Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries
Adjusting for Budget & BP deal
We adjust our earnings statements to factor in the Budget impact (rise in tax
rates), the deal with BP (sale of 30% interest in oil/gas blocks) and recent
strength in refining/petchem margins. Use of cash has now emerged as the
biggest stock driver, in our view. Maintain Hold, TP raised to Rs985 (from Rs966).
Operational parameters relatively robust
Higher global GDP growth is providing upside to refining and petchem margins. The sharp
rise in oil prices will also raise crude differentials and we raise our gross refining margin
(GRM) estimates by US$0.5-1/bbl. In petrochemicals, margins have risen sharply across the
polyester chain, remaining relatively subdued in polymers. The positive impact for RIL is
therefore lower than elsewhere as the external sale of polymers (4.4mmt) is higher than for
polyester and intermediates (2.9mmt). In E&P, we maintain our KG-D6 gas volume estimates
at 60mmscmd in FY12/13 (current level 51mmscmd) on the assumption that production will
rise when new wells are (inevitably) brought on line.
Earnings adjusted for higher tax and BP deal
We forecast RIL’s cash tax rate will rise to MAT levels of 20% (up 350bp) and overall rates to
23% (up 300bp) as the new refinery will now be subject to MAT. The US$7.2bn that RIL is to
receive from BP on transfer of 30% stake in 23 oil/gas blocks will be adjusted against the
cost of E&P assets in the books. This should result in zero immediate tax (though lowering
tax depreciation cover for the future) and also a lower book depreciation rate. The
transaction would thus be EPS accretive, as it would convert a non-recurring gain into a
recurring one via a permanently lower depreciation charge.
Maintain Hold, TP Rs985
We raise our FY11-13F EPS forecasts by 4-9% and our SOTP-based target price from
Rs966 to Rs985, maintaining our Hold rating. The cash from BP and lower capex on E&P
should lower net debt, boosting our SOTP. However, the actual impact on the stock price is
not that straight-forward as the market will likely wait for clarity on use of cash. Deployment
opportunities in the core business appear relatively limited, increasing the risk of greater
investment in non-core areas where RIL’s ability to deliver returns is yet to be tested.
Adjusting for Budget & BP deal
Post the BP deal, RIL’s cash surpluses should increase, calling for greater clarity on use of
cash. We see no new opportunities in current businesses, which increases the risk of
higher investment in non-core areas.
Operational parameters relatively robust
GRM estimates raised by US$0.5-1/bbl
On the back of rising demand, Singapore GRMs have been strong, rising sharply to US$6.83/bbl
over January-February 2011. The rise in crude prices will also improve the differentials between
heavy/sour and sweet/light crude providing an additional boost to RIL’s GRMs. The only negative
we see relative to recent quarters is the likely drop in internal consumption of own gas from the
KG-D6 block (due to lower production) which will be substituted by higher-cost imported LNG. The
main risk to GRMs comes from higher oil prices, which can bring down global GDP growth and
hence oil demand.
On the back of improved fundamentals, we have raised RIL’s GRM forecasts by US$0.5-1/bbl
over FY11-13F. Every US$1/bbl rise in GRMs can raise RIL’s EPS by just over 7%, all else being
equal.
Petchem margin strength across polyester, not polymers
The petrochemical segment has provided significant positive surprise, albeit most of it is across
the polyester chain in terms of polyester products (PFY, PSF, PET) and its intermediates (PX,
PTA, MEG). Margins for polymers (PP, PE, PVC) have not risen to that extent and, in fact, PE
margins have been weak in recent months. One factor has been the lower domestic premiums
(domestic prices over landed price of imported material) for PE/PP probably due to the
commencement of full supply from Indian Oil’s new plant (for product margin trends, please see
Appendix).
While we have raised margins across the polyester chain, the overall impact on RIL has been
lower than elsewhere as the external sale volumes of polymers at 4.4mmt far exceed the volumes
of polyester and polyester intermediates (2.9mmt).
E&P – a confusing picture on production
It has become very difficult to take a view on the production profile for KG-D6 gas due to
conflicting statements made by RIL and the upstream regulator – the Director General of
Hydrocarbons (DGH). On 11 January 2011, Bloomberg quoted the DGH stating that KG-D6 gas
production would rise from 53mmscmd to 60mmscmd by April 2011. At the subsequent analyst
meeting, held on 21 January 2011, RIL management provided no update or guidance on the
production profile, stating that discussions were ongoing with the Indian government on this issue
and that it would comment only after some final decisions were made post consultations. We then
cut our production/E&P valuation, estimating KG-D6 gas production would average 60mmscmd
over FY12 and FY13.
