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Reliance Industries Ltd
Overweight ; RELI.BO, RIL IN
Compelling valuations; E&P uncertainty is providing entry opportunity
• Improving earnings mix, resilience not reflected in valuations: RIL
is trading at below historic average valuations and a discount to peers;
not reflecting the increasing contribution of steady E&P earnings,
earnings resilience imparted by asynchronous cycles in its commodity
businesses.
• Markets have fully priced in E&P uncertainty: A revisit to our Sum
of Parts valuation of RIL reveals that the RIL stock price fully discounts
the uncertainty on E&P ramp up. RIL stock trades at a discount to
regional valuations for refining and petrochem businesses and value on
its balance sheet. Value of new E&P assets, shorn of sustainability
premium/value for un-quantified reserves provides only Rs270/share in
our SOTP of Rs1240.
• Uncertainty has provided entry opportunities in the past: A look at
RIL's trading history shows periods of uncertainty have preceded periods
of significant value unlocking. We highlight the period of 1) late nineties
- RIL foraying into refining even as tariff barriers in core petchem was
coming off and 2) the mid noughties when uncertainty on fall-out of the
family settlement hurt stock performance.
• Catalysts, share price drivers: We think continued earnings growth
delivery from the refining and petchem business on the back of global
recovery tailwinds will be positive for the stock performance. With low
expectations on the E&P side, any incremental positive news flow will
be well received. In particular, a more measured approach to E&P by
way of distributing risks through partnerships will be positive for RIL
stock.
• We retain our Dec-11 PT of Rs1240; OW: Our Dec-11 PT is based
on.12.5 P/E (adj. for treasury stock), marginally higher than 10-year
average multiples. Key risk: Weaker economic recovery will hurt
refining, petchem cycles, and a slower than expected gas production
ramp-up.
RIL's stock price has lost significant value in 2011 – losing ~14% since early
January, led largely by issues surrounding the delay in ramp up of gas production
from the KG-D6 field. We revisit out sum-of-parts valuation to assess the impact on
E&P uncertainty on RIL.
For our SOTP, we value the refining business at 8x EV/EBITDA, and the
petrochemical business at 9x EV/EBITDA - in line with regional averages. Regional
refining and petrochem stock valuation has moved up significantly over the last 4
months reflecting the strength in the cycles. We believe regional valuations reflect
the early stage of recovery in petrochemicals and improving refining cycle on back
of global recovery tailwinds. With highly competitive assets in these segments and a
globally linked cost of capital (more than 80% of RIL's debt is overseas borrowing),
we see no reason for RIL to trade at its current discount to peer group.
With a value of Rs270/share from the new E&P business (largely KG-D6), we
ascribe Rs969/share to RIL’s legacy businesses and net cash/investments– essentially
indicating that the market is currently ascribing virtually no value to RIL’s newer
E&P assets. Even building in lower gas production than our current estimates, we
see an 18%-40% upside from current levels on a bear and bull case scenario (details
in the table below)
Table 2: RIL JPMe vs. Bear and Bull scenario
Dec-11 fair value upside Commetnts
JPMe 1,240 33% Gas production at 67.5/90 mmscmd for FY12/13
Bear 1,095 18% Gas production at 55/60 mmscmd for FY12/13
Bull 1,300 40% Gas production at 75/90 mmscmd for FY12/13; petchem EBITDA in line
with 2Q/3Q11 run-rate
Source: J.P. Morgan estimates, Bloomberg
For our PT, we use a 12.5x PE multiple on earnings adjusted for treasury stock
(higher than long-term (10 yr) averages due to improving earnings mix) for the fair
values. RIL currently trades at historical average multiples, despite an improving
earnings mix with contributions from the E&P business. We expect performance in
the refining/petchem businesses to drive stock performance in the coming quarters.
RIL is currently trading at 17-30% discount to its 6 year mean multiples. The 6 year
multiple captures RIL's value post the contours of the family settlement falling into
place.
