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Reliance Industries Ltd.
Risk reward analysis
„Risk-reward even; key is will US recession probability rise?
The risk of US recession is rising (US Economic Weekly, 19 August 2011). A US
recession will hit petrochemical and refining margins (GRM) of Reliance Industries
(RIL). RIL’s bear-case fair value implies 19% potential downside. RIL’s PO implies
20% potential upside. Risk-reward, thus, is evenly poised. The key is whether the
probability of a US recession, which we now estimate at 40%, rises. Bear-case
FY12-13E EPS are 17-32% lower than base case and would mean no growth.
Cut PO by 11% to Rs909; Bear case fair value Rs612
We are now valuing RIL’s refining and petrochemicals conservatively, at 6x FY13
EBITDA (DCF earlier), resulting in a cut in our PO by 11%, to Rs909. RIL’s bear-
case fair value, which assumes a US recession and, therefore, lower GRM
(US$7/bbl in FY13) and petrochemical margins, works out to Rs612. RIL’s share
price is unlikely to test October 2008 lows (Rs510). RIL had a net debt of
Rs174/share then, while it will turn net cash in the next 12 months. Though RIL’s
balance sheet is stronger, its E&P business has got de-rated and its EPS CAGR
in FY08-11 was just 5%. In the bear case, the FY11-13 EPS CAGR will be minus
3% (base case 17%).
Singapore GRM strong, but demand and capacity concerns
Reuters’ Singapore GRM to date in FY12 is US$8.7/bbl, which is even higher than
during the FY05-09 super-cycle. However, global oil demand is weakening. 2Q
2011 demand is the lowest in 7 quarters. In 2012, global oil demand may fall by
0.4m b/d in case of a mild US recession (Global Energy Weekly, 05 August 2011).
IEA expects global refining capacity addition at 2.4m b/d (highest since 1999) in
2012. Thus, refining over-capacity may rise by 2.8m b/d in 2012, causing a sharp
fall in GRM. RIL’s FY13 GRM could fall to US$7/bbl and cut EPS and fair value.
Risk-reward analysis
Risk of US recession
40% chance of US recession in 2012
There is a concern that the US may slip into recession. The BofAML US
economics team now believes that there is a 40% chance of a recession in 2012
(see US Economic Weekly, 19 August 2011), up from 35% earlier (see Economic
Commentary, 04 August 2011). Our baseline view is that the US economy will
continue to muddle through with trend-like growth, which will probably feel like a
recession to many, even if it is not officially one.
Refining & petrochemical margins
Singapore GRM to date in FY12 higher than super cycle
Singapore GRM TD in FY12 US$8.7/bbl; US$5.8-7.6/bbl in FY05-FY09
Reuters’ Singapore complex GRM, at US$8.7/bbl to date in FY12, is higher than
even the US$5.8-7.6/bbl during the refining super-cycle in FY05-FY09. Reuters’
Singapore GRM was US$8.5/bbl in 1Q FY12, while to date in 2Q it is at
US$8.7/bbl. The main factors driving strength in GRM are:
„ Strong global oil demand growth of 2.7m b/d (second strongest in 32 years)
in 2010 and refinery closures of over 2m b/d. This helped take care of at
least 80% of the refining over-capacity created in 2008-2009
„ Strong Chinese diesel demand growth due to power shortages (see PRC
Power, 04 August 2011) and consequent use of diesel to generate power.
Chinese apparent diesel consumption grew by 12% YoY in 1H 2011 as per
data from the National Bureau of Statistics
„ Boost to GRM from Japanese Tsunami in March 2011 and from the
shutdown of the Formosa refinery in Taiwan after an accident in end-July
2011. Reuters’ Singapore GRM had declined to US$7.8/bbl in July 2011 from
US$8.5/bbl in 1Q FY12. Singapore GRM has surged to US$10.2/bbl to date
in August 2011 after the accident at the Formosa refinery.
Polyester main driver of RIL blended margin strength
Polyester chain margins off peak as demand and cotton price declined
The main driver of the blended petrochemical margin strength since 3Q FY11
was strong polyester chain margins. Polyester chain margins, which touched an
all-time high in 4Q FY11, have since corrected, hit by decline in Chinese and
Indian demand and fall in cotton prices.
