Buy Reliance Industries - uncertainty on E&P value dilutes following BP deal; Edelweiss

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Reliance Industries (RIL IN, INR 956, Buy)

RIL announces 30% stake sale in E&P assets for USD 7.2 bn

Today, Reliance Industries (RIL) announced 30% stake sale of its 23 upstream blocks to BP Plc. (BP), a UK energy giant, for USD 7.2 bn. Of these 23 blocks, 19 are in the east coast of India. Four NELP blocks (which include GS-01 block), PMT fields and Pre-NELP GJ block (which constitute the remaining portfolio of RIL’s E&P blocks) are not included in the stake sale. In addition, RIL would be entitled to receive performance payment of USD 1.8 bn, contingent on exploration successes in the block resulting in commercial discoveries. Further, both RIL and BP announced formation of a 50:50 JV for sourcing and marketing natural gas in India. RIL is expected to receive the entire USD 7.2 bn by March 2012. This deal consummates RIL’s need to collaborate with a global energy major and BP was chosen, as it is one of the best deepwater finders of hydrocarbons in the world.

Our view/analysis on the deal

RIL’s KG-D6 gas production, at 51 mmscmd, has been struggling to ramp up production to targeted 89 mmscmd. Probably, there were technical issues related to deepwater expertise; however, these are likely to alleviate with the company’s association with BP, one of the largest and best E&P firms. This collaboration will lead to accelerated natural gas production, higher discoveries, and increase in gas recovery rates. We believe that the 50:50 gas sourcing and marketing JV would source natural gas from BP’s global gas pool. This will open up opportunities for RIL to start LNG imports into India. As per the Production Sharing Contract (PSC), GoI approval will be required. With, the cash coming in by March 2012, we believe that the future driver of RIL will be its ability to find high IRR investment opportunities.

Outlook and valuations: Big positive; maintain ‘BUY/SO’

We had earlier valued RIL’s entire blocks at USD 32.8 bn, with discovery/producing blocks pegged at USD 22.8 bn and exploration upsides at USD 10.0 bn. With the deal providing a valuation benchmark, we now value RIL’s entire E&P asset at USD 26.8 bn, of which, USD 2.5 bn is from PMT/overseas/CBM assets, USD 21.6 bn from the value of the 23 blocks and USD 2.7 bn value for the exploration upsides (p=50% for exploration success). Upsides from the fair value would be from faster scale-up of gas and higher discoveries. Our value for RIL falls from earlier INR 1,251/share to INR 1,160/share. At INR 956/share, RIL offers upsides of 21.4% from CMP. We maintain our ‘BUY/Sector Outperformer’ recommendation/rating on the stock.