Earnings resilience is a positive
RIL’s earnings resilience draws from its presence across the hydrocarbon value
chain. Currently, E&P contributes 24% of EBIT, with refining and petrochemicals
adding 38% each. Further, RIL has an even split across the polyester and polymer
chains. Cycles across these businesses are not necessarily coincident - RIL has
benefited from strength in the polyester business, while high capacity adds in the
polymer sector in 2010 depressed margins. Refining, which was weak through FY10,
has now ticked upwards. RIL also benefits from its presence across the polyester
chain, with evidence that strength is now shifting to polyester intermediaries such as
PX, PTA and MEG on the back of strong demand and relatively low capacity
additions.
We expect improving performance in the refining and petchem segments to help
drive 25% earnings CAGR over FY10-13. Market expectations have moved lower on
the E&P side of the business, and any incremental positive news flow would be well
received by the market. RIL is also reportedly in talks with BP regarding a stake sale
in the KG-D6 block (Source: livemint.com). We believe RIL is now adopting a more
measured approach to E&P risk and this move would fit into that strategy. This
would also allow RIL access to emerging deepwater technology, in addition to
“internationalizing” the D6 gas pricing issue.
Uncertainty a buying opportunity
Historically, periods of uncertainty have provided buying opportunities. We highlight
2 instances – (1) The late ‘90’s, in the midst of the Asian crisis, when RIL forayed
into refining at a time when petrochem tariff barriers (which aided margins) were
coming off and (2) The mid 2000's, when the family settlement splitting the group
assets was being worked out.
Earnings sensitivity = -7/-13% impact of lower gas
production
E&P remains the source of uncertainty in terms of earnings, and hence stock
performance for RIL – with production currently at less than 60mmscmd. While we
retain our gas production forecasts, we provide below the earnings/PT sensitivity for
lower gas production
Price Target, Earnings changes
We adjust our FY11 estimates downwards by 5% - taking into account a more
moderate full year GRM. Our earnings estimates into FY12/13 remain largely
unchanged as we retain our gas production targets. Our Dec-11 price target remains
Rs1240 - based on 12.5x P/E (adjusted for treasury shares). This is slightly higher
than long-term averages, on account of an improving earnings mix. Key risks to our
view include a weak global economy impacting the refining and petrochemical
businesses, and a 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
Compelling valuations; E&P uncertainty is providing entry opportunity
• Improving earnings mix, resilience not reflected in valuations: RIL
is trading at below historic average valuations and a discount to peers;
not reflecting the increasing contribution of steady E&P earnings,
earnings resilience imparted by asynchronous cycles in its commodity
businesses.
• Markets have fully priced in E&P uncertainty: A revisit to our Sum
of Parts valuation of RIL reveals that the RIL stock price fully discounts
the uncertainty on E&P ramp up. RIL stock trades at a discount to
regional valuations for refining and petrochem businesses and value on
its balance sheet. Value of new E&P assets, shorn of sustainability
premium/value for un-quantified reserves provides only Rs270/share in
our SOTP of Rs1240.
• Uncertainty has provided entry opportunities in the past: A look at
RIL's trading history shows periods of uncertainty have preceded periods
of significant value unlocking. We highlight the period of 1) late nineties
- RIL foraying into refining even as tariff barriers in core petchem was
coming off and 2) the mid noughties when uncertainty on fall-out of the
family settlement hurt stock performance.
• Catalysts, share price drivers: We think continued earnings growth
delivery from the refining and petchem business on the back of global
recovery tailwinds will be positive for the stock performance. With low
expectations on the E&P side, any incremental positive news flow will
be well received. In particular, a more measured approach to E&P by
way of distributing risks through partnerships will be positive for RIL
stock.
• We retain our Dec-11 PT of Rs1240; OW: Our Dec-11 PT is based
on.12.5 P/E (adj. for treasury stock), marginally higher than 10-year
average multiples. Key risk: Weaker economic recovery will hurt
refining, petchem cycles, and a slower than expected gas production
ramp-up.
RIL's stock price has lost significant value in 2011 – losing ~14% since early
January, led largely by issues surrounding the delay in ramp up of gas production
from the KG-D6 field. We revisit out sum-of-parts valuation to assess the impact on
E&P uncertainty on RIL.
