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Reliance Industries Ltd
Overweight
RELI.BO, RIL IN
Steady 3Q, but no clarity on E&P ramp-up
• Steady 3Q, but no clarity on E&P ramp-up: RIL’s 3QFY11 net
profits of Rs51.4bn came in line with our expectations. While operating
performance on Refining and Petrochemicals was very strong, E&P
business continues to lag, even as there is no clarity on gas ramp-up.
• Refining – strong quarter, with more to follow: RIL had an
exceptionally strong refining quarter, with GRMs of US$9/bbl (ahead of
our expectation of US$8.8/bbl). RIL continues to be positive on refining
outlook with strong demand growth east of the Suez and support for
diesel spreads due to changes in specs for off-road diesel in Europe.
Complex refiners will continue to benefit on low OPEC compliance and
a weak outlook for fuel oil, in RIL’s view.
• Petrochemicals: record quarter: Polymer spreads have held steady
despite the large capacity additions in 2010 (8% cap add). With limited
capacity additions on the horizon, we expect the polymer cycle to
bottom by mid-2011. Polyester margins were strong across the chain,
which benefited integrated producers like RIL. With high cotton prices
likely to sustain, we believe, polyester outlook for FY12 is positive.
• E&P stays the dark horse: KGD6 volumes are currently averaging 52-
55mmscmd. RIL did not indicate timelines for ramp-up, saying it was in
talks with the government/DGH on a gamut of issues related to its
domestic E&P portfolio, including technical and regulatory issues. With
no guidance on E&P ramp up, we are reducing our FY12 gas sales
estimates.
• Stock reflects E&P disappointment, not positive refining and
petchem outlook: We reduce our FY11/FY12 EPS estimates by 4%/5%
primarily to reflect lower gas production, and adjust our PT to Rs1240.
We reiterate our OW on RIL. Even building in a slower ramp-up in
E&P, three-year earnings CAGR is 25% and we think valuations are
undemanding at 12x FY12E adj. P/E. Key risk: Weaker economic
recovery will hurt refining, petchem cycles.
Key takeaways from management meet
• No joy on E&P ramp-up: RIL management gave no guidance on timelines for
ramp-up in the D6 field. The company is currently engaged in talks with the
government/DGH on various technical and regulatory issues pertaining to all of
their E&P blocks (issues cited were finalization of field development plans,
declaration of commerciality of various discoveries, rig moratorium, etc.), better
clarity on E&P ramp-up will be possible only on conclusion of these talks.
Management did not give any guidance on drilling programme as well.
• D6 production is currently at 52-55mmscmd with D1-D3 fields producing at
43-44mmscmd, oil production is at 17-17.5kbpd. Panna Mukta fields gas
production is now at 5.5mmscmd, with Tapti production at 6.5-7mmscmd (with
the field in natural decline). Further development efforts in PMT are also being
discussed with the government/DGH.
• Refining outlook strong over next few quarters per RIL: Reliance believes
that the refining cycle strength will continue for the next few quarters. The key
rationale for the positive outlook is: 1) Continuing strong demand growth from
the East of Suez Markets with the Western markets also now starting to tick up
on better economic prospects, 2) Middle distillates will continue to enjoy strong
spreads due to the harsher winter and drawdown in inventories. Tighter
environmental specifications for off-road diesel in Europe would also draw
products from Asia as there is insufficient capacity in Europe to meet the high
spec diesel demand, 3) Naphtha demand and spreads are expected to pick up on
the back of better petrochem demand, and 4) light heavy differentials will widen
with a) lower OPEC compliance/higher production from OPEC and b) fuel oil
margins will be under pressure due to higher supplies with increased refinery
throughput even while demand is declining with increased gas usage.
Structurally too, FO demand would be hurt on tightening environmental norms
for bunker.
• Refinery FCC unit will have a 36- to 37-day shutdown in February. The unit is
expected to be back on-line in time for the gasoline season. RIL does not
envisage any major shutdowns in FY12. In 3Q, RIL had taken a shutdown on its
CDU (cost Rs1bn)
• Shale gas update: The Atlas JV has now drilled 12 wells, with production of
35mmscfd. Midstream activity in the Atlas area was ongoing (4QFY11) and on
completion of this, further ramp-up in drilling/production would commence. IP
rates were ahead of expectations in the initial wells, with the company opting for
longer lateral well lengths of 3000ft. The other two JVs were still in preliminary
stages. RIL would look to prioritize the condensate production from its
Eagleford Shale JV in view of prevailing oil/gas prices – longer term RIL is
confident on a recovery in US gas prices.
• Polymers: With the large capacity additions (8%) of 2010 behind it, RIL
highlighted there is limited capacity addition in petrochemicals in the coming
years. With robust Asian demand growth, RIL believes the polymer chain could
witness a super cycle in the next 12-18 months. RIL did not give exact timelines
for its cracker/downstream project, with more details likely to be available next
quarter. RIL plans to spend US$11bn on petchem expansion with US$4bn slated
toward the offgas cracker/downstream units, US$2.5-3bn toward polyester
expansion, and US$3-3.5bn for petcoke gasification.
