Reliance Industries - recent correction provides a buying opportunity; Upgrade to Buy: Edelweiss

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Reliance Industries (RIL IN, INR 1,014, upgrade to Buy)

n  A key beneficiary of improved refining and petrochemical margins

We expect global refining and petrochemical margins to remain strong in the next two years. Reliance Industries (RIL), being a cyclical company, with 65% of its FY12E EBITDA coming from cyclical businesses (39% refining, 26% chemicals), will be the key beneficiary of the same. For Q3FY11, we expect RIL to report GRMs of USD 9.25/bbl. Refining margins are expected to remain strong in FY12 on the back of increased operating rates of refiners, globally; RIL also benefits from the higher light-heavy spread in crude. Also, we expect ethylene cracker margins to rebound strongly Q2CY11 onwards, and RIL will benefit from the same. Further, the company’s polyester business is expected to remain robust owing to high cotton prices, lower polyester/cotton price ratio and limited capacities of polyester intermediates (PTA, MEG).

n  FY12E earnings maintained due to weak USD/INR outlook & low KG-D6 production

We have broadly maintained our FY12E earnings as earnings increase due to our weaker USD/INR outlook (at 46.0) offset marginal fall in earnings owing to lower natural gas production. We are moderating our FY11E EPS estimates lower to account for lower KG-D6 gas production in FY11 at 57 mmscmd. We now estimate the USD/INR to remain at 46 for FY12E and FY13E. In FY12, we expect RIL to produce 57 mmscmd KG-D6 gas against 60 mmscmd earlier. RIL’s FY11E and FY12E consolidated EPS is now at INR 61.8 and INR 77.4, respectively.

n  Outlook and valuations: 23% upside from SOTP; upgrade to ‘BUY’

We believe that recent correction in the stock offers opportunity for investors to play the refining and petrochemical up-cycle. RIL’s recent failure in the KG-D9 exploration well has made us take a conservative stance; we have moderated our estimates of exploration upsides to INR 150/share (INR 175/share earlier). However, it is noteworthy that RIL’s EBITDA from both refining and petrochemicals increases with depreciation in the INR, which raises its SOTP. Accordingly, we have maintained our SOTP for the company at INR 1,251/share. At INR 1,014, RIL offers 23% upside from the current levels, and the recent correction in the stock could be a good entry point. Hence, we upgrade the stock to ‘BUY’, while maintaining the relative rating as ‘Sector Outperformer’. At CMP of INR 1,014, RIL is trading at FY11E and FY12E P/E of 16.4x and 13.1x, respectively, and at FY11E and FY12E EV/EBITDA of 8.9x and 7.4x, respectively.