On 11 February 2011, Niko Resources, RIL’s partner in the KG-D6 block, provided a statement
that gas production in FY12 would remain at current production levels and that this forecast had
been approved by RIL/Niko and had been forwarded to the DGH. Two days earlier, Niko had
issued its 3QFY11 results press release stating that gross gas sales from KG-D6 were currently at
51-52mmscmd.
News reports since have indicated that gas production has remained weak and is currently at 51-
52mmscmd. However, on 8 March 2011, the DGH again stated that gas production would rise to
67mmscmd in April 2011. RIL management has refused to comment except stating that there is
no change in their stance.
In our view, it would not be possible to raise gas production unless more wells are drilled and
started producing. RIL’s reluctance to drill more wells is probably related to technical and
commercial issues. The unexpected drop in gas production leads us to believe that there is a
technical challenge in producing from these deepwater wells which needs to be understood first
before more wells are drilled. Drilling more wells will also lead to rise in capex on which an
adequate return would not be clearly available unless there was clarity on future gas prices.
We have taken the view that, with BP coming on board, the technical challenges will be overcome
at some point this year. Drilling of more wells is, in a way, inevitable and should result in higher
gas production. Hence, on balance, we have opted to keep our estimates on gas production
unchanged. We would, however, highlight that while the drilling of more wells is inevitable, a
higher production level of 60mmscmd is not, since we have no idea whether there could be a
further production decline from the existing wells.
The deal with BP (in more detail below) will lower the impact of the KG-D6 block on RIL financials.
Every 10% change in gross output will impact EPS by around 1.3-1.4% -- that impact would have
been nearly 3.5% before the deal.
An analysis of RIL’s recent quarterly results also indicates that the fall in KG-D6 gas production
has resulted in a rise in operating costs of nearly US$1.2/bbl in 3QFY11. We believe that these
higher costs will persist and have now assumed a higher operating cost of US$4/boe (US$3/boe
earlier) for KG-D6.
Earnings adjusted for higher tax and BP deal
Budget has raised tax levels
RIL operates its new refinery (Reliance Petroleum, which was merged with RIL) under a special
economic zone (SEZ) and was previously paying virtually zero tax on its profits. However,
following the Union Budget, presented on 28 February 2011, it will have to pay the minimum
alternate tax (MAT) from FY12, which is effectively 20% (basic rate now 18.5%, surcharge 5%,
education cess 3%). This would raise RIL’s total cash tax rate from 16.5% currently to 20%. We
now project total effective tax rate (including deferred tax) will rise from 20% to 23%.
BP deal to enhance reported earnings
On 21 February 2011, RIL announced that BP would be taking a 30% stake in 23 blocks for
US$7.2bn. For details of this deal, please see report, Upside from BP deal, dated 21 February
2011. Of the 23 blocks, production and revenue is being generated currently only from one (KGD6)
while commercial reserves have been proved in two (KG-D6 and NEC-25). While the deal is
effective from 1 January 2011, for the sake of simplicity, we have made the adjustments in our
model from 1 April 2011.
In terms of accounting treatment, the entire proceeds from BP (US$7.2bn or Rs324bn at an
exchange rate of Rs45/USD) would be adjusted against the cost of RIL’s fixed assets or,
specifically, its E&P assets. This would result in zero immediate tax and also lower book
depreciation rate.
RIL follows a full-cost accounting policy for E&P assets. Under this method, all costs incurred for
in E&P (including the cost of surveys, seismic and dry wells) are capitalised and the country is
designated as a cost centre. This cost base is then depleted based on the total production to
reserves ratio for the country as a whole.
The proceeds from the BP transaction are well below the existing E&P cost base for the domestic
E&P assets. We estimate that the capex to date on KG-D6 block alone is about US$8.1bn.
Adjusting the cash inflow from the fixed-asset base would reduce the cost base subject to
depletion, thereby significantly reducing the book depletion charge. The accounting impact is
positive on earnings mainly because the cash inflow received relates not just to the existing KGD6
reserve base, but also to reserves that have yet to be developed in KG-D6, NEC-25 and other
blocks.
