Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Reliance Industries
Thoughts on Reliance-BP deal
„ Reliance ropes in global E&P player as partner
We believe given the technical capabilities that deepwater E&P requires, having
BP as a partner is a positive for the business’s long-term value. BP will pay
US$9bn (US$7.2bn by FY12 + US$1.8bn conditional) for a 30% stake in 23 of
Reliance’s E&P blocks. The transaction was done at close to our valuation of
US$26bn for Reliance’s upstream business.
„ Declining production at KG D6: BP’s technical expertise a plus
Reliance’s D1-D3 gas production has declined from a peak of ~52mmscmd to ~43-
45mmscmd now. We believe production at the reservoir turned out to be more
complex than the company expected, and Reliance was not sure how to raise
production without damaging the reservoir. Though Reliance Industries does not
have a precedent of selling a stake in its businesses, we believe the complexity of
the deep waters has forced its hand.
„ Emphasis on exploration in line with new BP strategy
BP will gain around 0.5Bcf/d (93kbd) of production but we believe the real value
is in the access as BP targets exploration in large basins. Following BP’s major
Arctic deal with Rosneft last month and with Devon, this represents an aggressive
reloading of exploration.
„ Valuation: maintain Neutral, SOTP-based PT of Rs1050; Buy on BP
Reliance has gained US$6.4bn in market cap since 1 February 2011. We believe
the stock price now reflects the unlocked value of its assets. The price paid by BP
allays some concerns as it supports the valuation of the upstream business. At
550p, our price target on BP is set at 5.4x 2012E EV/DACF and 7.2x 2012E PE.
Why could production be falling?
Reliance had been facing technical difficulties in ramping up production of
natural gas at its KG-D6 fields. For more details, please refer to our reports:
Reliance Industries: Low on gas, by Prakash Joshi, published 4 February 2011,
and Reliance Industries: Show me the gas, by Prakash Joshi, published 19
January 2011.
Production touched a peak of 60 mmscmd in Q1FY11 and has since been
decreasing. The field has been tested to flow at 80 mmscmd for a short period,
but that does not prove the ability for continuous flow at that level.
The production shortfall can be attributed to various technical and commercial
reasons:
Q A possibly incorrect assumption on the actual payzone across the field. The
actual payzone (the hydrocarbon-bearing horizontal cross-section) may not
have been accurately assessed. This can and does happen in E&P operations
during the development phase.
Q Other reservoir characteristics may be different from what preliminary tests
indicate. A faster-than-expected pressure drop and excess water are other
issues that can lead to a difference in production from the target numbers. At
this stage, the permeability of the well differing from the expected level is
not likely.
Q Lack of commercially viable demand: Since it is difficult and expensive to
store natural gas at surface, it is a common practice to produce only as much
gas as there is demand for. In case customers are not willing to promise
offtake, operators may decide to limit their production.
Do we expect any hurdles in the approval
process?
There are some structural differences between the Cairn Vedanta deal and
Reliance bringing in BP as partner. Based on these, we expect the government
approvals to take their due course once Reliance submits an application.
Key differences from the Cairn-Vedanta deal are:
Q The 23 blocks that have been included in the partnership are all blocks that
were auctioned in the NELP rounds of bidding. Unlike Cairn’s Raj-MBA,
which is a pre-NELP block, the procedures for stakeholders are well defined
for the PSCs of the NELP blocks and it allows for assignment of
participating interest. The deal excludes the CBM and the PMT blocks.
Q Reliance is bringing in a partner with in-depth expertise in exploration and
production, while Vedanta does not have any prior E&P experience.
Q Reliance will continue to be the operator of the block even after the
partnership with BP.
Reliance is confident that by end-FY12, the company would have gone through
the approval process and would have received the initial payment of US$7.2bn.
The deal is effective 1 January 2011.
