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E&P stalls, Ref & Pet hold
ƒ We evaluate RIL's different business lines and their status
ƒ E&P woes continue, future spending to determine growth plans
ƒ Recommend the shares as a defensive in choppy markets
ƒ Reiterate BUY, revised TP of INR965.44, expect range trading
Will there be a re-rating?
To put it briefly, we don’t think there is any
fundamental re-rating around the corner
for Reliance Industries (RIL). In this note
we evaluate very simply the different
business lines and the valuations for each
of these businesses. We conclude that,
valuations look attractive enough to
provide 10-12% potential upside from
current levels. However, we are not too
enthused over the 12-month period
because E&P upside, which in our view is
key to a re-rating, is still some time away,
and we are already capturing a large part
of the E&P upside, without any option
value (like MN-D4, KG-D9 prospects). For refining we assume GRMs of
USD10.5/bbl for FY12 and USD11/bbl for FY13, which in our view
captures the current strength in the refining cycle. For petrochemicals we
assume 14.5-15% EBIT margins on full utilisation. One area that could
surprise us, and which we are not able to factor in, is any potential valueaccretive acquisitions made by RIL.
EPS growth over FY11-14 lower than historical average
We don’t expect RIL’s earnings growth profile to mirror 13.7% CAGR
exhibited in FY07-11, and expect it to decline to 9% CAGR over FY11-
14E. This is primarily owing to E&P not providing the previously expected
earnings boost, and, with RIL being quiet on its capex plans for the E&P
business in light of the CAG audit, the future for E&P looks uncertain.
There is also news that another of RIL’s deepwater rig has now been
moved to the Gulf of Mexico, and currently RIL has only one deep water
rig which is dedicated to the KG Basin. We revise our EPS downwards
and now expect earnings growth of 11.1% for FY12 and 9.6% for FY13.
We expect RIL to kick off FY12 earnings with 5% earnings growth on a qq basis, with PAT at INR56b. We expect 1QFY12 blended GRMs at
USD10.3/bbl and D6 gas production at 47mmscmd.
A valuation play, lack of positive business catalysts
We reiterate our BUY rating on the shares of RIL with a revised TP of
INR965.00 (from INR1,077). A large part of the TP revision comes as a
result of downgrades to our E&P valuations (Exhibit 1). We do not see
material re-rating in the shares and recommend the shares more as
defensive with limited downside in choppy markets. RIL at our TP trades
at 14.1x FY12E P/E compared to historical average of 16.5x (Exhibit 3).
However RIL has now diverged into non-core businesses which could
result in the valuation premium that RIL has historically enjoyed being
challenged. Risks: Further reserve downgrades
Valuation – Growth gone, choppy markets make RIL defensive
A defensive with downside protection
A key overhang and one that has been persistent in nature has been the continuous
decline in production at KG-D6, which in turn has resulted in the negative sentiment
spreading across Reliance Industries’ (RIL) E&P business. Our historical discipline of
not valuing the un-drilled prospects has now come true as today there is only marginal
optionality given to RIL’s E&P business, across blocks where concrete reserves can be
determined. In the event refining loses its steam, earnings downgrades could follow – a
10% decline in D6 production would impact EPS by ~2% and a USD1/bbl change in
GRM’s impacts earnings by 7%.
We do not include exploration upside for RIL (like KG-D9 and MN-D4) in our valuation,
and more so especially in light of the CAG audit programme and the scepticism in the
market for valuing such discoveries post-audit. Until RIL (potentially along with BP)
announces an exhaustive appraisal programme for announced exploration successes
in KG-D9 and MN-D4, and get its reserve estimates and capex approved by
management, we do not think investors will view any such discoveries favourably.
Another downside is that such discoveries, even after reserves are booked, might not
be realised in their entire value, because, as with the D6 experience, flawless execution
is one key factor to realise full value. Hence, even for discoveries that have approved
reserves on RIL’s books, we take a very conservative valuation approach. We value D6
block (D1, D3 and MA fields) on a DCF basis at INR137/share at 9% WACC. Our E&P
valuation includes NEC-25 and CBM fields, valued on EV/boe basis.
We lower our expected value from Panna-Mukta-Tapti fields to INR36/share (based on
EV/EBITDA of 4.5x vs the previous 7x) primarily on the back of the overhang of the
CAG audit findings on overstated cost recovery, dwindling production profile and
potential cause for DGH not approving incremental capex to sustain production.
