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Reliance Industries (RIL)
N: Protecting the downside by stake sale
RIL enters into agreement with BP Plc to sell 30% stake in its
east coast offshore blocks in India for upfront payment of
USD7.2bn and a conditional payment of USD1.8bn
The transaction is likely to be used as a benchmark to value
RIL’s E&P assets in view of wide disparity among street
estimates with range likely to narrow to INR350-400/share
Maintain Neutral rating and TP of INR1084
RIL enters into agreement with BP to sell stake in exploration and production (E&P)
blocks. As per an announcement by RIL, it will sell a 30% stake in all of its New
Exploration Licensing Policy blocks to BP for an upfront consideration of USD7.2bn and
another conditional USD1.8bn in case of future exploration successes. The upfront
payment corresponds to valuation of these blocks at cINR300/share for RIL. This is likely
to set a benchmark for the valuation of its E&P assets. We expect street estimates to
narrow to INR350-INR400/share. We value the E&P business at INR352/share based on
DCF of producing blocks and reserves-based multiples for discovered blocks. Completion
of the deal is subject to Indian regulatory approvals and other customary conditions.
The deal does not solve RIL’s problem of future growth. RIL, which has cash and cash
equivalents of cUSD7bn on its books, is estimated to generate cash profit of cUSD8bn in
FY12. Add to this, the USD7.2bn from BP. Against this USD22bn inflow, RIL has lined
up cUSD7bn of investment over FY12 that includes a few projects that are yet to take off.
Therefore, we would not be surprised if RIL reconsiders overseas acquisitions. It could
consider a petrochemical acquisition given the focus of its current investment continues to
be on the petrochemical segment.
Valuation. Our unchanged INR1084 target price is based on sum-of-the-parts analysis.
We value the E&P business on DCF for producing properties and reserves multiples for
discovered fields. We value the refining & petrochemical segment on the average of
EV/EBITDA and PE and investments on actual. We are lowering earnings estimates in
view of falling gas production (by less than 5% for FY12-13 EPS). If the deal with BP
goes through, then FY13e EPS could decrease 1%.
Risks and catalysts. Refining and petrochemical margins, gas production ramp-up from
D6 block and USD/INR exchange rate are risks on the upside and downside. If production
from KG-D6 ramps up to 80mmscmd, then our FY13 EPS could increase by 9%. A
USD1/barrel change in refining margin could change our target price by INR70, while a
10% change in petrochemical margins could cause a 6% change.
Investment view
RIL is struggling to deploy the cash it is generating from its businesses. We further believe that given the
size of the company and limited organic growth options, maintaining the historical earnings growth of
c23% pa is a tall order in the absence of an aggressive inorganic growth strategy. This is likely to erode
the premium that RIL has commanded traditionally over integrated global oil and gas companies. We
believe investors may no longer consider RIL as a defensive stock and could start to view it as a proxy for
refining and petrochemical margins. Our estimate of USD9.5/barrel refining margin for the balance of
FY12 assumes regional margins ahead of mid-cycle levels, while our petrochemical margin estimates are
broadly in line with the prevailing prices and forecast by CMAI.
Downstream outlook robust but upstream outlook clouded. We expect the current refining and
petrochemical margins to continue into FY12. However, we believe RIL is unlikely to ramp-up its natural
gas production from current levels of c52-53m standard cubic metres/day (mmscmd) near term in the
absence of relevant regulatory approvals for new development, technical limitations with existing wells
and a long lead time for critical deepwater equipment. The current gas production was not only well
below the intended peak rate of 80mmscmd but also sequentially lower. However, we believe the
proposed association with BP is likely to ameliorate investors’ concerns in this regard to some extent.
New initiatives not adding significant value. We not only believe that the volume growth from core
businesses is likely to remain muted for the next few quarters as new petrochemical capacity is likely to
come through only in FY13-14, but also that new initiatives such as shale gas, telecoms and power are
unlikely to result in more than a 5-10% CAGR in earnings over FY13-15e. We expect investment of
cUSD20bn over FY11-13 but the corresponding net present value (NPV) is unlikely to be more than
USD8bn, or 10% of current EV (USD82bn). Although RIL can leverage its strength in the power
business, we think its attempts to diversify into new areas such as retail, telecommunications and
financial sectors may stretch management.
We value the upstream business on a DCF basis for the producing blocks and on a reserve multiple basis
for the discovered blocks. We value RIL’s downstream business using the average of 13x PE and 8x
EV/EBITDA multiples on FY13e earnings, which is in line with regional peers. We also value the recent
shale acquisitions, Pioneer and Atlas Energy, on a DCF basis. Our FY12 and FY13 EPS estimates are 5%
and 8% below consensus, respectively.
Under our research model, the stocks without a volatility indicator, the Neutral band is 5ppt above and
below our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price. Our unchanged
target price of INR1084 implies a return of c14% including the dividend yield, and hence we retain our
Neutral rating.
Sensitivity analysis and risks
Key risks to our earnings and valuation, both on the upside and downside, are refining margins,
petrochemical margins and production from KG-D6 being different from our assumptions.
Sensitivity to production ramp-up from KG-D6 block: If production from KG-D6 ramps up to
80mmscmd by FY13, our EPS estimate could increase by 9%.
Sensitivity of GRM: USD1/bbl change in gross margin could change our FY13e EPS by INR5 (c7%) and
target price by INR70.