Emphasis on valuation is in line with the new
BP strategy
UBS had earlier highlighted that after Macondo, BP would focus on high-impact
exploration to a greater degree—historically a strength for the company. For
that, though, BP needs access. The risk was that either the company would
undergo a period of self-doubt and caution or would be so reputationally
damaged that access would become problematic. However, this and the Rosneft
deal, along with the deal signed with CNOOC earlier, and potentially the
completion of the Devon Brazil purchase, suggests that is not the case—a big
positive for BP, in our view.
It also shows BP still does daring, innovative, deals and is a boost for CEO Bob
Dudley.
Does BP have the cash?
Below is an extract from our report, BP 4Q review: a glimpse of new BP?, by
Jon Rigby, published 2 February 2011.
Disposals are now at US$22bn against the target of US$25-30bn. There appears
to be an expectation among management that the programme will rise to the
top-end of that range. BP announced it would also look to sell the Texas City
and Carson refineries, as well as some of its US fuel marketing business.
Strategy update – emphasizing
safety and value
BP took the opportunity to provide an “investor update” at its 4Q results in lieu
of a dedicated strategy day.
— Safety: as expected given the events of 2010 much of the emphasis of the ‘new
BP’ was on safety. BP strongly emphasised changes it had made in its
organisation to improve safety; in particular the creation of the Safety and
Operational Risk organization, which is implementing the 26 recommendations
from the Bly report into the Macondo incident. The key challenge for BP
management is to convince investors why it’s different this time. Ultimately, only
time will tell.
— Reputation: BP listed “re-building trust” as one of its key themes for its
strategic agenda. Clearly the reputation of the company has been damaged and
it remains unclear what the long-term impact of this has been. BP highlighted its
contributions to various initiatives in the Gulf (Gulf of Mexico Research
Initiative, Rig Worker Assistance fund, etc.). The company is also supporting
tourism in the affected states. The CEO Bob Dudley was adamant that BP will
not be singled out for more harsh treatment in the Gulf than any other company.
He also emphasized that the existing expertise that the company had plus the
lesson learned from Macondo were proving to be interesting to resource
holders.
— “Value growth:” There has been much speculation over the shape of the ‘new
BP.’ Certainly given the asset sales it will be a smaller company – but as we
have highlighted previously we are skeptical of any promise to “shrink to
grow.” We see limited scope for disposals from an already focused upstream
portfolio and we find it hard to identify a kernel of the portfolio that has
material growth advantage. However as we have said we are fans of the “shrink
to add value” strategy and this appears to be what BP is trying to do. In both
E&P and R&M the company appears to want to exchange a larger operation for
a smaller but more profitable one, recycling capital and realizing value faster.
— E&P: BP highlighted that the speed of its asset sales was prompted by
liquidity issues as a result of Macondo; however the company also indicated it
had previously been holding onto assets sometimes for the sake of maintaining
production levels (although the assets still delivered value of course). However,
the good values realised by the disposals has demonstrated that there is a
potential upside in managing portfolios more aggressively.
— R&M: In perhaps a more surprising move, BP also laid out plans to divest its
largest refinery, Texas City, along with the Carson refinery in Los Angeles. This
is in addition to the 2010-11 disposal programme. The company is choosing to
sell these refineries in order to upgrade its remaining portfolio. The two
refineries are neither advantaged from a logistics or integration point of view
although the complexity and location will likely attract buyers. Post 2013, it is
aiming to have the smallest refining portfolio of the Majors but with the
performance improvement targeted (including refinery upgrades) to have
significantly improved profitability.
— Macondo: BP also provided a detailed update on the status of its financial
and legal position on the Macondo incident.
How does this deal affect the partnership with
Niko?
Reliance’s contract with Niko Resources, its partner in the D6,NEC 25 and D4
blocks, allows Niko to increase its stake by 30% of its holding in case Reliance
enters into a partnership with BP (or any other firm).
Niko will have the option of hiking its stake in the D6 and NEC 25 blocks to
13% from 10% and in D4 to 19.5% (from 15%). If Niko takes up the option then
this would further negatively affect Reliance’s earnings.
What is the effect on Reliance’s earnings and
balance sheet?