We estimate that reported earnings will rise by Rs11bn in FY12 and Rs15bn in FY13 after
considering the impact of the BP deal. While KG-D6 EBITDA contribution will decline by one-third
(as RIL’s stake in the block drops from 90% to 60%), the decline in depletion charge will be even
higher as explained above. The cash proceeds will also raise the investment income.
In terms of taxation, depreciation is considered, based on the concept of block of assets. Tax
depreciation is charged on the entire block (which could be all the E&P assets) and, hence,
proceeds from a sale of any part stake in the block can be adjusted against the value of assets as
per tax laws. Similar to the accounting treatment, if the value of assets, as per tax, is higher than
the cash inflow, then no tax is payable. However, adjustment of the cash proceeds will reduce the
tax depreciation cover available in future years, thereby potentially raising tax liability. The only
way to reduce this tax liability would be to continue investments in the domestic E&P business.
Value of RIL E&P assets benchmarked to BP transaction
Post the announcement of the deal with BP, we have valued the RIL E&P assets covered in this
transaction based on the deal value. The US$7.2bn payment for a 30% stake translates to a
valuation of US$24bn for 100% stake. Given that RIL’s stakes in the key blocks where discoveries
have already been made (KG-D6, NEC-25, KG-V-D3) are around 90%, we believe that the
resultant valuation for RIL’s E&P portfolio is around US$21.6bn (90% of US$24bn).
Prior to considering the impact of the BP deal, our valuation for KG-D6 was US$12.6bn (down
from US$13.4bn earlier due to higher operating cost assumption) and that of NEC-25 was
US$1.5bn. Hence, we have now assumed that BP’s higher valuation is for exploration upside,
which would be US$7.5bn (US$21.6-US$12.6-US$1.5).
Post the deal with BP, RIL’s stake in these blocks will drop by one-third and, accordingly, the
value of E&P assets, which we now use in our SOTP is US$14.5bn (one-third down from
US$21.6bn) or Rs219/share.
Note that since we are benchmarking the E&P valuation on the BP deal, any positive news on
KG-D6/NEC-25, which could raise the value of these blocks (perhaps by higher production) would
not change our total E&P valuation, as we would now correspondingly reduce the value of the
exploration upside.
Maintain Hold, TP Rs985
EPS estimates raised by 4-9%
After considering the impact of margin changes in refining/petchem, higher tax and impact of the
BP deal, we have raised our EPS estimates by 4-9% over FY11-13. Note that the BP deal by itself
will account for 55% of the earnings upgrade in FY12 and more than 100% in FY13. Our EPS and
target price are based on net shares (excluding treasury shares), whereas consensus estimates
tend to be on gross shares.
Our SOTP based target price rises marginally from Rs966 to Rs985, on our earnings upgrades,
and we maintain our Hold rating. Most of the changes in earnings arise from the BP deal, whereas
our target price had already factored in the valuation implied by the BP deal, which we have kept
unchanged. There could be further upside to our refining and petrochemical margin estimates, but
this may not result in a proportionate impact on valuation. For example, the current integrated
margins for PTA are probably the highest ever and, hence, such peak margins should result in a
lower valuation.
Higher cash paradox: positive for our SOTP, but not stock price
RIL has always been regarded as a growth stock with a long history of creating value by putting
up large global-scale greenfield projects at the low end of the cost curve. Hence, capex
announcements have always been a key positive share price trigger indicating visibility on future
growth. The impact of the capex announcements has perhaps lowered in recent years as not all
investments have managed to create value. Cash spent in retail and SEZs in earlier years is yet to
yield returns. Investments in shale gas assets in the US do not yet look attractive given low gas
prices and the proposed investments in telecom are being viewed with caution given the drop in
profitability being experienced by incumbents.
Even before the BP deal, RIL management had stated that investible funds over 2010-15 would
be US$55bn-60bn after considering cash in hand and internal cash generation. Announced capex
plans on the other hand amount to only US$30bn spread as follows:
US$10bn on petrochem, from which investment decisions have been taken for only US$2.5bn;
US$10bn on E&P (US$5bn on shale gas, rest domestic E&P);
US$5bn on telecom and retail; and
US$2bn-2.5bn on maintenance capex
With the BP deal, RIL will receive cash inflow of US$7.2bn and its future capex on domestic E&P
assets will drop by 33% (since its stake will reduce from 90-100% to 60-70%). The higher cash
surpluses will put pressure on RIL either to provide new investment plans or perhaps return cash
to shareholders.
