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Reliance Infrastructure Ltd
▼ Neutral
Previous: Overweight
RLIN.BO, RELI IN
The glass shoe slipped; downgrade to Neutral
• Lacking valuation triggers: Like its infrastructure conglomerate peers,
RELI has seen steep value erosion. However, revival catalysts do not appear
as strong as those of its peers. We downgrade to Neutral, with a new Mar-
12 SOTP PT of Rs950, and recommend a switch to GMRI / GVK.
• Company’s investment practices have come under regulatory scrutiny:
SEBI has indicted RELI for misusing ECB funds towards associate
company shares and misrepresenting yield management certificates in the
annual report. RELI is barred from equity market investments through Dec-
2012 – while this implies that balance sheet cash would not be misdirected
until then, the finding does not speak well of the company’s investment
practices. RELI had Rs27.7B inter-corporate deposits in its last balance
sheet.
• Emerging concerns in key businesses: a) Expiry of RELI’s Mumbai
distribution license in Aug-11 and competing bids invited by the regulator
cast doubt on the sustainability of cash flows and future growth. RELI has
sought an extension of the license period. B) Infrastructure portfolio will
likely generate moderate returns – our NPV is lower than project equity
investments in some cases. Mumbai, Delhi metros have seen delays, and
losses are likely in the initial years. C) EPC - equipment-procurementrelated
risks (e.g. currency, input costs) untested; our sustainable EBIT
margin estimate of 5% remains well below management guidance of ~9%.
• Our revised PT of Rs950 (down from Rs1360 earlier): RPWR main
contributor to SOP (~49%); reduced stake in RPWR (38.5%) post RNRL
merger into the latter has contributed Rs170 to the reduction in our PT. (2)
Distribution: 13.4% of SOP, regulatory uncertainty in this cash-generating
business has contributed ~Rs95 to the reduction in SOP. (3) Cash: We take
60% haircut on RELI’s ICD / preference share portfolio in light of recent
developments and value the net resultant cash (after subtracting debt) at 0.5x
book, considering the risk of its deployment into new projects that may not
add value immediately. Upside risks to our PT include the removal of
regulatory overhang on distribution, reduction in ICD investment and a pickup
in execution of EPC order book and infrastructure projects.
Deep value but few catalysts
Like its infrastructure conglomerate peers, RELI has seen steep value erosion and has
underperformed the Sensex by 40% over the past 12 months.
Despite the weak run, revival catalysts do not appear as strong as those of its peers.
We downgrade RELI to Neutral, with a new Mar-12 SOTP PT of Rs950, down from
our Mar-11 PT of Rs1360 (see our revised SOP in table below), and recommend a
switch to GMRI / GVK.
We discuss our revised view on each of the businesses and contribution of cash to
valuations followed by summary of model revisions which have resulted in the
downgrade to N from OW.
Regulatory uncertainties in electricity distribution business
Although the tariff related issues were largely resolved in Sep-10, the status of
RELI’s distribution license remains uncertain. The distribution license expires on 15
August 2011. In Oct-10, MERC had invited EoI from prospective applicants to
indicate their interest in undertaking distribution of electricity in RELI's area and to
seek grant of distribution license. Eight firms, including Tata Power and MSEDCL,
submitted EoIs in Nov-10. RELI sought an extension of license period. Given
regulatory uncertainty, we attribute 0% terminal growth to MLA, and higher WACC
of 15% vs. 12% earlier (see Table 3 for summary valuations of the distribution
businesses in Mumbai and Delhi).
Infrastructure – Large portfolio, but modest returns
Our estimated NPV for RELI’s portfolio of metro (ex-real estate upside),
transmission and sea-link projects is less than the project equity investment (see
Table 2)
Execution of Delhi Airport Express-line has been delayed by few months and we
expect the project to commence operations in FY12. We take a more conservative
view on real estate development associated with the project. We factor rentals of
Rs175/sq.ft/month vs. Rs225/sq.ft/month; the bulk of the land available for
development is in Dwarka (New Delhi).
The Mumbai metro project is expected to be operational in 2H FY12. Both metro
projects are likely to be loss-making for the first couple of years of operation, in our
view.
Our revised DCF based value for the roads portfolio implies 2.1x FY12E book. This
makes roads the most attractive asset class in RELI's infrastructure portfolio.
More conservative on cash contribution to SOP
75% yoy spike in ICDs to Rs27.7B was a significant disappointment in the FY10
annual report published in end-Nov-10, since management had been guiding to the
contrary. We factor in a 60% haircut on ICD and preference share investments that
have surfaced in accounts. We view deployment of net-cash as equity in pipeline
metro and transmission projects as value-erosive (our NPV of under construction
metro and transmission projects is less than project equity) and accordingly factor
0.5x net-cash into our SOP.
EPC business: Execution slippages
1H standalone EPC revenue of Rs14.3B (down 6.8% YoY) is lagging behind
management guidance of Rs45B for FY11 (reiterated in Sep-q). The implied pick-up
in growth in 2H FY11 is quite sharp at ~55%, and would require substantial progress
on large projects like Sasan (Rs120B EPC order), in our view. EPC segment margins
of 10% in 1H are tracking higher (vs. est. of <7% for FY11), but are expected to
come down if substantial revenue is booked on RPWR projects (e.g. Sasan) in 2H.
During Sep-q, RELI added four road projects to EPC OB which now stands at
Rs240B (vs. Rs185B at end of Jun-q).
We expect the EPC order backlog to grow further due to inclusion of RPWR pipeline
projects; Krishnapatnam UMPP (4GW) EPC contract is likely over the near term, in
our view.
In our view, equipment procurement related risks (e.g.: currency, input costs) are yet
untested and hence our sustainable EBIT margin estimate of 5% is well below
management guidance of ~9%.
Our revised Mar-12 PT of Rs950 (down from our Mar-11 PT of Rs1360)
includes the following. (1) RPWR- main contributor of SOP (~49%), valued at 20%
hold co. at a discount to our fair value estimate which factors in decent execution
scenario; upside appears unlikely. Reduced stake in RPWR (38.5%) post RNRL
merger into the latter has contributed Rs170 to the reduction in our PT. (2)
Distribution- 13.4% of SOP, regulatory uncertainty in cash generating business has
contributed ~Rs95 to reduction in SOP. (3) Infrastructure- 22.6% of SOP, more
favorable view of roads portfolio added Rs40 to SOP. (4) Net cash (8%): valued at
0.5x book, contribution down Rs170. (5) EPC (7%).
Key upside (and downside) risks to our rating and PT incude the removal of
regulatory overhang on distribution, reduction in ICD investment and pick-up in
execution of EPC order book and infrastructure projects.
Key estimate revisions and financials
Our FY11 and FY12 estimates are down 15% and ~24%, respectively, mainly on
account of lower other income, a higher tax rate, and a cut in RPWR’s contribution
to earnings in FY12.
The reduction in FY12E PAT is despite the fact that our EBITDA estimate is up ~1%
due to consolidation of operational Bandra Worli Sea Link.
We note that in the infrastructure conglomerate space RELI has maximum scope to
lever up the balance sheet and take on new projects. As we have not factored in
pipeline projects (UMTPs, Mumbai Metro-II, Greenfield cement plans) in our capex
estimates, it appears that the company will start generating FCF in FY13
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