Net debt to remain stable in FY21; FY21e EPS down 10% to factor in Covid-19; TP revised to Rs 1,544 from Rs 1,632; ‘OW’ maintained
The decline in global energy demand and expansion in CDS spreads for RIL, to 290bps over the past month, have raised investor questions about RIL’s balance sheet leverage. Per our assessment, RIL’s net debt (including other liabilities) would remain stable in FY21, if the COVID-19 situation were to persist for six months (our base case: three months), and recover only slowly thereafter. We estimate a $1.2-1.8 bn reduction in OCF, with near-zero FCF, if weak demand were to continue for six months.
However, RIL has flexibility to prioritise its investments in FY21, and could thereby reduce cash outlay by ~25-30% y-o-y. Still, capex on ongoing upstream gas production, telecom spectrum renewal, and maintenance may be required. Its net liabilities/equity, at 0.75x, will, however, continue to be amongst the most favourable levels vs. most global oil majors and local telecom/retail players.
Can balance sheet health sustain if asset sales are delayed? Net debt might not decline if asset sales are pushed out, but it still might not rise in FY21. Our analysis on the basis of FY19 disclosures suggests limited liquidity challenges even if RIL’s utilisation rates and margins remain challenges in its energy business.
Why OW? Debt reduction has been a key pillar of our OW thesis, but, post the sell-off, valuations vs. local indices are at multi-decade lows. Our analysis of RIL’s cashflows in various industry downcycles and sustaining weak demand for 2020 still projects upside, implying a lot is now priced in the stock. Hence, we lower our earnings estimates for a second time, by 10% for FY21, taking our total reduction to 17% over the past two months, to factor in three months of challenges.
Stronger after the storm: We expect Reliance to gain market share with better profitability as the current demand decline is driving global refiners and oil majors alike to reassess growth plans to conserve cash. Oversupplied oil markets as chemical/refinery markets tighten are a significant tailwind, as well. RIL’s strong cash-flows should help it gain market share faster in offline retail and telecom segments, as competition conserves cash.
Rise of returns: Over the past decade, RIL’s ROCE has been range-bound, at around 9-10%. We think this trend is set to change. We expect ROCE to rise to 14% in FY22, as telecom returns inch higher, utilisation rates in energy rise and the chemical cycle improves from the current trough. Combined with slower investments, we see 27%
FY20-F22 EPS CAGR, setting Reliance apart from most global energy and telecom players and making it our top pick.