Higher cash would boost our valuation, but not necessarily the stock price. Our SOTP valuation is
constructed such that net debt/cash is adjusted against the value of the assets. For example, the
near-term capex would have to be on petrochem projects of US$10bn. Capex details announced
till 3QFY11, however, indicate that actual spending on these projects is yet to commence. Given
time lines for project execution (CY13/14), we have assumed significant capex for FY12 and FY13
in our model. Any delays will actually lower capex, raise cash levels and increase our SOTP
valuation.
However, the stock price is unlikely to react favourably to any such rise in cash levels. RIL is still
priced for growth and any delays in projects will compress valuations. RIL is also not known to
return cash to shareholders (dividend payout range has been 11-13%) and is unlikely to do so, in
our view. Hence, the expectation is that cash will be deployed in new business opportunities and
the stock price will react according to whether the market perceives these investment plans (as
and when announced) to be value accretive or not.
The basic problem is that RIL was not short of cash even before the BP deal and all attractive
investment opportunities would have already been announced. Management’s track record in
organically growing its core business has been impeccable. But the question is whether there are
enough growth opportunities available under the old business model.
In its core business, building a third refinery does not look feasible despite the recent
improvement in GRMs. In petrochemicals, RIL has probably announced all that it could possibly
do, but even these projects will not yield immediate results. Investments in domestic E&P have
been cut due to the BP deal and valuation will remain benchmarked to the deal value in the
medium-term in any case. The main logical opportunity would be overseas acquisitions, which
now look unlikely given the rise in the price of assets post the pick-up in global GDP and RIL’s
historical discipline of not overpaying.
Hence, the best option to assume is that RIL will put incremental cash into non-core businesses
within the country. Past forays into non-core operations have not provided great results and,
hence, we believe that the market will continue to place some sort of risk premium on the shares
until these new investment plans are announced.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries
Adjusting for Budget & BP deal
We adjust our earnings statements to factor in the Budget impact (rise in tax
rates), the deal with BP (sale of 30% interest in oil/gas blocks) and recent
strength in refining/petchem margins. Use of cash has now emerged as the
biggest stock driver, in our view. Maintain Hold, TP raised to Rs985 (from Rs966).
Operational parameters relatively robust
Higher global GDP growth is providing upside to refining and petchem margins. The sharp
rise in oil prices will also raise crude differentials and we raise our gross refining margin
(GRM) estimates by US$0.5-1/bbl. In petrochemicals, margins have risen sharply across the
polyester chain, remaining relatively subdued in polymers. The positive impact for RIL is
therefore lower than elsewhere as the external sale of polymers (4.4mmt) is higher than for
polyester and intermediates (2.9mmt). In E&P, we maintain our KG-D6 gas volume estimates
at 60mmscmd in FY12/13 (current level 51mmscmd) on the assumption that production will
rise when new wells are (inevitably) brought on line.
Earnings adjusted for higher tax and BP deal
We forecast RIL’s cash tax rate will rise to MAT levels of 20% (up 350bp) and overall rates to
23% (up 300bp) as the new refinery will now be subject to MAT. The US$7.2bn that RIL is to
receive from BP on transfer of 30% stake in 23 oil/gas blocks will be adjusted against the
cost of E&P assets in the books. This should result in zero immediate tax (though lowering
tax depreciation cover for the future) and also a lower book depreciation rate. The
transaction would thus be EPS accretive, as it would convert a non-recurring gain into a
recurring one via a permanently lower depreciation charge.
Maintain Hold, TP Rs985
We raise our FY11-13F EPS forecasts by 4-9% and our SOTP-based target price from
Rs966 to Rs985, maintaining our Hold rating. The cash from BP and lower capex on E&P
should lower net debt, boosting our SOTP. However, the actual impact on the stock price is
not that straight-forward as the market will likely wait for clarity on use of cash. Deployment
opportunities in the core business appear relatively limited, increasing the risk of greater
investment in non-core areas where RIL’s ability to deliver returns is yet to be tested.
