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Reliance Industries (RIL)
Energy
Cash may not be king in this case. RIL’s recent AGM did not address the key issues
facing RIL and RIL stock—(1) use of cash, (2) future growth areas than can create
meaningful value and (3) conservative approach towards extant and new growth areas.
We have reduced our 12-month SOTP-based TP to `1,020 from `1,100 previously. In
our view, RIL stock may continue to get de-rated unless it can demonstrate ability to
successfully invest cash generated over the next few years to create meaningful value.
Nothing material in new announcement at recent annual general meeting (AGM)
RIL did not announce any major expansion plans or identify new growth areas in its 37th annual
general meeting of shareholders held on June 3, 2011. The company seems to have dropped
power as a growth area but stressed on a new ‘wave’ of growth in consumer and digital areas. It
did not provide much clarity on production issues in the KG D-6 block but acknowledged technical
issues in the block.
Use of cash critical for next leg of growth; stock de-rating may continue otherwise
In our view, RIL’s ability to use likely large gross cash flow generation fruitfully over the next few
years (US$20 bn in FY2012-14E) would determine RIL’s stock price in the medium term. RIL stock
has historically enjoyed a large growth premium associated with RIL’s ability to use cash flows and
capital markets aggressively to grow at scorching rates. However, RIL runs the risk of being valued
like a normal company on earnings and cash flows unless it can demonstrate the ability to create
value beyond cycles in extant areas and in new consumer-centric and knowledge-based areas.
The stock has already seen some de-rating of late.
Cash is just that, cash; several options to use it though
RIL’s free cash flow generation (US$5.5 bn per annum in FY2012-14E) may not be sufficient to
prevent a de-rating unless it can use the same to create additional value. RIL’s large size (US$62 bn
market capitalization) means that it will have to create US$9 bn of value every year to simply grow
at say, 14% CAGR (in line with India’s nominal GDP growth). RIL has several options to use the
large cash flow though—(1) invest in extant businesses, (2) invest in new businesses, (3) acquire
assets and (4) return the cash to shareholders.
Reduced target price to factor in continued delay in E&P activity, fine-tuned estimates
We have reduced our 12-month SOTP-based target price to `1,020 from `1,100 to factor in
(1) lower gas production at KG D-6 block for the next three years, (2) likely delay in gas production
from NEC-25, KG D-3, KG D-9 and MN D-4 blocks; we have pushed back production by 1-3 years
and (3) higher cost of capital to factor in enhanced risk. We have fine-tuned estimates.
Nothing material in AGM, most of the announcements are already known
We will not focus on the announcements of the AGM since almost of these have been
discussed by the management in recent analyst meetings, investor presentations and the
FY2011 annual report. In fact, the most significant ‘announcement’ (if it can be called so)
was a lack of any mention of the power sector in the chairman’s speech. In the previous
AGM, the management had announced “transformational initiatives power” with its
intention to participate in the “whole value chain of the power business, spanning
generation, transmission and distribution.” It seems the power sector is no longer a
growth area for RIL.
The management also did not provide further clarity on the production issues in KG D-6
block but acknowledged certain issues in the block. We reproduce the statement from
the chairman’s speech. “Significant efforts are underway to comprehend the character
and the behavior of these complex reservoirs, first of its kind developed in Indian deep
waters. These include extensive geoscientific and engineering work to be undertaken
with our partners to sustain and augment the production. After the government
approvals for the BP-Reliance partnership, the KG D6 reservoirs will be jointly assessed to
address the technical issues in ramping up production.”
We instead discuss the key challenges facing RIL stock at the current juncture.
Multiple de-rating may continue
We see a continued risk of de-rating of RIL stock without clear signals from the
management on its strategy to grow the company beyond the current businesses. The
market has historically accorded a growth premium to RIL’s valuation (through high value
of emerging businesses) with the expectation that RIL will use its cash flows to enter new
businesses, build leadership positions in those businesses and create value. Given the
continued delay in monetizing E&P assets and question marks on its most recent
businesses, we believe RIL runs the risk of being valued like any ‘normal’ company.
