Reliance Industries (RIL)
Energy
Weak Rupee versus weak cycles. We believe RIL stock offers a favorable reward-risk
balance post the 10% correction in its stock price in the past three weeks. The softness
likely reflects the market’s concerns about recent weakness in refining margins but
ignores the steep correction in the Rupee over the same period, which should partially
offset weaker margins. We have made a few changes to our earnings model but retain
our 12-month SOTP-based fair valuation of `1,000. We upgrade RIL stock to a BUY
rating from ADD noting 27% upside to our target price.
Recent correction offers opportunity to accumulate RIL stock
We see a favorable investment reward-risk balance at current levels. RIL stock has corrected by
10% in the past three weeks reflecting the market’s concerns on (1) sharp decline in global
refining margins (see Exhibit 1), (2) likely subdued chemical margins given a weak global macroenvironment
and (3) continued decline in KG D-6 gas production. RIL stock is currently trading at
10.3X FY2012E EPS and 9.7X FY2013E EPS (adjusted for treasury shares).
Refining margins tumble led by contraction in gasoline cracks
Singapore margins have plunged in the recent weeks, led by sharp contraction in gasoline/naphtha
cracks. We compute Singapore complex gross refining margins at -US$2.5/bbl in the latest week
versus US$3.5/bbl in October 2011. We would not be unduly concerned about weekly movement
in refining margins and expect a rebound from current very low levels. However, we maintain our
subdued view on the refining cycle for the next 12 months due to (1) demand weakness and
(2) refining capacity additions in CY2012E. We model RIL’s refining margins for FY2012-14E at
US$9.8/bbl, US$10.1/bbl and US$10.4/bbl; US$10.2/bbl in 1HFY12. Exhibit 2 gives the sensitivity
of RIL’s earnings to key variables—exchange rate assumption, refining margins and chemical prices.
Earnings to benefit from weakening of Rupee
We expect RIL’s earnings to benefit significantly from the recent sharp weakening of Indian Rupee
against the US dollar. We note that Rupee has depreciated by 15% against US dollar over the past
three months. RIL benefits from a weakening of the Rupee across all its segments. We note that
the domestic selling prices of its products and purchase price of raw materials are linked to landed
cost of imports; it gets export price in case of exports of products (refined products primarily). We
highlight that a `1/US$ depreciation in Rupee increases RIL’s earnings by ~3% for FY2012-13E.
Revised earnings to reflect weaker Rupee and lower margins
We have revised our FY2012E and FY2013E EPS to `70 and `74 from `70 and `71 previously, to
reflect (1) weaker Rupee assumptions, (2) lower petrochemical and refining margins and (3) other
minor changes. Key downside risks to our earnings estimates stem from (1) weaker-than-expected
petrochemical and refining margins and (2) further decline in gas production from KG D-6 block.
Energy
Weak Rupee versus weak cycles. We believe RIL stock offers a favorable reward-risk
balance post the 10% correction in its stock price in the past three weeks. The softness
likely reflects the market’s concerns about recent weakness in refining margins but
ignores the steep correction in the Rupee over the same period, which should partially
offset weaker margins. We have made a few changes to our earnings model but retain
our 12-month SOTP-based fair valuation of `1,000. We upgrade RIL stock to a BUY
rating from ADD noting 27% upside to our target price.
Recent correction offers opportunity to accumulate RIL stock
We see a favorable investment reward-risk balance at current levels. RIL stock has corrected by
10% in the past three weeks reflecting the market’s concerns on (1) sharp decline in global
refining margins (see Exhibit 1), (2) likely subdued chemical margins given a weak global macroenvironment
and (3) continued decline in KG D-6 gas production. RIL stock is currently trading at
10.3X FY2012E EPS and 9.7X FY2013E EPS (adjusted for treasury shares).
Refining margins tumble led by contraction in gasoline cracks
Singapore margins have plunged in the recent weeks, led by sharp contraction in gasoline/naphtha
cracks. We compute Singapore complex gross refining margins at -US$2.5/bbl in the latest week
versus US$3.5/bbl in October 2011. We would not be unduly concerned about weekly movement
in refining margins and expect a rebound from current very low levels. However, we maintain our
subdued view on the refining cycle for the next 12 months due to (1) demand weakness and
(2) refining capacity additions in CY2012E. We model RIL’s refining margins for FY2012-14E at
US$9.8/bbl, US$10.1/bbl and US$10.4/bbl; US$10.2/bbl in 1HFY12. Exhibit 2 gives the sensitivity
of RIL’s earnings to key variables—exchange rate assumption, refining margins and chemical prices.
Earnings to benefit from weakening of Rupee
We expect RIL’s earnings to benefit significantly from the recent sharp weakening of Indian Rupee
against the US dollar. We note that Rupee has depreciated by 15% against US dollar over the past
three months. RIL benefits from a weakening of the Rupee across all its segments. We note that
the domestic selling prices of its products and purchase price of raw materials are linked to landed
cost of imports; it gets export price in case of exports of products (refined products primarily). We
highlight that a `1/US$ depreciation in Rupee increases RIL’s earnings by ~3% for FY2012-13E.
Revised earnings to reflect weaker Rupee and lower margins
We have revised our FY2012E and FY2013E EPS to `70 and `74 from `70 and `71 previously, to
reflect (1) weaker Rupee assumptions, (2) lower petrochemical and refining margins and (3) other
minor changes. Key downside risks to our earnings estimates stem from (1) weaker-than-expected
petrochemical and refining margins and (2) further decline in gas production from KG D-6 block.
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