Post the deal, BP’s share will be released from the gross block. As we gain more
clarity on the numbers, we will ascertain what will be the one-time effect of the
reduction in the grow block due to the deal on the P&L of the company.
BP’s share in the upstream assets will come in as minority interest and will be
reflected below the EBIT line. EBIT forecast from the oil and gas business will
be about 20% in FY13 and oil and gas will continue to be an important business
for the company with the promise of maximum growth upside. The deal though,
has derisked this and hence both upside and downside are more muted than was
the case earlier.
For the next three years up to FY14, we estimate the deal leads to an EPS
neutral effect. This is assuming only interest earnings at the rate of 7% from the
US$7.2bn that Reliance would receive
Does the deal change our valuation?
We base our Rs1,050.00 price target on a sum-of-the-parts valuation. It implies
8.13x FY12E EV/EBITDA. Our valuation includes Rs647/share from the
refining and petrochemicals businesses. We use a multiple-based valuation for
the same and employ an EV/EBITDA multiple of 7x. We believe 7x is an
appropriate multiple for both the refining and petrochemicals businesses. We
base this on the valuations of its Asian peers and by applying a
premium/discount based on the specific differences among those peers. As
Reliance has a more complex and forward integrated refinery, we value it at a
premium at 7x EV/EBITDA. We value the petrochemicals business at a forward
EV/EBITDA of 7x, in line with the average for non-Taiwanese Asian
petrochemical companies.
We explicitly value gas from the KG-D6 basin and NEC gas using a DCF
methodology. We value oil from the KG basin on an EV/boe of US$10. Our
valuation incorporates the exploration option separately, and the retail and other
businesses as investments, which we value at Rs140/sh and Rs89/share,
respectively.
Q Reliance Industries
Reliance Industries (RIL) is the largest integrated oil and gas company in India.
Its three main businesses are exploration & production, refining and
petrochemicals. Its two refineries in Jamnagar, Gujarat have among the highest
complexity globally and a combined capacity of 1mbpd. The company's FY10
turnover was US$46bn. It derives more than 50% of its revenue from exports.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Reliance Industries
Thoughts on Reliance-BP deal
„ Reliance ropes in global E&P player as partner
We believe given the technical capabilities that deepwater E&P requires, having
BP as a partner is a positive for the business’s long-term value. BP will pay
US$9bn (US$7.2bn by FY12 + US$1.8bn conditional) for a 30% stake in 23 of
Reliance’s E&P blocks. The transaction was done at close to our valuation of
US$26bn for Reliance’s upstream business.
„ Declining production at KG D6: BP’s technical expertise a plus
Reliance’s D1-D3 gas production has declined from a peak of ~52mmscmd to ~43-
45mmscmd now. We believe production at the reservoir turned out to be more
complex than the company expected, and Reliance was not sure how to raise
production without damaging the reservoir. Though Reliance Industries does not
have a precedent of selling a stake in its businesses, we believe the complexity of
the deep waters has forced its hand.
„ Emphasis on exploration in line with new BP strategy
BP will gain around 0.5Bcf/d (93kbd) of production but we believe the real value
is in the access as BP targets exploration in large basins. Following BP’s major
Arctic deal with Rosneft last month and with Devon, this represents an aggressive
reloading of exploration.
„ Valuation: maintain Neutral, SOTP-based PT of Rs1050; Buy on BP
Reliance has gained US$6.4bn in market cap since 1 February 2011. We believe
the stock price now reflects the unlocked value of its assets. The price paid by BP
allays some concerns as it supports the valuation of the upstream business. At
550p, our price target on BP is set at 5.4x 2012E EV/DACF and 7.2x 2012E PE.
Why could production be falling?
Reliance had been facing technical difficulties in ramping up production of
natural gas at its KG-D6 fields. For more details, please refer to our reports:
Reliance Industries: Low on gas, by Prakash Joshi, published 4 February 2011,
and Reliance Industries: Show me the gas, by Prakash Joshi, published 19
January 2011.
Production touched a peak of 60 mmscmd in Q1FY11 and has since been
decreasing. The field has been tested to flow at 80 mmscmd for a short period,
but that does not prove the ability for continuous flow at that level.
