Reliance Industries: Too much to hedge:: Kotak Securities

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Too much to hedge. RIL reported weak results in 3QFY15 led by moderate
adventitious/inventory losses due to rather sharp decline in crude oil prices, which was
indeed challenging for the company to mitigate through effective hedging policies.
With a tough operating quarter behind us and potential value erosion from
telecom/shale largely priced in, we believe RIL (ADD, TP `1,000) can outperform
broader markets given its inexpensive valuations. Potential weakening of the global
economy is a key risk to our positive stance.

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3QFY15 results marred by adventitious/inventory losses due to sharp decline in crude prices
RIL reported 12.5% qoq decline in standalone EBITDA to `72.1 bn (-5.4% yoy), 10% below our
estimate, led by weak refining margins at US$7.3/bbl, which reflected adventitious losses and
inventory write-down due to sharp decline in crude oil prices. Higher other income and lower
DD&A expenses partially mitigated the impact on net income, which declined 11.4% to `50.9
bn, 5.5% below our estimate. Consolidated EBITDA declined 11.5% qoq to `86.9 bn and net
income declined 12% qoq to `52.6 bn, largely mirroring the standalone performance. We note
that the negative impact of lower crude oil prices on the profitability of US shale operations will
be reflected in 4QFY15/1QFY16 due to lag of one quarter in consolidation.
Weak performance across business segments
RIL’s petchem segment EBIT declined by 8.6% qoq to `22 bn in 3QFY15 reflecting (1) lower
production volumes for polymer and polyester segments and (2) lower realized margins during
the quarter. Refining segment EBIT declined 15.5% qoq to `32 bn despite higher crude
throughput (+2.3% qoq) reflecting lower refining margins (-US$1/bbl qoq). E&P segment EBIT
declined to `2.7 bn in 3QFY15 from `3.3 bn in 2QFY15 despite higher domestic gas prices
reflecting lower crude oil realizations. Retail business EBIT increased to `1.3 bn in 3QFY15 from
`1 bn in 2QFY15 led by 12.5% growth in revenues to `4.7 bn. Shale business EBIT increased to
`5.7 bn in 3QCY14 from `4.9 bn in 2QCY14 despite 8% decline in revenues to `1.5 bn.
Fine-tune estimates; retain ADD
We revise our FY2015-17E EPS estimates (standalone) for RIL to `68.4 (-4.3%), `73.4 (-1%)
and `87.4 (-3%) to reflect (1) modestly lower refining margins, (2) higher other income and (3)
other minor changes. We retain ADD on RIL noting (1) inexpensive valuations at 10.8X FY2016E
adjusted EPS versus BSE-30 Index at 16.4X, (2) strong earnings growth led by core business
projects and (3) 15% upside to our SOTP-based target price of `1,000. Our reverse valuation
exercise shows that the RIL stock is ascribing 4.9X FY2017E EV/EBITDA to its core businesses.
We have largely factored in potentially weak performance of the non-core businesses
(telecom/shale) by ascribing nil equity value. However, we do see risks to our expectations of
earnings growth and a positive view on the RIL stock from potential weakening of the global
economy, which may put to risk margins for the downstream refining and petchem businesses.

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily19012015tn.pdf