US recession & capacity addition risk to GRM
Weakening oil demand & large refining capacity addition
We see two main risks to prevailing strength in GRM sustaining
„ Weakening of global oil demand as OECD demand is hit by high oil prices
and emerging market demand by monetary tightening
„ Large refining capacity addition in 2012-2013
OECD demand decline main risk to global oil demand
Global oil demand fell in 2008-2009 as OECD demand fell 1.6-1.9m b/d
Global oil demand declined in 2008 and 2009 by 0.4-0.6m b/d, mainly due to a
decline in OECD oil demand by 1.6-1.9m b/d. Chinese oil demand grew in 2008-
2009, but it was also weak at 0.2-0.3m b/d. In fact, OECD oil demand had also
declined in 2006-2007 and is expected to decline in 2011-2012, even in the base
case.
OECD 52% of global oil demand & China just 10% in 2010
OECD oil demand growth is a crucial factor influencing global oil demand growth.
This is because OECD countries still account for over 50% of global oil demand.
In 2010, OECD countries accounted for 52% of global oil demand, while China
accounted for just 10%.
Global oil demand growth in 2Q 2011 lowest in 7 quarters
Global oil demand up 0.6m b/d in 2Q11; 0.9-3.4m b/d in last 6 quarters
Global oil demand growth was just 0.6m b/d in 2Q 2011, as per IEA estimates. It
is the lowest since 3Q 2009 (i.e., in 7 quarters). Global oil demand growth was
0.9-3.4m b/d in the last six quarters. It was last lower than in 2Q 2011 in 3Q 2009,
when it declined by 0.3m b/d.
Chinese oil demand growth in 2Q 2011 also lowest in 7 quarters
Chinese oil demand growth was 0.4m b/d in 2Q 2011, which is also the lowest in
7 quarters. Chinese oil demand growth was 0.5-1.4m b/d in last 6 quarters. It was
last lower than in 2Q 2011 in 3Q 2009, when it was up by just 0.3m b/d.
Bear-case fair value at Rs612/share
Refining and petrochemical valued at 6x FY13 EBITDA; 6.6x at 2008 low
Our bear-case fair value of RIL is Rs612/share. Bear-case fair value is based on
„ 6x FY13 bear-case refining EBITDA. RIL’s EV/EBITDA based on its October
2008 low of Rs510/share was 6.6x.
„ 6x FY13 bear-case petrochemical EBITDA
„ Bear-case E&P DCF valuation of Rs166/share. Bear-case E&P valuation
assumes KG D6 gas production never rises above current levels. Thus, it
does not ramp to 80mmscmd in FY15 as assumed in the base case. It also
assumes no 7-year income tax holiday for gas production.
Bear-case fair value 33% lower than base case
Biggest cut in refining valuation of Rs150/share
Our bear-case fair value is 33% lower than base case. Bear case
„ Refining EV at Rs196/share is 43% (Rs150/share) lower than base case
„ Petrochemical EV at Rs236/share is 20% (Rs58/share) lower than base case
„ E&P EV at Rs166/share is 20% (Rs42/share) lower than base case
„ Net cash at Rs13/share is 78% (Rs47/share) lower than base case
RIL’s share price unlikely to touch 2008 low of Rs510
Bear-case fair value at Rs612/share is 20% higher than 2008 low
The lowest level RIL’s share price declined to in October 2008 was Rs510/share.
We do not expect RIL’s share price to decline to that level in 2011-2012, even in
case of a US recession and a global slowdown.
RIL’s balance sheet stronger now than in 2008
Net debt Rs174/share in FY09; to be net cash in the next 12 months
RIL is unlikely to decline to the 2008 low of Rs510 in 2011-2012, as its balance
sheet is much stronger than in 2008. In end-FY09, RIL's net debt was
Rs174/share, while it is likely to turn net cash in the next 12 months. The main
drivers of this change from net debt to net cash are
„ Free cash flow generation by RIL in FY10-FY12E
„ Sale of 30% stake in Indian E&P assets at US$7.2bn to BP Plc in 2011
RIL’s de-rating
RIL’ 5-year average PE 16.8x in FY07-11; 7.3x in FY02-06
Re-rating driven by FY03-08 EPS CAGR of 36% & high E&P valuation
RIL’s 5-year average forward PE multiple rose from 7.3x in FY02-FY06 to 16.8x
in FY07-FY11. The main reasons for this re-rating were
„ Strong 5-year EPS CAGR of 36% in FY03-FY08
„ High valuation for its E&P business
RIL de-rated; trading at 10.5x FY12E base case EPS
RIL has under-performed BSE-30 by 69% since April 2009
RIL has under-performed the BSE-30 by 69% since April 2009. While the BSE-30
is up by 65% during this period, RIL’s share price has declined by 4%. RIL’s derating is apparent from the fact that it is now trading at just 10.5x FY12E EPS. As
discussed, its 5-year average forward PE was 16.8x in FY07-FY11.