Adjusting for Budget & BP deal
Post the BP deal, RIL’s cash surpluses should increase, calling for greater clarity on use of
cash. We see no new opportunities in current businesses, which increases the risk of
higher investment in non-core areas.
Operational parameters relatively robust
GRM estimates raised by US$0.5-1/bbl
On the back of rising demand, Singapore GRMs have been strong, rising sharply to US$6.83/bbl
over January-February 2011. The rise in crude prices will also improve the differentials between
heavy/sour and sweet/light crude providing an additional boost to RIL’s GRMs. The only negative
we see relative to recent quarters is the likely drop in internal consumption of own gas from the
KG-D6 block (due to lower production) which will be substituted by higher-cost imported LNG. The
main risk to GRMs comes from higher oil prices, which can bring down global GDP growth and
hence oil demand.
On the back of improved fundamentals, we have raised RIL’s GRM forecasts by US$0.5-1/bbl
over FY11-13F. Every US$1/bbl rise in GRMs can raise RIL’s EPS by just over 7%, all else being
equal.
Petchem margin strength across polyester, not polymers
The petrochemical segment has provided significant positive surprise, albeit most of it is across
the polyester chain in terms of polyester products (PFY, PSF, PET) and its intermediates (PX,
PTA, MEG). Margins for polymers (PP, PE, PVC) have not risen to that extent and, in fact, PE
margins have been weak in recent months. One factor has been the lower domestic premiums
(domestic prices over landed price of imported material) for PE/PP probably due to the
commencement of full supply from Indian Oil’s new plant (for product margin trends, please see
Appendix).
While we have raised margins across the polyester chain, the overall impact on RIL has been
lower than elsewhere as the external sale volumes of polymers at 4.4mmt far exceed the volumes
of polyester and polyester intermediates (2.9mmt).
E&P – a confusing picture on production
It has become very difficult to take a view on the production profile for KG-D6 gas due to
conflicting statements made by RIL and the upstream regulator – the Director General of
Hydrocarbons (DGH). On 11 January 2011, Bloomberg quoted the DGH stating that KG-D6 gas
production would rise from 53mmscmd to 60mmscmd by April 2011. At the subsequent analyst
meeting, held on 21 January 2011, RIL management provided no update or guidance on the
production profile, stating that discussions were ongoing with the Indian government on this issue
and that it would comment only after some final decisions were made post consultations. We then
cut our production/E&P valuation, estimating KG-D6 gas production would average 60mmscmd
over FY12 and FY13.
On 11 February 2011, Niko Resources, RIL’s partner in the KG-D6 block, provided a statement
that gas production in FY12 would remain at current production levels and that this forecast had
been approved by RIL/Niko and had been forwarded to the DGH. Two days earlier, Niko had
issued its 3QFY11 results press release stating that gross gas sales from KG-D6 were currently at
51-52mmscmd.
News reports since have indicated that gas production has remained weak and is currently at 51-
52mmscmd. However, on 8 March 2011, the DGH again stated that gas production would rise to
67mmscmd in April 2011. RIL management has refused to comment except stating that there is
no change in their stance.
In our view, it would not be possible to raise gas production unless more wells are drilled and
started producing. RIL’s reluctance to drill more wells is probably related to technical and
commercial issues. The unexpected drop in gas production leads us to believe that there is a
technical challenge in producing from these deepwater wells which needs to be understood first
before more wells are drilled. Drilling more wells will also lead to rise in capex on which an
adequate return would not be clearly available unless there was clarity on future gas prices.
We have taken the view that, with BP coming on board, the technical challenges will be overcome
at some point this year. Drilling of more wells is, in a way, inevitable and should result in higher
gas production. Hence, on balance, we have opted to keep our estimates on gas production
unchanged. We would, however, highlight that while the drilling of more wells is inevitable, a
higher production level of 60mmscmd is not, since we have no idea whether there could be a
further production decline from the existing wells.
The deal with BP (in more detail below) will lower the impact of the KG-D6 block on RIL financials.
Every 10% change in gross output will impact EPS by around 1.3-1.4% -- that impact would have
been nearly 3.5% before the deal.
An analysis of RIL’s recent quarterly results also indicates that the fall in KG-D6 gas production
has resulted in a rise in operating costs of nearly US$1.2/bbl in 3QFY11. We believe that these
higher costs will persist and have now assumed a higher operating cost of US$4/boe (US$3/boe
earlier) for KG-D6.
