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Reliance Industries (RELI.BO)
Alert: Stock Pricing in No Light at the End of the E&P Tunnel
What is the stock pricing in? Bare-bones E&P value — Following the recent stock
correction on the back of the draft CAG audit report, we have run sensitivities on our
SOTP to gauge what the stock is pricing in. We conclude that it is now building in: (i)
E&P back to trading on par with NAV (vs. a premium earlier), and that too of sharply
lower reserves (9.3 tcf), and (ii) refining and petchem trading at 6.2x EV/EBITDA (6-8x
for peers), despite refining margins remaining resilient of late. While sentiment on the
stock may continue to be governed by news flow (CAG audit, KG ramp-up, doubts on
reserves), the stock now seems to be pricing in a near no hope situation as far as E&P
is concerned, offering good value once (and if) all the noise subsides. We highlight
below what we believe are the assumptions embedded in the current price.
#1: Gas vols declining to 45 mmscmd and never recovering — If we assume gas
vols to decline to 45 mmscmd from current reported levels of ~47-48 (source:
indianpetro) and stay there through the asset life before their natural decline, this yields
a NAV of Rs151/sh for KG-D6, which is what the stock seems to be pricing in. This
conservatively assumes gas prices to increase by only US$1 to US$5.2 w.e.f. FY15,
which is in line with the prices already approved for some of ONGC's incremental gas
and lower than existing prices of US$5.6-5.7 for PMT gas. This also, extremely
conservatively, assumes no value for any of the other blocks and essentially completely
ignores RIL’s past exploration successes (as well as today’s gas discovery in KG-D9).
#2: Pricing in recoverable reserves of 9.3 tcf — The above assumption yields
cumulative recovery of 9.3 tcf for KG-D6. This is below the 11.3 tcf 2P reserves as per
the FDP filed for the block as well as below the 13.0 tcf reserves as per Niko's FY08
press release. Niko has recently published a reserve update indicating that its 2P
reserves have been reduced by 17%, without disclosing the break-up of this reduction
among its various assets (KG-D6, Hazira, Bangladesh). Given its other assets are
relatively small, a large portion of the downgrade could admittedly be attributable to
KG-D6. Even in a worst case, this would, however, be a downgrade of 2.7 tcf to its last
reported reserves of 13.0 tcf, still above the 9.3 tcf being currently implied for the block.
#3: Imputing EV/EBITDA of 6.2x for refining/petchem — Stripping out E&P value of
Rs151/sh, the stock is imputing 6.2x EV/EBITDA for refining and petchem, at the lower
end of the 6-8x band for regional peers. This is based on our GRM assumptions of
US$10.0/10.5 for FY12/13E. Refining margins have held on well recently and could
surprise on the upside, though they do remain exposed to a macro slowdown.
Refining strength could drive 1Q surprise — S’pore GRMs have averaged US$8.8
in 1QFY12TD. Excluding 4QFY11 where Reliance's GRMs were impacted by a
shutdown in its FCCU bringing down its premium to S’pore to US$1.8, the company
has reported premia of US$2.5-4.4 over the preceding 8 qtrs, with an avg premium of
US$3.4. Even at the lower end of this range, Reliance could report 1Q GRMs close to
~US$11 levels, well above what we or consensus are building into full-year forecasts.
Reliance Industries
Valuation
Our Rs1,115 target price is based on an average of a sum-of-the-parts value
(Rs1,070/sh) and P/E value (Rs1,101/sh) and explicitly adds NPV of the shale gas JVs
of Rs30/sh. Our SOTP is derived by: 1) Valuing RIL's core petchem and downstream
oil business on an EV/EBITDA of 7.0x mid-FY13E which yields a value of Rs705/sh; 2)
Valuing total E&P assets including oil & gas prospects and other blocks at Rs307/sh
based on a 25% premium to NAV of known reserves; 3) Valuing investments in the
organized retail business, SEZ, telecom, etc. at Rs42/share, based on book value of
investments so far; 4) Valuing treasury stock at a 20% discount to target price; 5)
Subtracting net debt estimated as on Sep-11E (net of capex on future expansion
projects such as petchem) of Rs200bn or Rs61/sh. For the P/E valuation, we ascribe a
13x mid-FY13E multiple, in line with the market multiple. While earnings from the E&P
business are now likely to be more back-ended given delays in gas ramp-up believe,
near-term earnings have support from the strong refinery and petchem outlook. This
prompts us to give equal weightage to a multiple-based methodology and a sum-of-theparts
based value while deducing our target price.
