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With increasing fears of lower global GDP growth, we analyse the potential impact on earnings
and valuations of Cairn India and RIL, the companies most leveraged to global economic cycles
in our coverage universe. In our bear-case scenario, FY13F EPS could be hit by 17-19% and
valuation by 16%, respectively.
Background to our analysis
Commentators are beginning to suggest that Europe and the US could dip into recession later
this year and into next year. Against this background, we see a realistic possibility that the outlook
for global GDP growth could be much worse than the near-4% 2012 estimate recently published
by the IMF. We highlight our current EPS forecasts for FY13 and EPS forecasts that
accommodate a material slowdown under this bear-case scenario. We then highlight fair values
were this scenario to develop.
Our bear-case scenario assumptions
We have assumed an average Brent price of US$80/bbl in FY13 based on comments from OPEC
delegates that production could be cut if oil prices fall below US$80-85/bbl. For RIL, we assume a
GRM of US$8/bbl in FY13 vs US$10.3/bbl under our base case and petchem margins reverting
back to the FY09 level, leading to a 20% drop in FY13F petchem EBITDA. Lastly, we assume the
rupee depreciating to Rs47/US$ (Rs45 under the base case)
RIL and Cairn would be the worst hit companies in our coverage universe
Our SOTP-based fair value for RIL includes the petchem and refining business at 7x FY13F
EV/EBITDA. We calculate RIL’s FY13F EPS would be hit by 19%, bringing our fair value down by
16% to Rs780/share from Rs925. We value Cairn at Rs310 on a DCF basis, with the oil price,
production profile and opex being key cash flow drivers. We run a sanity check on our DCF
valuation against a PE-based valuation. We believe investor focus would shift to near-term
earnings during recession and thus use PE valuations for our bear-case analysis. At our current
target price, the stock trades at 7.5x FY13F EPS. Under our bear case, the EPS reduces by 17%
and fair value declines to Rs260, assuming no PE de-rating. That said, the stock has limited
trading history to support the above thesis.
Free cash flow impact and balance sheet vulnerability
CIL is already net-cash surplus. We expect RIL to turn net cash in FY12. Thus, the resultant
lower free cash flows in FY13 under our bear case would have no impact on their capex and
balance sheet strength. In fact, lack of clarity on use of cash has been an overhang on both the
stocks. Furthermore, in case of a slump in asset prices, both companies could look to make
acquisitions to grow further.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
With increasing fears of lower global GDP growth, we analyse the potential impact on earnings
and valuations of Cairn India and RIL, the companies most leveraged to global economic cycles
in our coverage universe. In our bear-case scenario, FY13F EPS could be hit by 17-19% and
valuation by 16%, respectively.
Background to our analysis
Commentators are beginning to suggest that Europe and the US could dip into recession later
this year and into next year. Against this background, we see a realistic possibility that the outlook
for global GDP growth could be much worse than the near-4% 2012 estimate recently published
by the IMF. We highlight our current EPS forecasts for FY13 and EPS forecasts that
accommodate a material slowdown under this bear-case scenario. We then highlight fair values
were this scenario to develop.
Our bear-case scenario assumptions
We have assumed an average Brent price of US$80/bbl in FY13 based on comments from OPEC
delegates that production could be cut if oil prices fall below US$80-85/bbl. For RIL, we assume a
GRM of US$8/bbl in FY13 vs US$10.3/bbl under our base case and petchem margins reverting
back to the FY09 level, leading to a 20% drop in FY13F petchem EBITDA. Lastly, we assume the
rupee depreciating to Rs47/US$ (Rs45 under the base case)
RIL and Cairn would be the worst hit companies in our coverage universe
Our SOTP-based fair value for RIL includes the petchem and refining business at 7x FY13F
EV/EBITDA. We calculate RIL’s FY13F EPS would be hit by 19%, bringing our fair value down by
16% to Rs780/share from Rs925. We value Cairn at Rs310 on a DCF basis, with the oil price,
production profile and opex being key cash flow drivers. We run a sanity check on our DCF
valuation against a PE-based valuation. We believe investor focus would shift to near-term
earnings during recession and thus use PE valuations for our bear-case analysis. At our current
target price, the stock trades at 7.5x FY13F EPS. Under our bear case, the EPS reduces by 17%
and fair value declines to Rs260, assuming no PE de-rating. That said, the stock has limited
trading history to support the above thesis.
Free cash flow impact and balance sheet vulnerability
CIL is already net-cash surplus. We expect RIL to turn net cash in FY12. Thus, the resultant
lower free cash flows in FY13 under our bear case would have no impact on their capex and
balance sheet strength. In fact, lack of clarity on use of cash has been an overhang on both the
stocks. Furthermore, in case of a slump in asset prices, both companies could look to make
acquisitions to grow further.
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