• Polyester: RIL continues to be very bullish on polyester, with spreads likely to
be strong across the polyester/intermediate chain. With high cotton prices likely
to sustain in 2011, polyester prices have been healthy and margins for both
polyester and intermediates are significantly above five-year average levels.
• Cash capex for the quarter was Rs19bn, largely toward E&P (Rs17bn). Decapitalization on account of F/X changes was Rs1.9bn, with F/X gains during
the quarter at Rs800m.
Refining: outlook brighter, but still range-bound
In 3QFY11, regional benchmark GRMs rose to $4.4/bbl (from $4.2/bbl in 2QFY11),
benefiting from higher light-heavy differentials and tighter diesel spreads in Asia. As
a result, RIL GRMs rose to $9/bbl (from $7.9/bbl).
GRMs have ticked upward significantly since December, averaging over $5.5/bbl,
building increasing optimism for a sustained earnings boost post a difficult 18
months. Better discipline from refiners during lean periods, in addition to stronger
diesel spreads, has contributed to this increase.
However, with overcapacity still in the system, remunerative margins could bring
mothballed capacities back into operation, as witnessed by Valero restarting
operations at its Aruba refinery. Heightened M&A activity in the refining space
could also lead to inefficient refineries remaining in operation in the expectation of a
sale.
As such, while we expect margins to be higher than in 2010, we believe the upside
will be capped.
Petrochemicals: polymer turnaround in the offing?
In the petchem space, focus has remained on the polyester side over the past few
months, as high cotton prices and relatively tight supply have kept spreads elevated.
With cotton prices expected to remain high in 2011, we believe, spreads are likely to
stay robust.
Polymers, on the other hand, have remained weak, with significant capacity additions
over the past year weighing on utilization rates and profitability. However, with
limited capacities being added in the near future, we expect to see the polymer cycle
bottom in mid-2011, leading to an uptick in margins.
Valuation, earnings and risks
We adjust our FY11/12 earnings estimates downwards by 4%/5% to primarily reflect
lower gas production – we adjust our estimate for FY11/12 KG-D6 gas production to
55/67.5 mmscmd (from 60/75 mmscmd) earlier.
We reiterate our OW rating on RIL, and adjust our PT to Rs1240 (from Rs1260). Our
PT is based on 12.5x earnings (adjusted for treasury shares), marginally higher than
LT average earnings multiples. Key risks to our view are a renewed global economic
slowdown affecting the cyclical refining and petchem businesses, along with a
further delay in gas production ramp-up
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries Ltd
Overweight
RELI.BO, RIL IN
Steady 3Q, but no clarity on E&P ramp-up
• Steady 3Q, but no clarity on E&P ramp-up: RIL’s 3QFY11 net
profits of Rs51.4bn came in line with our expectations. While operating
performance on Refining and Petrochemicals was very strong, E&P
business continues to lag, even as there is no clarity on gas ramp-up.
• Refining – strong quarter, with more to follow: RIL had an
exceptionally strong refining quarter, with GRMs of US$9/bbl (ahead of
our expectation of US$8.8/bbl). RIL continues to be positive on refining
outlook with strong demand growth east of the Suez and support for
diesel spreads due to changes in specs for off-road diesel in Europe.
Complex refiners will continue to benefit on low OPEC compliance and
a weak outlook for fuel oil, in RIL’s view.
despite the large capacity additions in 2010 (8% cap add). With limited
capacity additions on the horizon, we expect the polymer cycle to
bottom by mid-2011. Polyester margins were strong across the chain,
which benefited integrated producers like RIL. With high cotton prices
likely to sustain, we believe, polyester outlook for FY12 is positive.
• E&P stays the dark horse: KGD6 volumes are currently averaging 52-
55mmscmd. RIL did not indicate timelines for ramp-up, saying it was in
talks with the government/DGH on a gamut of issues related to its
domestic E&P portfolio, including technical and regulatory issues. With
no guidance on E&P ramp up, we are reducing our FY12 gas sales
estimates.
• Stock reflects E&P disappointment, not positive refining and
petchem outlook: We reduce our FY11/FY12 EPS estimates by 4%/5%
primarily to reflect lower gas production, and adjust our PT to Rs1240.
We reiterate our OW on RIL. Even building in a slower ramp-up in
E&P, three-year earnings CAGR is 25% and we think valuations are
undemanding at 12x FY12E adj. P/E. Key risk: Weaker economic
recovery will hurt refining, petchem cycles.
Key takeaways from management meet
• No joy on E&P ramp-up: RIL management gave no guidance on timelines for
ramp-up in the D6 field. The company is currently engaged in talks with the
government/DGH on various technical and regulatory issues pertaining to all of
their E&P blocks (issues cited were finalization of field development plans,
declaration of commerciality of various discoveries, rig moratorium, etc.), better
clarity on E&P ramp-up will be possible only on conclusion of these talks.
Management did not give any guidance on drilling programme as well.