Sensitivity of petrochemical margins: Increase in petrochemical margins by c10% could raise our FY12e
EPS by 6%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries (RIL)
N: Protecting the downside by stake sale
RIL enters into agreement with BP Plc to sell 30% stake in its
east coast offshore blocks in India for upfront payment of
USD7.2bn and a conditional payment of USD1.8bn
The transaction is likely to be used as a benchmark to value
RIL’s E&P assets in view of wide disparity among street
estimates with range likely to narrow to INR350-400/share
Maintain Neutral rating and TP of INR1084
RIL enters into agreement with BP to sell stake in exploration and production (E&P)
blocks. As per an announcement by RIL, it will sell a 30% stake in all of its New
Exploration Licensing Policy blocks to BP for an upfront consideration of USD7.2bn and
another conditional USD1.8bn in case of future exploration successes. The upfront
payment corresponds to valuation of these blocks at cINR300/share for RIL. This is likely
to set a benchmark for the valuation of its E&P assets. We expect street estimates to
narrow to INR350-INR400/share. We value the E&P business at INR352/share based on
DCF of producing blocks and reserves-based multiples for discovered blocks. Completion
of the deal is subject to Indian regulatory approvals and other customary conditions.
The deal does not solve RIL’s problem of future growth. RIL, which has cash and cash
equivalents of cUSD7bn on its books, is estimated to generate cash profit of cUSD8bn in
FY12. Add to this, the USD7.2bn from BP. Against this USD22bn inflow, RIL has lined
up cUSD7bn of investment over FY12 that includes a few projects that are yet to take off.
Therefore, we would not be surprised if RIL reconsiders overseas acquisitions. It could
consider a petrochemical acquisition given the focus of its current investment continues to
be on the petrochemical segment.
Valuation. Our unchanged INR1084 target price is based on sum-of-the-parts analysis.
We value the E&P business on DCF for producing properties and reserves multiples for
discovered fields. We value the refining & petrochemical segment on the average of
EV/EBITDA and PE and investments on actual. We are lowering earnings estimates in
view of falling gas production (by less than 5% for FY12-13 EPS). If the deal with BP
goes through, then FY13e EPS could decrease 1%.
Risks and catalysts. Refining and petrochemical margins, gas production ramp-up from
D6 block and USD/INR exchange rate are risks on the upside and downside. If production
from KG-D6 ramps up to 80mmscmd, then our FY13 EPS could increase by 9%. A
USD1/barrel change in refining margin could change our target price by INR70, while a
10% change in petrochemical margins could cause a 6% change.
Investment view
RIL is struggling to deploy the cash it is generating from its businesses. We further believe that given the
size of the company and limited organic growth options, maintaining the historical earnings growth of
c23% pa is a tall order in the absence of an aggressive inorganic growth strategy. This is likely to erode
the premium that RIL has commanded traditionally over integrated global oil and gas companies. We
believe investors may no longer consider RIL as a defensive stock and could start to view it as a proxy for
refining and petrochemical margins. Our estimate of USD9.5/barrel refining margin for the balance of
FY12 assumes regional margins ahead of mid-cycle levels, while our petrochemical margin estimates are
broadly in line with the prevailing prices and forecast by CMAI.
Downstream outlook robust but upstream outlook clouded. We expect the current refining and
petrochemical margins to continue into FY12. However, we believe RIL is unlikely to ramp-up its natural
gas production from current levels of c52-53m standard cubic metres/day (mmscmd) near term in the
absence of relevant regulatory approvals for new development, technical limitations with existing wells
and a long lead time for critical deepwater equipment. The current gas production was not only well
below the intended peak rate of 80mmscmd but also sequentially lower. However, we believe the
proposed association with BP is likely to ameliorate investors’ concerns in this regard to some extent.
New initiatives not adding significant value. We not only believe that the volume growth from core
businesses is likely to remain muted for the next few quarters as new petrochemical capacity is likely to
come through only in FY13-14, but also that new initiatives such as shale gas, telecoms and power are
unlikely to result in more than a 5-10% CAGR in earnings over FY13-15e. We expect investment of
cUSD20bn over FY11-13 but the corresponding net present value (NPV) is unlikely to be more than
USD8bn, or 10% of current EV (USD82bn). Although RIL can leverage its strength in the power
business, we think its attempts to diversify into new areas such as retail, telecommunications and
financial sectors may stretch management.
We value the upstream business on a DCF basis for the producing blocks and on a reserve multiple basis
for the discovered blocks. We value RIL’s downstream business using the average of 13x PE and 8x
EV/EBITDA multiples on FY13e earnings, which is in line with regional peers. We also value the recent
shale acquisitions, Pioneer and Atlas Energy, on a DCF basis. Our FY12 and FY13 EPS estimates are 5%
and 8% below consensus, respectively.
Under our research model, the stocks without a volatility indicator, the Neutral band is 5ppt above and
below our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price. Our unchanged
target price of INR1084 implies a return of c14% including the dividend yield, and hence we retain our
Neutral rating.
Sensitivity analysis and risks
Key risks to our earnings and valuation, both on the upside and downside, are refining margins,
petrochemical margins and production from KG-D6 being different from our assumptions.
Sensitivity to production ramp-up from KG-D6 block: If production from KG-D6 ramps up to
80mmscmd by FY13, our EPS estimate could increase by 9%.
Sensitivity of GRM: USD1/bbl change in gross margin could change our FY13e EPS by INR5 (c7%) and
target price by INR70.
Sensitivity of petrochemical margins: Increase in petrochemical margins by c10% could raise our FY12e
EPS by 6%.
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