemption on gas production
from KG D-6 block in our forecasts. We compute RIL’s FY2012E and FY2013E EPS to
decline by 8.7% and 9.7% to `67 and `77 if the income tax exemption is not available.