• D6 production is currently at 52-55mmscmd with D1-D3 fields producing at
43-44mmscmd, oil production is at 17-17.5kbpd. Panna Mukta fields gas
production is now at 5.5mmscmd, with Tapti production at 6.5-7mmscmd (with
the field in natural decline). Further development efforts in PMT are also being
discussed with the government/DGH.
• Refining outlook strong over next few quarters per RIL: Reliance believes
that the refining cycle strength will continue for the next few quarters. The key
rationale for the positive outlook is: 1) Continuing strong demand growth from
the East of Suez Markets with the Western markets also now starting to tick up
on better economic prospects, 2) Middle distillates will continue to enjoy strong
spreads due to the harsher winter and drawdown in inventories. Tighter
environmental specifications for off-road diesel in Europe would also draw
products from Asia as there is insufficient capacity in Europe to meet the high
spec diesel demand, 3) Naphtha demand and spreads are expected to pick up on
the back of better petrochem demand, and 4) light heavy differentials will widen
with a) lower OPEC compliance/higher production from OPEC and b) fuel oil
margins will be under pressure due to higher supplies with increased refinery
throughput even while demand is declining with increased gas usage.
Structurally too, FO demand would be hurt on tightening environmental norms
for bunker.
• Refinery FCC unit will have a 36- to 37-day shutdown in February. The unit is
expected to be back on-line in time for the gasoline season. RIL does not
envisage any major shutdowns in FY12. In 3Q, RIL had taken a shutdown on its
CDU (cost Rs1bn)
• Shale gas update: The Atlas JV has now drilled 12 wells, with production of
35mmscfd. Midstream activity in the Atlas area was ongoing (4QFY11) and on
completion of this, further ramp-up in drilling/production would commence. IP
rates were ahead of expectations in the initial wells, with the company opting for
longer lateral well lengths of 3000ft. The other two JVs were still in preliminary
stages. RIL would look to prioritize the condensate production from its
Eagleford Shale JV in view of prevailing oil/gas prices – longer term RIL is
confident on a recovery in US gas prices.
• Polymers: With the large capacity additions (8%) of 2010 behind it, RIL
highlighted there is limited capacity addition in petrochemicals in the coming
years. With robust Asian demand growth, RIL believes the polymer chain could
witness a super cycle in the next 12-18 months. RIL did not give exact timelines
for its cracker/downstream project, with more details likely to be available next
quarter. RIL plans to spend US$11bn on petchem expansion with US$4bn slated
toward the offgas cracker/downstream units, US$2.5-3bn toward polyester
expansion, and US$3-3.5bn for petcoke gasification.
• Polyester: RIL continues to be very bullish on polyester, with spreads likely to
be strong across the polyester/intermediate chain. With high cotton prices likely
to sustain in 2011, polyester prices have been healthy and margins for both
polyester and intermediates are significantly above five-year average levels.
• Cash capex for the quarter was Rs19bn, largely toward E&P (Rs17bn). Decapitalization on account of F/X changes was Rs1.9bn, with F/X gains during
the quarter at Rs800m.
Refining: outlook brighter, but still range-bound
In 3QFY11, regional benchmark GRMs rose to $4.4/bbl (from $4.2/bbl in 2QFY11),
benefiting from higher light-heavy differentials and tighter diesel spreads in Asia. As
a result, RIL GRMs rose to $9/bbl (from $7.9/bbl).
GRMs have ticked upward significantly since December, averaging over $5.5/bbl,
building increasing optimism for a sustained earnings boost post a difficult 18
months. Better discipline from refiners during lean periods, in addition to stronger
diesel spreads, has contributed to this increase.
However, with overcapacity still in the system, remunerative margins could bring
mothballed capacities back into operation, as witnessed by Valero restarting
operations at its Aruba refinery. Heightened M&A activity in the refining space
could also lead to inefficient refineries remaining in operation in the expectation of a
sale.
As such, while we expect margins to be higher than in 2010, we believe the upside
will be capped.
Petrochemicals: polymer turnaround in the offing?
In the petchem space, focus has remained on the polyester side over the past few
months, as high cotton prices and relatively tight supply have kept spreads elevated.
With cotton prices expected to remain high in 2011, we believe, spreads are likely to
stay robust.
Polymers, on the other hand, have remained weak, with significant capacity additions
over the past year weighing on utilization rates and profitability. However, with
limited capacities being added in the near future, we expect to see the polymer cycle
bottom in mid-2011, leading to an uptick in margins.
Valuation, earnings and risks
We adjust our FY11/12 earnings estimates downwards by 4%/5% to primarily reflect
lower gas production – we adjust our estimate for FY11/12 KG-D6 gas production to
55/67.5 mmscmd (from 60/75 mmscmd) earlier.
We reiterate our OW rating on RIL, and adjust our PT to Rs1240 (from Rs1260). Our
PT is based on 12.5x earnings (adjusted for treasury shares), marginally higher than
LT average earnings multiples. Key risks to our view are a renewed global economic
slowdown affecting the cyclical refining and petchem businesses, along with a
further delay in gas production ramp-up
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