Earnings adjusted for higher tax and BP deal
Budget has raised tax levels
RIL operates its new refinery (Reliance Petroleum, which was merged with RIL) under a special
economic zone (SEZ) and was previously paying virtually zero tax on its profits. However,
following the Union Budget, presented on 28 February 2011, it will have to pay the minimum
alternate tax (MAT) from FY12, which is effectively 20% (basic rate now 18.5%, surcharge 5%,
education cess 3%). This would raise RIL’s total cash tax rate from 16.5% currently to 20%. We
now project total effective tax rate (including deferred tax) will rise from 20% to 23%.
BP deal to enhance reported earnings
On 21 February 2011, RIL announced that BP would be taking a 30% stake in 23 blocks for
US$7.2bn. For details of this deal, please see report, Upside from BP deal, dated 21 February
2011. Of the 23 blocks, production and revenue is being generated currently only from one (KGD6)
while commercial reserves have been proved in two (KG-D6 and NEC-25). While the deal is
effective from 1 January 2011, for the sake of simplicity, we have made the adjustments in our
model from 1 April 2011.
In terms of accounting treatment, the entire proceeds from BP (US$7.2bn or Rs324bn at an
exchange rate of Rs45/USD) would be adjusted against the cost of RIL’s fixed assets or,
specifically, its E&P assets. This would result in zero immediate tax and also lower book
depreciation rate.
RIL follows a full-cost accounting policy for E&P assets. Under this method, all costs incurred for
in E&P (including the cost of surveys, seismic and dry wells) are capitalised and the country is
designated as a cost centre. This cost base is then depleted based on the total production to
reserves ratio for the country as a whole.
The proceeds from the BP transaction are well below the existing E&P cost base for the domestic
E&P assets. We estimate that the capex to date on KG-D6 block alone is about US$8.1bn.
Adjusting the cash inflow from the fixed-asset base would reduce the cost base subject to
depletion, thereby significantly reducing the book depletion charge. The accounting impact is
positive on earnings mainly because the cash inflow received relates not just to the existing KGD6
reserve base, but also to reserves that have yet to be developed in KG-D6, NEC-25 and other
blocks.
We estimate that reported earnings will rise by Rs11bn in FY12 and Rs15bn in FY13 after
considering the impact of the BP deal. While KG-D6 EBITDA contribution will decline by one-third
(as RIL’s stake in the block drops from 90% to 60%), the decline in depletion charge will be even
higher as explained above. The cash proceeds will also raise the investment income.
In terms of taxation, depreciation is considered, based on the concept of block of assets. Tax
depreciation is charged on the entire block (which could be all the E&P assets) and, hence,
proceeds from a sale of any part stake in the block can be adjusted against the value of assets as
per tax laws. Similar to the accounting treatment, if the value of assets, as per tax, is higher than
the cash inflow, then no tax is payable. However, adjustment of the cash proceeds will reduce the
tax depreciation cover available in future years, thereby potentially raising tax liability. The only
way to reduce this tax liability would be to continue investments in the domestic E&P business.
Value of RIL E&P assets benchmarked to BP transaction
Post the announcement of the deal with BP, we have valued the RIL E&P assets covered in this
transaction based on the deal value. The US$7.2bn payment for a 30% stake translates to a
valuation of US$24bn for 100% stake. Given that RIL’s stakes in the key blocks where discoveries
have already been made (KG-D6, NEC-25, KG-V-D3) are around 90%, we believe that the
resultant valuation for RIL’s E&P portfolio is around US$21.6bn (90% of US$24bn).
Prior to considering the impact of the BP deal, our valuation for KG-D6 was US$12.6bn (down
from US$13.4bn earlier due to higher operating cost assumption) and that of NEC-25 was
US$1.5bn. Hence, we have now assumed that BP’s higher valuation is for exploration upside,
which would be US$7.5bn (US$21.6-US$12.6-US$1.5).
Post the deal with BP, RIL’s stake in these blocks will drop by one-third and, accordingly, the
value of E&P assets, which we now use in our SOTP is US$14.5bn (one-third down from
US$21.6bn) or Rs219/share.
