Weak refining/chemicals business, a plethora of negative news flow on upstream and investments in non-related businesses like telecom resulted in Reliance Industries (RIL) underperforming over the past three years. However, we believe the current price more-or-less prices in all negatives. Ergo, going forward, we expect cyclical improvement in chemicals/refining and earnings growth from shale – all unregulated businesses – to drive stock valuations. At CMP of INR719, risk-reward clearly is in favour (2% downside, 26% upside). Maintain ‘BUY’ with target price of INR906/share.
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Current stock price factors in all negatives
RIL’s stock factors in continuity of status quo - refining/chemicals remaining at cyclical bottom, absence of approvals in upstream, sustained losses in retail and adverse gas prices for shale gas in US. We estimate the worst case at INR707, only ~2% downside.
The upsides story – Unregulated segments to drive earnings growth
Despite all the noise around India E&P, non-regulated businesses will contribute 90% of FY12-17 incremental EBITDA driven by refining, chemicals and investments in shale. Refining: Margins to improve as current GRMs imply CROCI of 5.7% for a new refinery, which can only go up. Moreover, refining capacity closures will offset capacity additions. Chemicals: RIL’s chemicals portfolio is fairly diversified and hence stable margins will continue; Utilisation in polyester and ethylene have bottomed out. Shale: FY12-17 production CAGR of >50% will contribute 39% of incremental EBITDA. India upstream: Expect EBITDA contribution to fall from 29% in FY12 to 13% in FY16E due to 15+% CAGR decline in gas production, bottoming out in FY16E at 15.5 mmscmd with commencement of the ‘Next Wave’ of projects. USD 12bn capex: Announced capex will generate 15% CROCI and will be fully commercial in next three years.
Valuations: CEPS yield of 15%; adjusted P/BV at 1.1x is attractive
(1) CMP of INR719/share implies CEPS yield of 15%. This corresponds to perpetual negative-to-zero growth firm, while we expect RIL’s earnings to grow at FY12-17 CAGR of 15%. (2) While book RoE is 12.2%, RoE adjusted for CWIP is 14.7%. At FY13E P/BV of 1.1x, the RIL stock looks attractive at the current level. (3) Estimated replacement cost of refining and petchem at INR739/share implying almost no value of other assets.
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