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● With the recent stock price correction and monetisation of RIL’s
E&P assets (through BP deal), implied valuations have corrected
materially. Using comparable multiples for refining and petchem,
and valuing cash and treasury stock, we estimate the market is
paying c.US$9 bn for RIL’s E&P, shale, retail, telecom, etc.
● This is low. BP has agreed to pay US$7.2 bn for a 30% stake in
RIL’s E&P. Even after the sale, RIL will have a c.60% residual
stake in the acreage. Other assets’ book value is c.US$5 bn.
● It is probably too early to suggest BP has overpaid (BP has likely
done significant due diligence). We think BP has paid for longerterm
resource upsides, with the hope of ‘fixing’ output at D6.
● This now apparent E&P valuation discrepancy is attractive, but is
likely to take time to fix. BP will take time to bring its skills to the
table. Given recent disappointments, the market is unlikely to pay
for E&P upsides until actual evidence emerges. Refining margins
should continue to improve, yet use of cash remains the one large
potential catalyst – that is difficult to predict. RIL can be a good
defensive and value buy at current prices. OUTPERFORM.
Low implied expectations
RIL delivered US$5.5 bn in refining and petchem EBITDA in FY11.
Asian comparables (ex-Formosa, which tend to be expensive) trade at
7.3-7.5x 2011E (higher on 2010 delivered). Using these multiples for
RIL FY11E EBITDA and adding net cash estimates (CS FY12E, post
completion of the BP deal) and valuation of the treasury stock, yields
Rs706/share (EV of US$51 bn). Our DCF-based valuation of RIL’s
refining/petchem is higher, reflecting 1) lower upfront taxes, 2) GRM
expansion expectations, and 3) petchem volume growth.
At Rs830/share, this implies the market is paying Rs124/share (or
US$9 bn) for RIL’s other businesses – E&P, shale gas, retail, telecom
etc. BP has agreed to pay US$7.2 bn for a 30% stake in RIL’s E&P –
RIL will have a c.60% residual stake in these fields post the sale to BP,
which, using BP’s valuation metrics, should be worth c.US$14.4 bn.
Where is the disconnect?
Either the market is unwilling to pay comparable multiples for RIL’s
core businesses, or is paying much less for E&P than implied by the
deal with BP. The latter raises three possibilities:
● BP has overpaid – BP has reportedly done two years of diligence
on RIL’s blocks. BP is effectively selling assets to buy into RIL
acreage, and has ongoing cash outflows related to the Macondo
issue. It is therefore likely to have made doubly sure of numbers
or data before partnering with RIL. Since it’s been only five
months since the deal was signed, it is probably too early to make
this call.
● BP aims to fix D6 faster than expected by the market – besides
technical expertise, ‘fixing’ D6 relies on government approvals
(which remain uncertain). Higher gas prices are a regulatory
‘arbitrage’, and are unlikely to have attracted BP by themselves.
To us, this seems like a marginal argument (for a US$7 bn spend).
● BP is willing to pay for longer-term upsides – as an E&P company,
BP could potentially have taken a longer-term call on the KG basin,
and may hope to find material new oil and gas resources.
However, given a lack of data and a shorter-term focus, markets
may be unwilling or unable to price these in today.
The E&P valuation gap may take time to fix
If BP has paid up for longer-term E&P upsides in the KG basin (and
elsewhere in India), then these upsides will have to be fairly large – to
meet the IRR and to justify the large gestation to FCF (time value).
However, given recent disappointments at KG D6 and KG D9, E&P
upside expectations for RIL are unlikely to increase unless actual
evidence is presented (large exploratory successes), we think. On its
recent conference call, BP suggested D6 is not an ‘instant fix’ and that
they may take up to a year to work with Reliance and define an
exploration programme. ‘Fixing’ RIL E&P valuations may take time.
Clarity on the ongoing CAG audit can help RIL’s stock. Refining
margins should continue to improve, yet low balance sheet leverage
and large other businesses mean RIL has lower leverage to GRMs
(an US$1/bbl increase implies 7% FY13 EPS improvement). With RIL
now ruling out near-term D6 volume growth, use of large cash or cash
flow remains the one potentially large catalyst – which is unfortunately
difficult to predict. Maintain OUTPERFORM.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● With the recent stock price correction and monetisation of RIL’s
E&P assets (through BP deal), implied valuations have corrected
materially. Using comparable multiples for refining and petchem,
and valuing cash and treasury stock, we estimate the market is
paying c.US$9 bn for RIL’s E&P, shale, retail, telecom, etc.