Note that since we are benchmarking the E&P valuation on the BP deal, any positive news on
KG-D6/NEC-25, which could raise the value of these blocks (perhaps by higher production) would
not change our total E&P valuation, as we would now correspondingly reduce the value of the
exploration upside.
Maintain Hold, TP Rs985
EPS estimates raised by 4-9%
After considering the impact of margin changes in refining/petchem, higher tax and impact of the
BP deal, we have raised our EPS estimates by 4-9% over FY11-13. Note that the BP deal by itself
will account for 55% of the earnings upgrade in FY12 and more than 100% in FY13. Our EPS and
target price are based on net shares (excluding treasury shares), whereas consensus estimates
tend to be on gross shares.
Our SOTP based target price rises marginally from Rs966 to Rs985, on our earnings upgrades,
and we maintain our Hold rating. Most of the changes in earnings arise from the BP deal, whereas
our target price had already factored in the valuation implied by the BP deal, which we have kept
unchanged. There could be further upside to our refining and petrochemical margin estimates, but
this may not result in a proportionate impact on valuation. For example, the current integrated
margins for PTA are probably the highest ever and, hence, such peak margins should result in a
lower valuation.
Higher cash paradox: positive for our SOTP, but not stock price
RIL has always been regarded as a growth stock with a long history of creating value by putting
up large global-scale greenfield projects at the low end of the cost curve. Hence, capex
announcements have always been a key positive share price trigger indicating visibility on future
growth. The impact of the capex announcements has perhaps lowered in recent years as not all
investments have managed to create value. Cash spent in retail and SEZs in earlier years is yet to
yield returns. Investments in shale gas assets in the US do not yet look attractive given low gas
prices and the proposed investments in telecom are being viewed with caution given the drop in
profitability being experienced by incumbents.
Even before the BP deal, RIL management had stated that investible funds over 2010-15 would
be US$55bn-60bn after considering cash in hand and internal cash generation. Announced capex
plans on the other hand amount to only US$30bn spread as follows:
US$10bn on petrochem, from which investment decisions have been taken for only US$2.5bn;
US$10bn on E&P (US$5bn on shale gas, rest domestic E&P);
US$5bn on telecom and retail; and
US$2bn-2.5bn on maintenance capex
With the BP deal, RIL will receive cash inflow of US$7.2bn and its future capex on domestic E&P
assets will drop by 33% (since its stake will reduce from 90-100% to 60-70%). The higher cash
surpluses will put pressure on RIL either to provide new investment plans or perhaps return cash
to shareholders.
Higher cash would boost our valuation, but not necessarily the stock price. Our SOTP valuation is
constructed such that net debt/cash is adjusted against the value of the assets. For example, the
near-term capex would have to be on petrochem projects of US$10bn. Capex details announced
till 3QFY11, however, indicate that actual spending on these projects is yet to commence. Given
time lines for project execution (CY13/14), we have assumed significant capex for FY12 and FY13
in our model. Any delays will actually lower capex, raise cash levels and increase our SOTP
valuation.
However, the stock price is unlikely to react favourably to any such rise in cash levels. RIL is still
priced for growth and any delays in projects will compress valuations. RIL is also not known to
return cash to shareholders (dividend payout range has been 11-13%) and is unlikely to do so, in
our view. Hence, the expectation is that cash will be deployed in new business opportunities and
the stock price will react according to whether the market perceives these investment plans (as
and when announced) to be value accretive or not.
The basic problem is that RIL was not short of cash even before the BP deal and all attractive
investment opportunities would have already been announced. Management’s track record in
organically growing its core business has been impeccable. But the question is whether there are
enough growth opportunities available under the old business model.
In its core business, building a third refinery does not look feasible despite the recent
improvement in GRMs. In petrochemicals, RIL has probably announced all that it could possibly
do, but even these projects will not yield immediate results. Investments in domestic E&P have
been cut due to the BP deal and valuation will remain benchmarked to the deal value in the
medium-term in any case. The main logical opportunity would be overseas acquisitions, which
now look unlikely given the rise in the price of assets post the pick-up in global GDP and RIL’s
historical discipline of not overpaying.
Hence, the best option to assume is that RIL will put incremental cash into non-core businesses
within the country. Past forays into non-core operations have not provided great results and,
hence, we believe that the market will continue to place some sort of risk premium on the shares
until these new investment plans are announced.
No comments:
Post a Comment