Hit by 3-year EPS CAGR to FY11 of 5% and E&P de-rating
RIL’s de-rating is mainly due to the following factors
„ Its earnings growth since FY08 is very weak, with 3-year CAGR to FY11
being just 5%
„ Its E&P business has got de-rated due to production problems in KG D6 and
as no significant discoveries have been made in the last few years
Retain Buy on RIL
Risk-reward evenly poised
Bear-case fair value implies 19% downside; PO implies 20% upside
Risk-reward analysis of RIL suggests risk-reward is evenly poised. The bear-case
fair value of RIL of Rs612, which assumes a US recession and, therefore, lower
GRM and petrochemical margins, implies 19% potential downside. Our new,
lower, PO (base-case fair value) of Rs909/share implies 20% potential upside.
Probability of US recession 40% now; Will it rise further?
Risk-reward is evenly poised, as potential upside in the base case is similar to
potential downside in the bear case, which assumes a US recession. The key,
therefore, is whether the probability of US recession rises further. We estimated
probability of a US recession in 2012 at 35% earlier. We have now raised the
probability of a US recession in the next 12 months to 40%.
GRM most at risk in case of US recession
At a bear-case FY13 GRM of US$7/bbl, hit to fair value & EPS 19-21%
In case of a US recession, refining over-capacity could rise by 2.8m b/d in 2012,
as demand declines by 0.4m b/d and 2.4m b/d of capacity is added. Refining
over-capacity added since 2007 could rise back to 3.5m b/d in 2012, like it did in
2009. RIL’s GRM in that case could decline to US$7/bbl in FY13 (US$6.6/bbl in
FY10) vis-à-vis US$10.6/bbl in the base case. This would mean a hit to basecase EPS of Rs17.8 (21%) and to fair value (refining EV down by Rs150 and net
cash down by Rs23) of Rs173/share (19%).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries Ltd.
Risk reward analysis
„Risk-reward even; key is will US recession probability rise?
The risk of US recession is rising (US Economic Weekly, 19 August 2011). A US
recession will hit petrochemical and refining margins (GRM) of Reliance Industries
(RIL). RIL’s bear-case fair value implies 19% potential downside. RIL’s PO implies
20% potential upside. Risk-reward, thus, is evenly poised. The key is whether the
probability of a US recession, which we now estimate at 40%, rises. Bear-case
FY12-13E EPS are 17-32% lower than base case and would mean no growth.
Cut PO by 11% to Rs909; Bear case fair value Rs612
We are now valuing RIL’s refining and petrochemicals conservatively, at 6x FY13
EBITDA (DCF earlier), resulting in a cut in our PO by 11%, to Rs909. RIL’s bear-
case fair value, which assumes a US recession and, therefore, lower GRM
(US$7/bbl in FY13) and petrochemical margins, works out to Rs612. RIL’s share
price is unlikely to test October 2008 lows (Rs510). RIL had a net debt of
Rs174/share then, while it will turn net cash in the next 12 months. Though RIL’s
balance sheet is stronger, its E&P business has got de-rated and its EPS CAGR
in FY08-11 was just 5%. In the bear case, the FY11-13 EPS CAGR will be minus
3% (base case 17%).
Singapore GRM strong, but demand and capacity concerns
Reuters’ Singapore GRM to date in FY12 is US$8.7/bbl, which is even higher than
during the FY05-09 super-cycle. However, global oil demand is weakening. 2Q
2011 demand is the lowest in 7 quarters. In 2012, global oil demand may fall by
0.4m b/d in case of a mild US recession (Global Energy Weekly, 05 August 2011).
IEA expects global refining capacity addition at 2.4m b/d (highest since 1999) in
2012. Thus, refining over-capacity may rise by 2.8m b/d in 2012, causing a sharp
fall in GRM. RIL’s FY13 GRM could fall to US$7/bbl and cut EPS and fair value.