We note that RIL stock has traded at premium multiples compared to the cyclical
commodity nature of its earnings (see Exhibit 1 that compares RIL’s 12-month rolling
forward P/E multiple with the market’s since April 1999). The market has historically
accorded a ‘growth’ premium to RIL given that it has (1) grown earnings rapidly by
aggressively creating capacities to participate in the growing markets of petrochemicals
and refining in India and (2) identified growth opportunities, which the market has given
disproportionate value to in the initial years of those new businesses
In our view, the recent de-rating of the stock reflects the market’s growing concerns
about the two aforementioned growth drivers of RIL.
Earnings growth. We model RIL’s EPS to grow at 8.7% CAGR between FY2011 and
FY2014E in contrast to very rapid growth in its earnings over the past two decades.
RIL’s EPS has grown at 15% CAGR between FY1993 and FY2011 and at 24% CAGR
between FY2001 and FY2011 (see Exhibit 2 that charts RIL’s yearly EPS and growth
rate between various periods). We choose these periods since 1993 marked the
beginning of RIL’s rapid push into petrochemicals and FY2001 marked its entry into
refining with the first full year of operation of its first Jamnagar refinery. RIL’s EPS has
grown a more sedate 14.4% CAGR between FY2006 and FY2011 despite start of its
second Jamnagar refinery and a much more significant foray into the E&P segment
with the start of gas production from its KG D-6 block
RIL has historically used cash flows of extant businesses to expand aggressively into the
same business through vertical integration or has invested in growth areas that have
further contributed to earnings growth. However, RIL’s current expansion plans are
quite small in the context of its extant operations.
Value of new businesses. We see low value in RIL’s future initiatives given limited
progress in organized retailing, retreat from SEZs and lack of other initiatives. We treat
E&P as a traditional business even though we ascribe some value to several of RIL’s oil
and gas blocks where it has made discoveries. RIL’s recent production problems at its
KG D-6 block and continued delay in E&P activity in other blocks may lead to the
market questioning the street’s valuations of the E&P segment, notwithstanding the
US$24 bn valuation implied for RIL’s 23 oil and gas blocks in India (other than PMT
fields) by the recent RIL-BP deal.
RIL’s stock price has typically reflected value for new initiatives, be it telecom in
CY2001-05, E&P in CY2004-08 (and even now) and retailing and SEZ in CY2007-08.
The market has accorded massive value to RIL’s new initiatives at very early stages of
those initiatives.
Reduced SOTP-based target price to `1,020, fine-tuned estimates
Exhibit 3 is our SOTP valuation of RIL based on FY2013E estimates. We have made a few
changes to our SOTP and earnings models.
Reduced KG D-6 gas production. We have cut FY2012E, FY2013E, FY2014E gas
production to 50 mcm/d, 55 mcm/d and 70 mcm/d against 52 mcm/d, 65 mcm/d and
80 mcm/d previously. Our revised FY2012E, FY2013E and FY2014E EPS are `68, `70.9
and `79.6 versus `68.5, `73.1 and `81.5 previously.
Pushed back production from other blocks by 1-3 years. We now model gas
production from NEC-25 block in FY2017E and from KG D-3 and KG D-9 blocks in
FY2018E. We model eventual gas production of 1.9 tcf, 9.3 tcf and 5.3 tcf from NEC-
25, KG D-3 and KG D-9 blocks. We have pushed back gas production in MN D-4
block to FY2021E versus FY2018E earlier noting that RIL is yet to commence
exploration drilling in the block. RIL took about 6.5 years to produce gas from the KG
D-6 block after discovery of first gas in the block.
Finally, we have removed the valuation of the CBM blocks (Sohagpur East and
Sohagpur West) from our SOTP model since RIL is yet to make any significant progress
in exploiting the blocks and it will be some time before RIL is able to develop the
blocks and pipeline infrastructure to evacuate the gas to consumption centers. The
blocks are far from consumption centers and in the coal-rich eastern part of the
country. We were overly optimistic about the prospects of the CBM blocks and had
accorded `107 bn value (`36/share) to them previously. We will value them on
earnings basis as and when they commence production; initial production would be
too small to make any material difference, in our view.
No change to refining and chemical margin assumptions. We model FY2012E,
FY2013E and FY2014E refining margins at US$9.5/bbl, US$10.1/bbl and US$10.5/bbl.