● This is low. BP has agreed to pay US$7.2 bn for a 30% stake in
RIL’s E&P. Even after the sale, RIL will have a c.60% residual
stake in the acreage. Other assets’ book value is c.US$5 bn.
● It is probably too early to suggest BP has overpaid (BP has likely
done significant due diligence). We think BP has paid for longerterm
resource upsides, with the hope of ‘fixing’ output at D6.
● This now apparent E&P valuation discrepancy is attractive, but is
likely to take time to fix. BP will take time to bring its skills to the
table. Given recent disappointments, the market is unlikely to pay
for E&P upsides until actual evidence emerges. Refining margins
should continue to improve, yet use of cash remains the one large
potential catalyst – that is difficult to predict. RIL can be a good
defensive and value buy at current prices. OUTPERFORM.
Low implied expectations
RIL delivered US$5.5 bn in refining and petchem EBITDA in FY11.
Asian comparables (ex-Formosa, which tend to be expensive) trade at
7.3-7.5x 2011E (higher on 2010 delivered). Using these multiples for
RIL FY11E EBITDA and adding net cash estimates (CS FY12E, post
completion of the BP deal) and valuation of the treasury stock, yields
Rs706/share (EV of US$51 bn). Our DCF-based valuation of RIL’s
refining/petchem is higher, reflecting 1) lower upfront taxes, 2) GRM
expansion expectations, and 3) petchem volume growth.
At Rs830/share, this implies the market is paying Rs124/share (or
US$9 bn) for RIL’s other businesses – E&P, shale gas, retail, telecom
etc. BP has agreed to pay US$7.2 bn for a 30% stake in RIL’s E&P –
RIL will have a c.60% residual stake in these fields post the sale to BP,
which, using BP’s valuation metrics, should be worth c.US$14.4 bn.
Where is the disconnect?
Either the market is unwilling to pay comparable multiples for RIL’s
core businesses, or is paying much less for E&P than implied by the
deal with BP. The latter raises three possibilities:
● BP has overpaid – BP has reportedly done two years of diligence
on RIL’s blocks. BP is effectively selling assets to buy into RIL
acreage, and has ongoing cash outflows related to the Macondo
issue. It is therefore likely to have made doubly sure of numbers
or data before partnering with RIL. Since it’s been only five
months since the deal was signed, it is probably too early to make
this call.
● BP aims to fix D6 faster than expected by the market – besides
technical expertise, ‘fixing’ D6 relies on government approvals
(which remain uncertain). Higher gas prices are a regulatory
‘arbitrage’, and are unlikely to have attracted BP by themselves.
To us, this seems like a marginal argument (for a US$7 bn spend).
● BP is willing to pay for longer-term upsides – as an E&P company,
BP could potentially have taken a longer-term call on the KG basin,
and may hope to find material new oil and gas resources.
However, given a lack of data and a shorter-term focus, markets
may be unwilling or unable to price these in today.
The E&P valuation gap may take time to fix
If BP has paid up for longer-term E&P upsides in the KG basin (and
elsewhere in India), then these upsides will have to be fairly large – to
meet the IRR and to justify the large gestation to FCF (time value).
However, given recent disappointments at KG D6 and KG D9, E&P
upside expectations for RIL are unlikely to increase unless actual
evidence is presented (large exploratory successes), we think. On its
recent conference call, BP suggested D6 is not an ‘instant fix’ and that
they may take up to a year to work with Reliance and define an
exploration programme. ‘Fixing’ RIL E&P valuations may take time.
Clarity on the ongoing CAG audit can help RIL’s stock. Refining
margins should continue to improve, yet low balance sheet leverage
and large other businesses mean RIL has lower leverage to GRMs
(an US$1/bbl increase implies 7% FY13 EPS improvement). With RIL
now ruling out near-term D6 volume growth, use of large cash or cash
flow remains the one potentially large catalyst – which is unfortunately
difficult to predict. Maintain OUTPERFORM.
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