Risks
We rate RIL Low Risk, in line with the rating suggested by our quantitative risk-rating
system. With the core refining and petrochemicals businesses gaining momentum, we
believe that risks on slower KG ramp-up could be partly offset. Downside risks that
could prevent the shares from reaching our target price include: RIL's margins are
exposed to the global refining and petrochemical cycles, which could be impacted in
the eventuality of a global macro slowdown; further delays in the ramp-up of production
of KG-D6 gas; delays in the drilling programme and/or negative news-flow for the other
blocks (D9, D3, MN-D4); charges against RIL pertaining to a 2007 case regarding
insider trading in shares of RPL (an erstwhile subsidiary), which could impact stock
sentiment; lack of clarity on deployment of cash and/or announcements on unrelated
diversifications.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries (RELI.BO)
Alert: Stock Pricing in No Light at the End of the E&P Tunnel
What is the stock pricing in? Bare-bones E&P value — Following the recent stock
correction on the back of the draft CAG audit report, we have run sensitivities on our
SOTP to gauge what the stock is pricing in. We conclude that it is now building in: (i)
E&P back to trading on par with NAV (vs. a premium earlier), and that too of sharply
lower reserves (9.3 tcf), and (ii) refining and petchem trading at 6.2x EV/EBITDA (6-8x
for peers), despite refining margins remaining resilient of late. While sentiment on the
stock may continue to be governed by news flow (CAG audit, KG ramp-up, doubts on
reserves), the stock now seems to be pricing in a near no hope situation as far as E&P
is concerned, offering good value once (and if) all the noise subsides. We highlight
below what we believe are the assumptions embedded in the current price.
#1: Gas vols declining to 45 mmscmd and never recovering — If we assume gas
vols to decline to 45 mmscmd from current reported levels of ~47-48 (source:
indianpetro) and stay there through the asset life before their natural decline, this yields
a NAV of Rs151/sh for KG-D6, which is what the stock seems to be pricing in. This
conservatively assumes gas prices to increase by only US$1 to US$5.2 w.e.f. FY15,
which is in line with the prices already approved for some of ONGC's incremental gas
and lower than existing prices of US$5.6-5.7 for PMT gas. This also, extremely
conservatively, assumes no value for any of the other blocks and essentially completely
ignores RIL’s past exploration successes (as well as today’s gas discovery in KG-D9).
#2: Pricing in recoverable reserves of 9.3 tcf — The above assumption yields
cumulative recovery of 9.3 tcf for KG-D6. This is below the 11.3 tcf 2P reserves as per
the FDP filed for the block as well as below the 13.0 tcf reserves as per Niko's FY08
press release. Niko has recently published a reserve update indicating that its 2P
reserves have been reduced by 17%, without disclosing the break-up of this reduction
among its various assets (KG-D6, Hazira, Bangladesh). Given its other assets are
relatively small, a large portion of the downgrade could admittedly be attributable to
KG-D6. Even in a worst case, this would, however, be a downgrade of 2.7 tcf to its last
reported reserves of 13.0 tcf, still above the 9.3 tcf being currently implied for the block.
#3: Imputing EV/EBITDA of 6.2x for refining/petchem — Stripping out E&P value of
Rs151/sh, the stock is imputing 6.2x EV/EBITDA for refining and petchem, at the lower
end of the 6-8x band for regional peers. This is based on our GRM assumptions of
US$10.0/10.5 for FY12/13E. Refining margins have held on well recently and could
surprise on the upside, though they do remain exposed to a macro slowdown.
Refining strength could drive 1Q surprise — S’pore GRMs have averaged US$8.8
in 1QFY12TD. Excluding 4QFY11 where Reliance's GRMs were impacted by a
shutdown in its FCCU bringing down its premium to S’pore to US$1.8, the company
has reported premia of US$2.5-4.4 over the preceding 8 qtrs, with an avg premium of
US$3.4. Even at the lower end of this range, Reliance could report 1Q GRMs close to
~US$11 levels, well above what we or consensus are building into full-year forecasts.
Reliance Industries
Valuation
Our Rs1,115 target price is based on an average of a sum-of-the-parts value
(Rs1,070/sh) and P/E value (Rs1,101/sh) and explicitly adds NPV of the shale gas JVs
of Rs30/sh. Our SOTP is derived by: 1) Valuing RIL's core petchem and downstream
oil business on an EV/EBITDA of 7.0x mid-FY13E which yields a value of Rs705/sh; 2)
Valuing total E&P assets including oil & gas prospects and other blocks at Rs307/sh
based on a 25% premium to NAV of known reserves; 3) Valuing investments in the
organized retail business, SEZ, telecom, etc. at Rs42/share, based on book value of
investments so far; 4) Valuing treasury stock at a 20% discount to target price; 5)
Subtracting net debt estimated as on Sep-11E (net of capex on future expansion
projects such as petchem) of Rs200bn or Rs61/sh. For the P/E valuation, we ascribe a
13x mid-FY13E multiple, in line with the market multiple. While earnings from the E&P
business are now likely to be more back-ended given delays in gas ramp-up believe,
near-term earnings have support from the strong refinery and petchem outlook. This
prompts us to give equal weightage to a multiple-based methodology and a sum-of-theparts
based value while deducing our target price.
Risks
We rate RIL Low Risk, in line with the rating suggested by our quantitative risk-rating
system. With the core refining and petrochemicals businesses gaining momentum, we
believe that risks on slower KG ramp-up could be partly offset. Downside risks that
could prevent the shares from reaching our target price include: RIL's margins are
exposed to the global refining and petrochemical cycles, which could be impacted in
the eventuality of a global macro slowdown; further delays in the ramp-up of production
of KG-D6 gas; delays in the drilling programme and/or negative news-flow for the other
blocks (D9, D3, MN-D4); charges against RIL pertaining to a 2007 case regarding
insider trading in shares of RPL (an erstwhile subsidiary), which could impact stock
sentiment; lack of clarity on deployment of cash and/or announcements on unrelated
diversifications.
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