E&P Blip Obscures Strong Cyclical Biz
RIL reported Q3FY11 EBITDA of Rs 9,545 cr and PAT of Rs 5,136 cr bang in-line with our estimates. The petchem biz reported best ever EBIT of Rs 2,429 cr aided by decade high margins in polyester chain, which we expect to sustain going forward. The R&M segment also reported strong results backed by a cyclical recovery in margins. However, there was a slight blip in the E&P biz, wherein lack of clarity over future outlook of business may delay monetization of E&P assets, in our view.
ü Refining EBIT growth at 77% (YoY): RIL exhibited strong cyclical recovery in refining biz, reporting a GRM of USD 9.0/bbl (Sing. margins at USD 5.0/bbl) on the back of strong recovery in gasoline spread along with widening light-heavy differential. Mgmt has indicated that the improvement in product spreads, along with stricter environmental norms in Europe/Turkey, would also support complex refining margins.
ü Petchem recorded decade high margins: Polyester margins remained strong on the back of: (a) spiraling domestic demand (15% growth in 9M-YoY); (b) lack of incremental global capacity addition; and (c) tightness in cotton market. Most of the polymer capacity additions are behind us, which would support polymer margins going forward.
ü KG-D6 – lack of clarity an overhang: The mgmt has indicated that RIL is continuing discussions with govt. and DGH to understand the policy framework and its impact on RIL. In view of the sensitivities, mgmt has not provided any clarity on KG-D6 production, which could remain an overhang on valuations. Moreover, the company’s development/ exploratory plans in other blocks may get delayed, which would delay monetization of E&P assets further.
Maintain BUY with Target Price of Rs 1,145/ sh
Due to expected delay in exploratory plans in NEC-25, MN-D4 and lack of clarity on KG-D6, we have reduced RIL’s E&P business valuation by 10% leading to our fair value coming to Rs 1,145/share. Our TP still offers 18% upside to CMP. We retain our Buy rating on the stock and believe any weakness in the stock is an opportunity to BUY.
Analyst meet highlights
Refining: GRMs exhibit cyclical uptrend
RIL’s GRM improved to USD 9.0/ bbl (Q2FY11- USD 7.9/ bbl) due to a strong recovery in gasoline spreads (up 25% QoQ) along with widening light-heavy crude differential (highest in last 2 years). Gasoil spreads remained firm as cold weather in Europe supported demand. Naphtha spreads turned positive, after a weak Q2FY11, primarily on the back of healthy demand from Saudi Arabia. RIL’s mgmt is expecting product cracks to widen going forward on the back of (a) strong recovery in global demand; (b) reduction in product inventories; and (c) widening light-heavy differential amidst the increasing demand for lighter product along with weakening FO cracks. Utilization rate was marginally lower at 104% compared to 109% in Q2FY11, primarily due to planned shutdown in the CDU unit, albeit remained significantly high when compared to other global peers.
Petrochem: margins are at decade high, to sustain going forward
RIL’s mgmt has indicated that despite rising feedstock costs (oil/naphtha), the company has managed to achieve significant growth in petchem profitability as spiraling demand along with high operating rates supported petchem margins. Polyester margins remained strong on the back of: (a) spiraling domestic demand (15% growth in 9M- YoY); (b) lack of incremental global capacity addition; and (c) tightness in cotton market. The Chemical profitability further improved as shortage of Benzene, Butadiene and SBR/PBR increased pricing power. Lastly, since most of ethylene cracking facilities are behind us, recovery in polymer spreads over the next two years is expected, which would support petrochemical margins for RIL.
E&P – lack of clarity mars outlook
The mgmt has indicated that they have initiated a discussion with GoI and DGH over interpretation of E&P policy framework. The mgmt has not provided any further details citing that the discussion is sensitive in- nature. We believe that the on-going discussion would not only impede production outlook of existing KG-D6 basin, but also likely to delay monetization of RIL’s other E&P blocks.
Earnings revision
We have marginally revised our FY11/12/13E estimates downward by 1.0-2.0%. The revised estimates have largely remained flat vis-à-vis our previous estimates as the upward revision in R&M/petchem business have been partly offset by weakness in upstream business (lower KG-D6 production and higher risk factor to incorporate the lack of visibility over future outlook of the business).
Valuation and assumptions
Building in delay in E&P asset monetization and strong cyclical recovery in R&M/petchem
E&P business: RIL’s upstream business has recently faced headwinds amidst the slower than- expected ramp-up of its KG-D6 gas production and a minor setback in its exploratory portfolio (D9 dry well). The company’s mgmt has not furnished any clarity over the future outlook of its upstream business. We believe that the current uncertainty would not only impede production outlook of existing KG-D6 basin, but also likely to delay monetization of RIL’s other E&P assets. We have incorporated the uncertainty over E&P business by: (a) moderating our production estimates for KG-D6 block; and (b) applying a risk discount of 20% on valuation of other reserves (NEC-25, CBM, contingent and future reserve accretions). We have reduced our fair value estimates for RIL’s E&P business to Rs 394/share from our earlier estimates of Rs 440/share.
Refining and petrochemicals biz: We have marginally raised our refining margin assumptions from USD 8.2/9.3/10 to USD 8.4/10/10.5 per bbl for FY11/12/13E respectively, owing to a strong recovery in global demand. Additionally, we are building in a substantial cyclical recovery in petrochemical margins, even higher than our previous estimates, on the back of an indication from RIL mgmt that the current healthy petchem margins are likely to sustain in future. We value the extant R&M and petchem biz at Rs 631/share.