We continue to value the refining segment at EV/EBITDA 7.5x FY12E which is a slight
premium to peers, which we think, is warranted on the back of RIL’s higher complexity
(blended Nelson number at c.12).
Exhibit 1: RIL – Sum-of-the-parts valuation snapshot
Business New Old Comments
(INR/share) (INR/share)
Refining and Petrochemicals
Refining - incl. RPL 333 339 Valued at 7.5x EV/EBITDA, a slight premium to global peers owing to complexity
Petrochemicals 287 283 Valued at 7.0x EV/EBITDA, a slight premium to global peers owing to better margin control and
strong domestic demand
Sub total 620 622
E&P
Oil and Gas - PMT 36 67 Valued at 4x EV/EBITDA; maturing fields + under CAG lens - hence a de-rated multiple
KG D6 Gas (D1/D3) 123 149 DCF at 9% WACC. Using a 2P reserve estimate of 11.2tcf of gas (including effect of NIKO
reserve downgrade)
KG D6 Oil (MA) 14 48 DCF at 9% WACC. Using a 2P reserve estimate of 44mn bbls of oil
KG D6 Gas - Upsides 15 25 2P reserves of 2.2tcf, valuing at USD3 EV/boe
KG D3 block 5 - 2C reserves of 683bcf, valuing at USD3 EV/boe
NEC-25 8 20 2P reserves of 1.2tcf, valuing at USD3 EV/boe
CBM 11 22 Sohagpur East & West Reserves only, 2P reserve estimate of 3tcf, assuming 50% optionality,
valuing at USD3 EV/boe
Sub total 212 331
TOTAL STANDALONE 832 953
Net Cash 70 41 Includes sale value of treasury shares at CMP and Trade/ Liquid investments
RIL- Shale ventures
Atlas JV 18 28 Cost of capital of 10% and average long term gas price assumption of USD6.0/mmbtu
Pioneer JV 15 25 Cost of capital of 10%; Potential upside on liquids rich play, which is ~50% of acreage
Carizzo JV 5 - Valued recoverable reserves of 3.4tcfe, 60% stake at EV/boe of USD2 (based on Atlas/Pioneer
acquisition value)
Shale Sub total 37 53
Reliance Retail 26 31 Valued at 25% discount to equity investment
Target price 965 1,077
Source: BNP Paribas estimates
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
E&P stalls, Ref & Pet hold
ƒ We evaluate RIL's different business lines and their status
ƒ E&P woes continue, future spending to determine growth plans
ƒ Recommend the shares as a defensive in choppy markets
ƒ Reiterate BUY, revised TP of INR965.44, expect range trading
Will there be a re-rating?
To put it briefly, we don’t think there is any
fundamental re-rating around the corner
for Reliance Industries (RIL). In this note
we evaluate very simply the different
business lines and the valuations for each
of these businesses. We conclude that,
valuations look attractive enough to
provide 10-12% potential upside from
current levels. However, we are not too
enthused over the 12-month period
because E&P upside, which in our view is
key to a re-rating, is still some time away,
and we are already capturing a large part
of the E&P upside, without any option
value (like MN-D4, KG-D9 prospects). For refining we assume GRMs of
USD10.5/bbl for FY12 and USD11/bbl for FY13, which in our view
captures the current strength in the refining cycle. For petrochemicals we
assume 14.5-15% EBIT margins on full utilisation. One area that could
surprise us, and which we are not able to factor in, is any potential valueaccretive acquisitions made by RIL.
EPS growth over FY11-14 lower than historical average
We don’t expect RIL’s earnings growth profile to mirror 13.7% CAGR
exhibited in FY07-11, and expect it to decline to 9% CAGR over FY11-
14E. This is primarily owing to E&P not providing the previously expected
earnings boost, and, with RIL being quiet on its capex plans for the E&P
business in light of the CAG audit, the future for E&P looks uncertain.
There is also news that another of RIL’s deepwater rig has now been
moved to the Gulf of Mexico, and currently RIL has only one deep water
rig which is dedicated to the KG Basin. We revise our EPS downwards
and now expect earnings growth of 11.1% for FY12 and 9.6% for FY13.
We expect RIL to kick off FY12 earnings with 5% earnings growth on a qq basis, with PAT at INR56b. We expect 1QFY12 blended GRMs at
USD10.3/bbl and D6 gas production at 47mmscmd.