Exhibit 4 gives our key assumptions for the refining segment. Exhibit 5 gives the major
price and margin assumptions for the chemical segment. As can be seen, we expect
EBITDA of both the chemical and refining segments to grow moderately over the next
three years.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries (RIL)
Energy
Cash may not be king in this case. RIL’s recent AGM did not address the key issues
facing RIL and RIL stock—(1) use of cash, (2) future growth areas than can create
meaningful value and (3) conservative approach towards extant and new growth areas.
We have reduced our 12-month SOTP-based TP to `1,020 from `1,100 previously. In
our view, RIL stock may continue to get de-rated unless it can demonstrate ability to
successfully invest cash generated over the next few years to create meaningful value.
Nothing material in new announcement at recent annual general meeting (AGM)
RIL did not announce any major expansion plans or identify new growth areas in its 37th annual
general meeting of shareholders held on June 3, 2011. The company seems to have dropped
power as a growth area but stressed on a new ‘wave’ of growth in consumer and digital areas. It
did not provide much clarity on production issues in the KG D-6 block but acknowledged technical
issues in the block.
Use of cash critical for next leg of growth; stock de-rating may continue otherwise
In our view, RIL’s ability to use likely large gross cash flow generation fruitfully over the next few
years (US$20 bn in FY2012-14E) would determine RIL’s stock price in the medium term. RIL stock
has historically enjoyed a large growth premium associated with RIL’s ability to use cash flows and
capital markets aggressively to grow at scorching rates. However, RIL runs the risk of being valued
like a normal company on earnings and cash flows unless it can demonstrate the ability to create
value beyond cycles in extant areas and in new consumer-centric and knowledge-based areas.
The stock has already seen some de-rating of late.
Cash is just that, cash; several options to use it though
RIL’s free cash flow generation (US$5.5 bn per annum in FY2012-14E) may not be sufficient to
prevent a de-rating unless it can use the same to create additional value. RIL’s large size (US$62 bn
market capitalization) means that it will have to create US$9 bn of value every year to simply grow
at say, 14% CAGR (in line with India’s nominal GDP growth). RIL has several options to use the
large cash flow though—(1) invest in extant businesses, (2) invest in new businesses, (3) acquire
assets and (4) return the cash to shareholders.
Reduced target price to factor in continued delay in E&P activity, fine-tuned estimates
We have reduced our 12-month SOTP-based target price to `1,020 from `1,100 to factor in
(1) lower gas production at KG D-6 block for the next three years, (2) likely delay in gas production
from NEC-25, KG D-3, KG D-9 and MN D-4 blocks; we have pushed back production by 1-3 years
and (3) higher cost of capital to factor in enhanced risk. We have fine-tuned estimates.
Nothing material in AGM, most of the announcements are already known
We will not focus on the announcements of the AGM since almost of these have been
discussed by the management in recent analyst meetings, investor presentations and the
FY2011 annual report. In fact, the most significant ‘announcement’ (if it can be called so)
was a lack of any mention of the power sector in the chairman’s speech. In the previous
AGM, the management had announced “transformational initiatives power” with its
intention to participate in the “whole value chain of the power business, spanning
generation, transmission and distribution.” It seems the power sector is no longer a
growth area for RIL.
The management also did not provide further clarity on the production issues in KG D-6
block but acknowledged certain issues in the block. We reproduce the statement from
the chairman’s speech. “Significant efforts are underway to comprehend the character
and the behavior of these complex reservoirs, first of its kind developed in Indian deep
waters. These include extensive geoscientific and engineering work to be undertaken
with our partners to sustain and augment the production. After the government
approvals for the BP-Reliance partnership, the KG D6 reservoirs will be jointly assessed to
address the technical issues in ramping up production.”
We instead discuss the key challenges facing RIL stock at the current juncture.
Multiple de-rating may continue
We see a continued risk of de-rating of RIL stock without clear signals from the
management on its strategy to grow the company beyond the current businesses. The
market has historically accorded a growth premium to RIL’s valuation (through high value
of emerging businesses) with the expectation that RIL will use its cash flows to enter new
businesses, build leadership positions in those businesses and create value. Given the
continued delay in monetizing E&P assets and question marks on its most recent
businesses, we believe RIL runs the risk of being valued like any ‘normal’ company.