Risk-reward analysis
Risk of US recession
40% chance of US recession in 2012
There is a concern that the US may slip into recession. The BofAML US
economics team now believes that there is a 40% chance of a recession in 2012
(see US Economic Weekly, 19 August 2011), up from 35% earlier (see Economic
Commentary, 04 August 2011). Our baseline view is that the US economy will
continue to muddle through with trend-like growth, which will probably feel like a
recession to many, even if it is not officially one.
Refining & petrochemical margins
Singapore GRM to date in FY12 higher than super cycle
Singapore GRM TD in FY12 US$8.7/bbl; US$5.8-7.6/bbl in FY05-FY09
Reuters’ Singapore complex GRM, at US$8.7/bbl to date in FY12, is higher than
even the US$5.8-7.6/bbl during the refining super-cycle in FY05-FY09. Reuters’
Singapore GRM was US$8.5/bbl in 1Q FY12, while to date in 2Q it is at
US$8.7/bbl. The main factors driving strength in GRM are:
„ Strong global oil demand growth of 2.7m b/d (second strongest in 32 years)
in 2010 and refinery closures of over 2m b/d. This helped take care of at
least 80% of the refining over-capacity created in 2008-2009
„ Strong Chinese diesel demand growth due to power shortages (see PRC
Power, 04 August 2011) and consequent use of diesel to generate power.
Chinese apparent diesel consumption grew by 12% YoY in 1H 2011 as per
data from the National Bureau of Statistics
„ Boost to GRM from Japanese Tsunami in March 2011 and from the
shutdown of the Formosa refinery in Taiwan after an accident in end-July
2011. Reuters’ Singapore GRM had declined to US$7.8/bbl in July 2011 from
US$8.5/bbl in 1Q FY12. Singapore GRM has surged to US$10.2/bbl to date
in August 2011 after the accident at the Formosa refinery.
Polyester main driver of RIL blended margin strength
Polyester chain margins off peak as demand and cotton price declined
The main driver of the blended petrochemical margin strength since 3Q FY11
was strong polyester chain margins. Polyester chain margins, which touched an
all-time high in 4Q FY11, have since corrected, hit by decline in Chinese and
Indian demand and fall in cotton prices.
US recession & capacity addition risk to GRM
Weakening oil demand & large refining capacity addition
We see two main risks to prevailing strength in GRM sustaining
„ Weakening of global oil demand as OECD demand is hit by high oil prices
and emerging market demand by monetary tightening
„ Large refining capacity addition in 2012-2013
OECD demand decline main risk to global oil demand
Global oil demand fell in 2008-2009 as OECD demand fell 1.6-1.9m b/d
Global oil demand declined in 2008 and 2009 by 0.4-0.6m b/d, mainly due to a
decline in OECD oil demand by 1.6-1.9m b/d. Chinese oil demand grew in 2008-
2009, but it was also weak at 0.2-0.3m b/d. In fact, OECD oil demand had also
declined in 2006-2007 and is expected to decline in 2011-2012, even in the base
case.
OECD 52% of global oil demand & China just 10% in 2010
OECD oil demand growth is a crucial factor influencing global oil demand growth.
This is because OECD countries still account for over 50% of global oil demand.
In 2010, OECD countries accounted for 52% of global oil demand, while China
accounted for just 10%.
Global oil demand growth in 2Q 2011 lowest in 7 quarters
Global oil demand up 0.6m b/d in 2Q11; 0.9-3.4m b/d in last 6 quarters
Global oil demand growth was just 0.6m b/d in 2Q 2011, as per IEA estimates. It
is the lowest since 3Q 2009 (i.e., in 7 quarters). Global oil demand growth was
0.9-3.4m b/d in the last six quarters. It was last lower than in 2Q 2011 in 3Q 2009,
when it declined by 0.3m b/d.
Chinese oil demand growth in 2Q 2011 also lowest in 7 quarters
Chinese oil demand growth was 0.4m b/d in 2Q 2011, which is also the lowest in
7 quarters. Chinese oil demand growth was 0.5-1.4m b/d in last 6 quarters. It was
last lower than in 2Q 2011 in 3Q 2009, when it was up by just 0.3m b/d.
Bear-case fair value at Rs612/share
Refining and petrochemical valued at 6x FY13 EBITDA; 6.6x at 2008 low
Our bear-case fair value of RIL is Rs612/share. Bear-case fair value is based on
„ 6x FY13 bear-case refining EBITDA. RIL’s EV/EBITDA based on its October
2008 low of Rs510/share was 6.6x.