A valuation play, lack of positive business catalysts
We reiterate our BUY rating on the shares of RIL with a revised TP of
INR965.00 (from INR1,077). A large part of the TP revision comes as a
result of downgrades to our E&P valuations (Exhibit 1). We do not see
material re-rating in the shares and recommend the shares more as
defensive with limited downside in choppy markets. RIL at our TP trades
at 14.1x FY12E P/E compared to historical average of 16.5x (Exhibit 3).
However RIL has now diverged into non-core businesses which could
result in the valuation premium that RIL has historically enjoyed being
challenged. Risks: Further reserve downgrades
Valuation – Growth gone, choppy markets make RIL defensive
A defensive with downside protection
A key overhang and one that has been persistent in nature has been the continuous
decline in production at KG-D6, which in turn has resulted in the negative sentiment
spreading across Reliance Industries’ (RIL) E&P business. Our historical discipline of
not valuing the un-drilled prospects has now come true as today there is only marginal
optionality given to RIL’s E&P business, across blocks where concrete reserves can be
determined. In the event refining loses its steam, earnings downgrades could follow – a
10% decline in D6 production would impact EPS by ~2% and a USD1/bbl change in
GRM’s impacts earnings by 7%.
We do not include exploration upside for RIL (like KG-D9 and MN-D4) in our valuation,
and more so especially in light of the CAG audit programme and the scepticism in the
market for valuing such discoveries post-audit. Until RIL (potentially along with BP)
announces an exhaustive appraisal programme for announced exploration successes
in KG-D9 and MN-D4, and get its reserve estimates and capex approved by
management, we do not think investors will view any such discoveries favourably.
Another downside is that such discoveries, even after reserves are booked, might not
be realised in their entire value, because, as with the D6 experience, flawless execution
is one key factor to realise full value. Hence, even for discoveries that have approved
reserves on RIL’s books, we take a very conservative valuation approach. We value D6
block (D1, D3 and MA fields) on a DCF basis at INR137/share at 9% WACC. Our E&P
valuation includes NEC-25 and CBM fields, valued on EV/boe basis.
We lower our expected value from Panna-Mukta-Tapti fields to INR36/share (based on
EV/EBITDA of 4.5x vs the previous 7x) primarily on the back of the overhang of the
CAG audit findings on overstated cost recovery, dwindling production profile and
potential cause for DGH not approving incremental capex to sustain production.
We continue to value the refining segment at EV/EBITDA 7.5x FY12E which is a slight
premium to peers, which we think, is warranted on the back of RIL’s higher complexity
(blended Nelson number at c.12).
Exhibit 1: RIL – Sum-of-the-parts valuation snapshot
Business New Old Comments
(INR/share) (INR/share)
Refining and Petrochemicals
Refining - incl. RPL 333 339 Valued at 7.5x EV/EBITDA, a slight premium to global peers owing to complexity
Petrochemicals 287 283 Valued at 7.0x EV/EBITDA, a slight premium to global peers owing to better margin control and
strong domestic demand
Sub total 620 622
E&P
Oil and Gas - PMT 36 67 Valued at 4x EV/EBITDA; maturing fields + under CAG lens - hence a de-rated multiple
KG D6 Gas (D1/D3) 123 149 DCF at 9% WACC. Using a 2P reserve estimate of 11.2tcf of gas (including effect of NIKO
reserve downgrade)
KG D6 Oil (MA) 14 48 DCF at 9% WACC. Using a 2P reserve estimate of 44mn bbls of oil
KG D6 Gas - Upsides 15 25 2P reserves of 2.2tcf, valuing at USD3 EV/boe
KG D3 block 5 - 2C reserves of 683bcf, valuing at USD3 EV/boe
NEC-25 8 20 2P reserves of 1.2tcf, valuing at USD3 EV/boe
CBM 11 22 Sohagpur East & West Reserves only, 2P reserve estimate of 3tcf, assuming 50% optionality,
valuing at USD3 EV/boe
Sub total 212 331
TOTAL STANDALONE 832 953
Net Cash 70 41 Includes sale value of treasury shares at CMP and Trade/ Liquid investments
RIL- Shale ventures
Atlas JV 18 28 Cost of capital of 10% and average long term gas price assumption of USD6.0/mmbtu
Pioneer JV 15 25 Cost of capital of 10%; Potential upside on liquids rich play, which is ~50% of acreage
Carizzo JV 5 - Valued recoverable reserves of 3.4tcfe, 60% stake at EV/boe of USD2 (based on Atlas/Pioneer
acquisition value)
Shale Sub total 37 53
Reliance Retail 26 31 Valued at 25% discount to equity investment
Target price 965 1,077
Source: BNP Paribas estimates
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