Asian refining margins remain strong but a correction is likely due to large capacity additions in 2012. We have cut FY13-14 GRM of Reliance Industries (RIL) by 15-27% (2-10% YoY fall).
We have also cut RIL?s FY13-14 blended petrochemical margin by 4-12%. We have cut KG D6 gas volumes to 46mmscmd for FY12-14 and also value of US shale gas assets (US gas price cut). This has meant a cut in RIL?s price target by 4% and FY13-14 EPS by 9-19%. Revised price target implies 14% potential upside. RIL is also cheap at 10x FY13 (last 5-year average forward PE 16.8x). We retain Buy on RIL.
Asian GRM strength is driven by strong 2010 oil demand rise and low refining capacity addition in 2010-11. However, GRM is likely to correct due to large refining capacity addition in 2012 (highest since 1999). We have cut RIL?s FY13-14 GRM to $8.8-9.0/bbl from $10.6-12.0/bbl. We have also cut its FY13-14 petrochemical margins (already down hit by Chinese demand fall in 2Q 2011).
If large refining capacity addition coincides with oil demand fall, RIL?s FY13 GRM may fall to $6.5-7.0/bbl. When demand fall last coincided with large capacity add, RIL?s GRM fell to U$6.6/bbl in FY10 (FY09: $12.2/bbl).
Global slowdown may even cut its FY13 petrochemical margin (19% lower than base case in bear case. However, a weak rupee would provide upside. FY13 rupee is assumed at 45.5 (currently R49.5).
Rupee at 49.5 would boost FY13 EPS by 11% (19% yoy up) and fair value to R947. It would also limit cut in FY13 EPS to 4% instead of 13% if GRM falls to $7/bbl.
Our price target of R870 (GDR $36.76) is a sum-of-the-parts valuation. It includes EV of RIL?s 3 businesses of R825/share and net cash of R45/share. The EV of the refining business is calculated based on 7x FY13E Ebitda while EV of petrochemical business is based on 6x FY13E EBITDA. The EV of E&P business is calculated on a discounted basis, using a WACC(Weighted Average Cost of Capital) of 11.8%. Refining and marketing (R342) is 42% of the EV, E&P valuation (R195) 24%, and petrochemicals (R287) 35%.
RIL is set to turn net cash for the first time in its history by the end of FY12.
BofAML