„ 6x FY13 bear-case petrochemical EBITDA
„ Bear-case E&P DCF valuation of Rs166/share. Bear-case E&P valuation
assumes KG D6 gas production never rises above current levels. Thus, it
does not ramp to 80mmscmd in FY15 as assumed in the base case. It also
assumes no 7-year income tax holiday for gas production.
Bear-case fair value 33% lower than base case
Biggest cut in refining valuation of Rs150/share
Our bear-case fair value is 33% lower than base case. Bear case
„ Refining EV at Rs196/share is 43% (Rs150/share) lower than base case
„ Petrochemical EV at Rs236/share is 20% (Rs58/share) lower than base case
„ E&P EV at Rs166/share is 20% (Rs42/share) lower than base case
„ Net cash at Rs13/share is 78% (Rs47/share) lower than base case
RIL’s share price unlikely to touch 2008 low of Rs510
Bear-case fair value at Rs612/share is 20% higher than 2008 low
The lowest level RIL’s share price declined to in October 2008 was Rs510/share.
We do not expect RIL’s share price to decline to that level in 2011-2012, even in
case of a US recession and a global slowdown.
RIL’s balance sheet stronger now than in 2008
Net debt Rs174/share in FY09; to be net cash in the next 12 months
RIL is unlikely to decline to the 2008 low of Rs510 in 2011-2012, as its balance
sheet is much stronger than in 2008. In end-FY09, RIL's net debt was
Rs174/share, while it is likely to turn net cash in the next 12 months. The main
drivers of this change from net debt to net cash are
„ Free cash flow generation by RIL in FY10-FY12E
„ Sale of 30% stake in Indian E&P assets at US$7.2bn to BP Plc in 2011
RIL’s de-rating
RIL’ 5-year average PE 16.8x in FY07-11; 7.3x in FY02-06
Re-rating driven by FY03-08 EPS CAGR of 36% & high E&P valuation
RIL’s 5-year average forward PE multiple rose from 7.3x in FY02-FY06 to 16.8x
in FY07-FY11. The main reasons for this re-rating were
„ Strong 5-year EPS CAGR of 36% in FY03-FY08
„ High valuation for its E&P business
RIL de-rated; trading at 10.5x FY12E base case EPS
RIL has under-performed BSE-30 by 69% since April 2009
RIL has under-performed the BSE-30 by 69% since April 2009. While the BSE-30
is up by 65% during this period, RIL’s share price has declined by 4%. RIL’s derating is apparent from the fact that it is now trading at just 10.5x FY12E EPS. As
discussed, its 5-year average forward PE was 16.8x in FY07-FY11.
Hit by 3-year EPS CAGR to FY11 of 5% and E&P de-rating
RIL’s de-rating is mainly due to the following factors
„ Its earnings growth since FY08 is very weak, with 3-year CAGR to FY11
being just 5%
„ Its E&P business has got de-rated due to production problems in KG D6 and
as no significant discoveries have been made in the last few years
Retain Buy on RIL
Risk-reward evenly poised
Bear-case fair value implies 19% downside; PO implies 20% upside
Risk-reward analysis of RIL suggests risk-reward is evenly poised. The bear-case
fair value of RIL of Rs612, which assumes a US recession and, therefore, lower
GRM and petrochemical margins, implies 19% potential downside. Our new,
lower, PO (base-case fair value) of Rs909/share implies 20% potential upside.
Probability of US recession 40% now; Will it rise further?
Risk-reward is evenly poised, as potential upside in the base case is similar to
potential downside in the bear case, which assumes a US recession. The key,
therefore, is whether the probability of US recession rises further. We estimated
probability of a US recession in 2012 at 35% earlier. We have now raised the
probability of a US recession in the next 12 months to 40%.
GRM most at risk in case of US recession
At a bear-case FY13 GRM of US$7/bbl, hit to fair value & EPS 19-21%
In case of a US recession, refining over-capacity could rise by 2.8m b/d in 2012,
as demand declines by 0.4m b/d and 2.4m b/d of capacity is added. Refining
over-capacity added since 2007 could rise back to 3.5m b/d in 2012, like it did in
2009. RIL’s GRM in that case could decline to US$7/bbl in FY13 (US$6.6/bbl in
FY10) vis-à-vis US$10.6/bbl in the base case. This would mean a hit to basecase EPS of Rs17.8 (21%) and to fair value (refining EV down by Rs150 and net
cash down by Rs23) of Rs173/share (19%).
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