In our view, it is still too early to crystalise a value for the R1,500 bn (and likely to increase further) investment into the telecom business. At our price target, there is an implied negative equity value of R160/share for the telecom segment, and this would narrow/ widen over the coming quarters as we get more clarity on (i) further capital spend; (ii) customer additions once the free period ends; (iii) ARPUs and whether Jio is able to get ~2x the industry average and (iv) Jio’s Ebitda margins vs the peer group range of 35-40%. On the core projects, we see full flow through only from 2HFY18, with full benefits of gasifier coming through in FY19. Overall, we maintain our estimates though there is some downside risk to FY18 on telecom losses and push out of the gasifier. We remain Neutral,
although we expect reported refining earnings to be robust.
Thesis of falling capex and increasing FCF intact, but could get pushed out
We broadly agree with the bulls on RIL’s FCF thesis, as the company comes out of +$45 bn multi-year investment programme. However, we remain uncertain of the inflection year, as core projects’ full benefit is unlikely before FY19 (though some benefits should be seen from 2HFY18), and telecom remains difficult to call given industry dynamics. We see upside risks to our net debt forecasts (net debt+capital advances+ deferred payment, stands at R1,560 bn or $24 bn) but clarity depends on telecom and this should come only after spectrum auctions are completed.
Telecom—Further increase in investment; too early to take a call on investment value
We expect total telecom investment to increase from the current R1,500 bn, with clarity only post the spectrum auction. Given the sheer size of the investment and high competitive intensity with entrenched incumbents, we believe more visibility would emerge only over the coming quarters. Base, optimistic and pessimistic scenarios over FY18-20 show the wide range of earnings/losses from RJio depending on how the product offering, ARPU and costs evolve.
Near-term earnings strong, but FY18 earnings to be noisy
We remain uncertain about the interest + depreciation costs impact in FY18 and also the timing of Ebitda flow from projects. Admittedly, FY18 should likely be trough year and should improve from FY19 increasing capital return possibilities. Near-term core refining should continue to report $9-10 GRM even as the overall refining environment remains sluggish. The key assumptions underlying our FY18 earnings are: (i) $10.5/bbl GRM with $2 benefit coming from the gasifier, and (ii) substantial Ebitda uplift from the other core projects. As of now the gasifier has been pushed out, but overall GRMs remain elevated for the company. The Ebitda ramp up from other projects (ROGC, Ethane sourcing, PX) would depend on the ramp up through FY18. In our view, markets would likely look through some quarterly slippages as long as the ramp up is happening without any glitches. The bigger issue is the telecom Ebitda loss in FY18. Below the Ebitda line, how interest and depreciation costs flow through the P&L would have a large impact on the P&L. Core refining strong and
Core refining strong and FCF thesis remains intact
RIL’s refining business continues to fire on all cylinders and we expect Q2 to be another strong quarter with reported GRM likely in the $9-9.5 range, reporting premiums substantially higher than benchmark. A weak crude environment continues to throw up attractive crude sourcing opportunities which are helping margins. JPM’s house view on refining remains bearish and we expect the Chinese teapots to remain a structural headwind. In the near term, heavy maintenance by the Chinese refineries has pushed up cracks and has helped GRM recover. The Petrochemical business is benefiting from strong chemical spreads.
RIL’s core projects should start the commissioning process over the coming months. While the gasifier has been pushed out with mechanical completion by mid of next year, the other three projects—Refinery Off Gas Cracker (ROGC), Ethane Sourcing, and PX Expansion—should commission over the next two quarters and benefits should start flowing through from FY18. The pet coke gasifier full benefits are likely only in FY19.
The key underlying investment thesis for RIL is the surge in FCF post the completion of the projects and the higher OCF. We do not dispute this thesis; however, with our house view of depressed refining and expectations of a decline in ethylene spreads post the completion of the US crackers, our FCF expectations are somewhat lower than consensus.