The production shortfall can be attributed to various technical and commercial
reasons:
Q A possibly incorrect assumption on the actual payzone across the field. The
actual payzone (the hydrocarbon-bearing horizontal cross-section) may not
have been accurately assessed. This can and does happen in E&P operations
during the development phase.
Q Other reservoir characteristics may be different from what preliminary tests
indicate. A faster-than-expected pressure drop and excess water are other
issues that can lead to a difference in production from the target numbers. At
this stage, the permeability of the well differing from the expected level is
not likely.
Q Lack of commercially viable demand: Since it is difficult and expensive to
store natural gas at surface, it is a common practice to produce only as much
gas as there is demand for. In case customers are not willing to promise
offtake, operators may decide to limit their production.
Do we expect any hurdles in the approval
process?
There are some structural differences between the Cairn Vedanta deal and
Reliance bringing in BP as partner. Based on these, we expect the government
approvals to take their due course once Reliance submits an application.
Key differences from the Cairn-Vedanta deal are:
Q The 23 blocks that have been included in the partnership are all blocks that
were auctioned in the NELP rounds of bidding. Unlike Cairn’s Raj-MBA,
which is a pre-NELP block, the procedures for stakeholders are well defined
for the PSCs of the NELP blocks and it allows for assignment of
participating interest. The deal excludes the CBM and the PMT blocks.
Q Reliance is bringing in a partner with in-depth expertise in exploration and
production, while Vedanta does not have any prior E&P experience.
Q Reliance will continue to be the operator of the block even after the
partnership with BP.
Reliance is confident that by end-FY12, the company would have gone through
the approval process and would have received the initial payment of US$7.2bn.
The deal is effective 1 January 2011.
Emphasis on valuation is in line with the new
BP strategy
UBS had earlier highlighted that after Macondo, BP would focus on high-impact
exploration to a greater degree—historically a strength for the company. For
that, though, BP needs access. The risk was that either the company would
undergo a period of self-doubt and caution or would be so reputationally
damaged that access would become problematic. However, this and the Rosneft
deal, along with the deal signed with CNOOC earlier, and potentially the
completion of the Devon Brazil purchase, suggests that is not the case—a big
positive for BP, in our view.
It also shows BP still does daring, innovative, deals and is a boost for CEO Bob
Dudley.
Does BP have the cash?
Below is an extract from our report, BP 4Q review: a glimpse of new BP?, by
Jon Rigby, published 2 February 2011.
Disposals are now at US$22bn against the target of US$25-30bn. There appears
to be an expectation among management that the programme will rise to the
top-end of that range. BP announced it would also look to sell the Texas City
and Carson refineries, as well as some of its US fuel marketing business.
Strategy update – emphasizing
safety and value
BP took the opportunity to provide an “investor update” at its 4Q results in lieu
of a dedicated strategy day.
— Safety: as expected given the events of 2010 much of the emphasis of the ‘new
BP’ was on safety. BP strongly emphasised changes it had made in its
organisation to improve safety; in particular the creation of the Safety and
Operational Risk organization, which is implementing the 26 recommendations
from the Bly report into the Macondo incident. The key challenge for BP
management is to convince investors why it’s different this time. Ultimately, only
time will tell.
— Reputation: BP listed “re-building trust” as one of its key themes for its
strategic agenda. Clearly the reputation of the company has been damaged and
it remains unclear what the long-term impact of this has been. BP highlighted its
contributions to various initiatives in the Gulf (Gulf of Mexico Research
Initiative, Rig Worker Assistance fund, etc.). The company is also supporting
tourism in the affected states. The CEO Bob Dudley was adamant that BP will
not be singled out for more harsh treatment in the Gulf than any other company.
He also emphasized that the existing expertise that the company had plus the
lesson learned from Macondo were proving to be interesting to resource
holders.
