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● We look at RIL using a three-stage DDM (using an 11% cost of
equity). Assuming no growth beyond FY20, we think RIL, at
Rs950/share implies a steady state RoE of between 16-17%.
● These expectations are not aggressive. Over the last ten years,
refining companies’ average RoE have been c.17% – 18% for
E&P and 13% for petchem. On a somewhat crude measure, we
could argue that RIL is then implying average or mid cycle returns.
If RIL were to deliver these returns, the stock could go up 10%
each year (on the roll forward), with an approx.1% dividend yield.
● The stock would do better if (1) core returns saw cyclical gains or
(2) RIL generated excess returns on reinvestment of FCF. The
former is likely, with improvements in refining/ polymer margins.
With leverage (needed for higher returns), RIL can invest c.US$50
bn over the next five years. This might be difficult to spend
organically, within its core businesses and within India.
● While any clarity on KG D6 gas volumes can be a significant
catalyst (helping RoE outlook) in the near term, use of large FCF,
and returns generated will determine share prices longer term
A top down look at RIL
We step back from the daily concerns on KG oil/ gas volumes to look
at potential stock price drivers in the long run. We build a three stage
DDM for RIL assuming no reinvestment beyond FY20. Using an 11%
cost of equity (which is perhaps aggressive given interest rate
increases), RIL today implies a steady state RoE of 16-17%
(depending on whether one counts treasury stock or not). A 1% higher
discount rate would increase this implied expectation by about 150 bp.
These expectations are not aggressive
A simple average of refining company RoE’s over the last decade
comes in at 17% – 18% for E&P and 13% for petchem. While it may
be argued that long-term returns before CY2000 were much lower, we
do not see crude prices/ refining spare capacities getting to levels
seen then any time soon. The ten-year average captures both the
uptrend and the correction in returns and should therefore represent
close to mid cycle expectations. Petchem RoEs are lower, but RIL has
an advantaged position in India, with vertical integration that should
help it deliver better returns. On a somewhat crude measure, we could
argue that RIL is then implying average, or mid cycle returns.
If RIL were to deliver these returns, the stock could likely go up 10%
each year (on the roll forward), with an approx.1% dividend yield.
How would the stock go up then?
a) If commodity returns (refining/ petchem) improved. This is likely.
Refining capacity growth is slowing, but margins could continue to
improve. Capacity growth on polymers is expected to slow, though
polyester margins can ease along with cotton prices in near term.
b) If RIL is able to generate better returns on new projects – returns
on cash reinvested.
On a separate model, an 18% return on RIL’s estimated free cash
flow stream would be worth c.Rs140/share (at an 11% discount rate) –
not large in the context of RIL. A larger impact could be had if RIL
were able to leverage its FCF and invest this in projects that generate
excess returns.
Figure 2: PV of returns on FCF if reinvested at RoE
RoE PV of returns on FCF
9% 71
12% 94
15% 118
18% 141
21% 165
24% 189
Source: Company data, Credit Suisse estimates
The last can be a significant challenge. RIL should generate at least
US$25 bn in FCF over the next five years. With a 1:1 leverage, it
could potentially invest US$50 bn. This may be too large an amount to
spend organically, especially in its core businesses within India.
Acquisitions can absorb cash, but it becomes difficult to expect excess
returns from such spends upfront. While clarity on gas volumes can
be a significant catalyst in the near term, excess cash is a larger,
longer term issue.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● We look at RIL using a three-stage DDM (using an 11% cost of
equity). Assuming no growth beyond FY20, we think RIL, at
Rs950/share implies a steady state RoE of between 16-17%.
● These expectations are not aggressive. Over the last ten years,
refining companies’ average RoE have been c.17% – 18% for
E&P and 13% for petchem. On a somewhat crude measure, we
could argue that RIL is then implying average or mid cycle returns.
If RIL were to deliver these returns, the stock could go up 10%
each year (on the roll forward), with an approx.1% dividend yield.
● The stock would do better if (1) core returns saw cyclical gains or
(2) RIL generated excess returns on reinvestment of FCF. The
former is likely, with improvements in refining/ polymer margins.
With leverage (needed for higher returns), RIL can invest c.US$50
bn over the next five years. This might be difficult to spend
organically, within its core businesses and within India.
● While any clarity on KG D6 gas volumes can be a significant
catalyst (helping RoE outlook) in the near term, use of large FCF,
and returns generated will determine share prices longer term
A top down look at RIL
We step back from the daily concerns on KG oil/ gas volumes to look
at potential stock price drivers in the long run. We build a three stage
DDM for RIL assuming no reinvestment beyond FY20. Using an 11%
cost of equity (which is perhaps aggressive given interest rate
increases), RIL today implies a steady state RoE of 16-17%
(depending on whether one counts treasury stock or not). A 1% higher
discount rate would increase this implied expectation by about 150 bp.
These expectations are not aggressive
A simple average of refining company RoE’s over the last decade
comes in at 17% – 18% for E&P and 13% for petchem. While it may
be argued that long-term returns before CY2000 were much lower, we
do not see crude prices/ refining spare capacities getting to levels
seen then any time soon. The ten-year average captures both the
uptrend and the correction in returns and should therefore represent
close to mid cycle expectations. Petchem RoEs are lower, but RIL has
an advantaged position in India, with vertical integration that should
help it deliver better returns. On a somewhat crude measure, we could
argue that RIL is then implying average, or mid cycle returns.
If RIL were to deliver these returns, the stock could likely go up 10%
each year (on the roll forward), with an approx.1% dividend yield.
How would the stock go up then?
a) If commodity returns (refining/ petchem) improved. This is likely.
Refining capacity growth is slowing, but margins could continue to
improve. Capacity growth on polymers is expected to slow, though
polyester margins can ease along with cotton prices in near term.
b) If RIL is able to generate better returns on new projects – returns
on cash reinvested.
On a separate model, an 18% return on RIL’s estimated free cash
flow stream would be worth c.Rs140/share (at an 11% discount rate) –
not large in the context of RIL. A larger impact could be had if RIL
were able to leverage its FCF and invest this in projects that generate
excess returns.
Figure 2: PV of returns on FCF if reinvested at RoE
RoE PV of returns on FCF
9% 71
12% 94
15% 118
18% 141
21% 165
24% 189
Source: Company data, Credit Suisse estimates
The last can be a significant challenge. RIL should generate at least
US$25 bn in FCF over the next five years. With a 1:1 leverage, it
could potentially invest US$50 bn. This may be too large an amount to
spend organically, especially in its core businesses within India.
Acquisitions can absorb cash, but it becomes difficult to expect excess
returns from such spends upfront. While clarity on gas volumes can
be a significant catalyst in the near term, excess cash is a larger,
longer term issue.
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