For our SOTP, we value the refining business at 8x EV/EBITDA, and the
petrochemical business at 9x EV/EBITDA - in line with regional averages. Regional
refining and petrochem stock valuation has moved up significantly over the last 4
months reflecting the strength in the cycles. We believe regional valuations reflect
the early stage of recovery in petrochemicals and improving refining cycle on back
of global recovery tailwinds. With highly competitive assets in these segments and a
globally linked cost of capital (more than 80% of RIL's debt is overseas borrowing),
we see no reason for RIL to trade at its current discount to peer group.
With a value of Rs270/share from the new E&P business (largely KG-D6), we
ascribe Rs969/share to RIL’s legacy businesses and net cash/investments– essentially
indicating that the market is currently ascribing virtually no value to RIL’s newer
E&P assets. Even building in lower gas production than our current estimates, we
see an 18%-40% upside from current levels on a bear and bull case scenario (details
in the table below)
Table 2: RIL JPMe vs. Bear and Bull scenario
Dec-11 fair value upside Commetnts
JPMe 1,240 33% Gas production at 67.5/90 mmscmd for FY12/13
Bear 1,095 18% Gas production at 55/60 mmscmd for FY12/13
Bull 1,300 40% Gas production at 75/90 mmscmd for FY12/13; petchem EBITDA in line
with 2Q/3Q11 run-rate
Source: J.P. Morgan estimates, Bloomberg
For our PT, we use a 12.5x PE multiple on earnings adjusted for treasury stock
(higher than long-term (10 yr) averages due to improving earnings mix) for the fair
values. RIL currently trades at historical average multiples, despite an improving
earnings mix with contributions from the E&P business. We expect performance in
the refining/petchem businesses to drive stock performance in the coming quarters.
RIL is currently trading at 17-30% discount to its 6 year mean multiples. The 6 year
multiple captures RIL's value post the contours of the family settlement falling into
place.
Earnings resilience is a positive
RIL’s earnings resilience draws from its presence across the hydrocarbon value
chain. Currently, E&P contributes 24% of EBIT, with refining and petrochemicals
adding 38% each. Further, RIL has an even split across the polyester and polymer
chains. Cycles across these businesses are not necessarily coincident - RIL has
benefited from strength in the polyester business, while high capacity adds in the
polymer sector in 2010 depressed margins. Refining, which was weak through FY10,
has now ticked upwards. RIL also benefits from its presence across the polyester
chain, with evidence that strength is now shifting to polyester intermediaries such as
PX, PTA and MEG on the back of strong demand and relatively low capacity
additions.
We expect improving performance in the refining and petchem segments to help
drive 25% earnings CAGR over FY10-13. Market expectations have moved lower on
the E&P side of the business, and any incremental positive news flow would be well
received by the market. RIL is also reportedly in talks with BP regarding a stake sale
in the KG-D6 block (Source: livemint.com). We believe RIL is now adopting a more
measured approach to E&P risk and this move would fit into that strategy. This
would also allow RIL access to emerging deepwater technology, in addition to
“internationalizing” the D6 gas pricing issue.
Uncertainty a buying opportunity
Historically, periods of uncertainty have provided buying opportunities. We highlight
2 instances – (1) The late ‘90’s, in the midst of the Asian crisis, when RIL forayed
into refining at a time when petrochem tariff barriers (which aided margins) were
coming off and (2) The mid 2000's, when the family settlement splitting the group
assets was being worked out.
production
E&P remains the source of uncertainty in terms of earnings, and hence stock
performance for RIL – with production currently at less than 60mmscmd. While we
retain our gas production forecasts, we provide below the earnings/PT sensitivity for
lower gas production
Price Target, Earnings changes
We adjust our FY11 estimates downwards by 5% - taking into account a more
moderate full year GRM. Our earnings estimates into FY12/13 remain largely
unchanged as we retain our gas production targets. Our Dec-11 price target remains
Rs1240 - based on 12.5x P/E (adjusted for treasury shares). This is slightly higher
than long-term averages, on account of an improving earnings mix. Key risks to our
view include a weak global economy impacting the refining and petrochemical
businesses, and a delay in gas production ramp-up.
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