Reliance Industries rating: Buy; deal to allay concerns on high debt level

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Updated: August 27, 2019 5:15:25 PM

Aramco’s potential 20% stake in RIL’s O2C division comprising the refining, petrochemicals and 51% of the fuel retailing JV is based on an EV of $75 bn.

RIL will induct leading global investors in consumer businesses (Reliance Jio and Reliance Retail) in the next few quarters, and move towards their listing within the next five years.RIL will induct leading global investors in consumer businesses (Reliance Jio and Reliance Retail) in the next few quarters, and move towards their listing within the next five years.

During its Annual general meeting (AGM), Reliance provided a roadmap to becoming a zero net debt company (from Rs 1.5 trn consolidated net debt as of FY19 end) within the next 18 months (or by Mar 31, 2021), which we view as a big positive. The key steps towards RIL becoming zero net debt company are:

Saudi Aramco and RIL have signed a non-binding letter of intent to acquire a 20% stake in the Oil to Chemicals (O2C) division of RIL valued at an enterprise value (EV) of $75 bn.
British Petroleum (BP) and RIL have signed a joint venture (JV) in the petroleum retailing business with BP acquiring 49% stake in RIL’s petro retailing business for $1 bn (Rs 70 bn).
RIL will induct leading global investors in consumer businesses (Reliance Jio and Reliance Retail) in the next few quarters, and move towards their listing within the next five years.
It plans to evaluate value-unlocking options for real estate/financial investments.

Refining/petchem deal valuation of $75 bn EV in line with ours
Aramco’s potential 20% stake in RIL’s O2C division comprising the refining, petrochemicals and 51% of the fuel retailing JV is based on an EV of $75 bn. The proposed investment would also entail Aramco supplying 500kbpd of Arabian crude oil to RIL’s Jamnagar refinery on a long-term basis. The proposed investment is subject to due diligence. We note the deal valuation is in line with our SoTP valuation for RIL’s refining business at ~$34 bn (7x FY21F EV/ Ebitda) and petchem business at ~$41 bn (8x FY21F EV/Ebitda).

Aramco to get 20% economic interest in O2C division
The complete structure of transaction is not finalised yet. But, Aramco will not be given any shares of RIL’s stand-alone entity. Rather, Aramco will be given 20% economic interest of the O2C division, and this stake may be in the form of non-voting or preference shares. At this stage, there is no plan to separately de-merge the O2C division to avoid cash-flow isolation in the subsidiary structure. The agreement will provide for a potential demerger into a subsidiary structure at a later stage.

We estimate deal to be ~6% EPS dilutive for RIL stand-alone for FY21F
We note that the transaction is still at a non-binding letter of intent stage, and will likely be complete only by Mar-20F.

Assuming ~$15-bn payout from Aramco to RIL standalone and 20% of petchem/ refining Ebitda being attributable to Aramco, we estimate on a ball-park basis, the transaction to be value dilutive by about 6% for RIL’s FY21 standalone EPS. But, in our view, this transaction will allay investor concerns on Reliance’s high debt levels. In our view, the completion of this transaction will pave the way for RIL’s target of being zero net-debt by FY21F end.

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