We note that RIL stock has traded at premium multiples compared to the cyclical
commodity nature of its earnings (see Exhibit 1 that compares RIL’s 12-month rolling
forward P/E multiple with the market’s since April 1999). The market has historically
accorded a ‘growth’ premium to RIL given that it has (1) grown earnings rapidly by
aggressively creating capacities to participate in the growing markets of petrochemicals
and refining in India and (2) identified growth opportunities, which the market has given
disproportionate value to in the initial years of those new businesses
In our view, the recent de-rating of the stock reflects the market’s growing concerns
about the two aforementioned growth drivers of RIL.
Earnings growth. We model RIL’s EPS to grow at 8.7% CAGR between FY2011 and
FY2014E in contrast to very rapid growth in its earnings over the past two decades.
RIL’s EPS has grown at 15% CAGR between FY1993 and FY2011 and at 24% CAGR
between FY2001 and FY2011 (see Exhibit 2 that charts RIL’s yearly EPS and growth
rate between various periods). We choose these periods since 1993 marked the
beginning of RIL’s rapid push into petrochemicals and FY2001 marked its entry into
refining with the first full year of operation of its first Jamnagar refinery. RIL’s EPS has
grown a more sedate 14.4% CAGR between FY2006 and FY2011 despite start of its
second Jamnagar refinery and a much more significant foray into the E&P segment
with the start of gas production from its KG D-6 block
RIL has historically used cash flows of extant businesses to expand aggressively into the
same business through vertical integration or has invested in growth areas that have
further contributed to earnings growth. However, RIL’s current expansion plans are
quite small in the context of its extant operations.
Value of new businesses. We see low value in RIL’s future initiatives given limited
progress in organized retailing, retreat from SEZs and lack of other initiatives. We treat
E&P as a traditional business even though we ascribe some value to several of RIL’s oil
and gas blocks where it has made discoveries. RIL’s recent production problems at its
KG D-6 block and continued delay in E&P activity in other blocks may lead to the
market questioning the street’s valuations of the E&P segment, notwithstanding the
US$24 bn valuation implied for RIL’s 23 oil and gas blocks in India (other than PMT
fields) by the recent RIL-BP deal.
RIL’s stock price has typically reflected value for new initiatives, be it telecom in
CY2001-05, E&P in CY2004-08 (and even now) and retailing and SEZ in CY2007-08.
The market has accorded massive value to RIL’s new initiatives at very early stages of
those initiatives.
Reduced SOTP-based target price to `1,020, fine-tuned estimates
Exhibit 3 is our SOTP valuation of RIL based on FY2013E estimates. We have made a few
changes to our SOTP and earnings models.
Reduced KG D-6 gas production. We have cut FY2012E, FY2013E, FY2014E gas
production to 50 mcm/d, 55 mcm/d and 70 mcm/d against 52 mcm/d, 65 mcm/d and
80 mcm/d previously. Our revised FY2012E, FY2013E and FY2014E EPS are `68, `70.9
and `79.6 versus `68.5, `73.1 and `81.5 previously.
Pushed back production from other blocks by 1-3 years. We now model gas
production from NEC-25 block in FY2017E and from KG D-3 and KG D-9 blocks in
FY2018E. We model eventual gas production of 1.9 tcf, 9.3 tcf and 5.3 tcf from NEC-
25, KG D-3 and KG D-9 blocks. We have pushed back gas production in MN D-4
block to FY2021E versus FY2018E earlier noting that RIL is yet to commence
exploration drilling in the block. RIL took about 6.5 years to produce gas from the KG
D-6 block after discovery of first gas in the block.
Finally, we have removed the valuation of the CBM blocks (Sohagpur East and
Sohagpur West) from our SOTP model since RIL is yet to make any significant progress
in exploiting the blocks and it will be some time before RIL is able to develop the
blocks and pipeline infrastructure to evacuate the gas to consumption centers. The
blocks are far from consumption centers and in the coal-rich eastern part of the
country. We were overly optimistic about the prospects of the CBM blocks and had
accorded `107 bn value (`36/share) to them previously. We will value them on
earnings basis as and when they commence production; initial production would be
too small to make any material difference, in our view.
No change to refining and chemical margin assumptions. We model FY2012E,
FY2013E and FY2014E refining margins at US$9.5/bbl, US$10.1/bbl and US$10.5/bbl.
Exhibit 4 gives our key assumptions for the refining segment. Exhibit 5 gives the major
price and margin assumptions for the chemical segment. As can be seen, we expect
EBITDA of both the chemical and refining segments to grow moderately over the next
three years.
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