— “Value growth:” There has been much speculation over the shape of the ‘new
BP.’ Certainly given the asset sales it will be a smaller company – but as we
have highlighted previously we are skeptical of any promise to “shrink to
grow.” We see limited scope for disposals from an already focused upstream
portfolio and we find it hard to identify a kernel of the portfolio that has
material growth advantage. However as we have said we are fans of the “shrink
to add value” strategy and this appears to be what BP is trying to do. In both
E&P and R&M the company appears to want to exchange a larger operation for
a smaller but more profitable one, recycling capital and realizing value faster.
— E&P: BP highlighted that the speed of its asset sales was prompted by
liquidity issues as a result of Macondo; however the company also indicated it
had previously been holding onto assets sometimes for the sake of maintaining
production levels (although the assets still delivered value of course). However,
the good values realised by the disposals has demonstrated that there is a
potential upside in managing portfolios more aggressively.
— R&M: In perhaps a more surprising move, BP also laid out plans to divest its
largest refinery, Texas City, along with the Carson refinery in Los Angeles. This
is in addition to the 2010-11 disposal programme. The company is choosing to
sell these refineries in order to upgrade its remaining portfolio. The two
refineries are neither advantaged from a logistics or integration point of view
although the complexity and location will likely attract buyers. Post 2013, it is
aiming to have the smallest refining portfolio of the Majors but with the
performance improvement targeted (including refinery upgrades) to have
significantly improved profitability.
— Macondo: BP also provided a detailed update on the status of its financial
and legal position on the Macondo incident.
How does this deal affect the partnership with
Niko?
Reliance’s contract with Niko Resources, its partner in the D6,NEC 25 and D4
blocks, allows Niko to increase its stake by 30% of its holding in case Reliance
enters into a partnership with BP (or any other firm).
Niko will have the option of hiking its stake in the D6 and NEC 25 blocks to
13% from 10% and in D4 to 19.5% (from 15%). If Niko takes up the option then
this would further negatively affect Reliance’s earnings.
What is the effect on Reliance’s earnings and
balance sheet?
Post the deal, BP’s share will be released from the gross block. As we gain more
clarity on the numbers, we will ascertain what will be the one-time effect of the
reduction in the grow block due to the deal on the P&L of the company.
BP’s share in the upstream assets will come in as minority interest and will be
reflected below the EBIT line. EBIT forecast from the oil and gas business will
be about 20% in FY13 and oil and gas will continue to be an important business
for the company with the promise of maximum growth upside. The deal though,
has derisked this and hence both upside and downside are more muted than was
the case earlier.
For the next three years up to FY14, we estimate the deal leads to an EPS
neutral effect. This is assuming only interest earnings at the rate of 7% from the
US$7.2bn that Reliance would receive
Does the deal change our valuation?
We base our Rs1,050.00 price target on a sum-of-the-parts valuation. It implies
8.13x FY12E EV/EBITDA. Our valuation includes Rs647/share from the
refining and petrochemicals businesses. We use a multiple-based valuation for
the same and employ an EV/EBITDA multiple of 7x. We believe 7x is an
appropriate multiple for both the refining and petrochemicals businesses. We
base this on the valuations of its Asian peers and by applying a
premium/discount based on the specific differences among those peers. As
Reliance has a more complex and forward integrated refinery, we value it at a
premium at 7x EV/EBITDA. We value the petrochemicals business at a forward
EV/EBITDA of 7x, in line with the average for non-Taiwanese Asian
petrochemical companies.
We explicitly value gas from the KG-D6 basin and NEC gas using a DCF
methodology. We value oil from the KG basin on an EV/boe of US$10. Our
valuation incorporates the exploration option separately, and the retail and other
businesses as investments, which we value at Rs140/sh and Rs89/share,
respectively.
Q Reliance Industries
Reliance Industries (RIL) is the largest integrated oil and gas company in India.
Its three main businesses are exploration & production, refining and
petrochemicals. Its two refineries in Jamnagar, Gujarat have among the highest
complexity globally and a combined capacity of 1mbpd. The company's FY10
turnover was US$46bn. It derives more than 50% of its revenue from exports.
No comments:
Post a Comment