>RELIANCE INDUSTRIES LIMITED (MERRILL LYNCH)

Still factoring too much potential upside

■ Revised PO implies 9% downside; cut to Underperform
The Mumbai High Court on June 15 ruled against Reliance Industries (RIL) in its litigation with RNRL, the consequent hit to PO being Rs173/share. A stronger rupee means hit of another Rs68/share. We have cut PO by 5% to Rs1,837/share even after factoring in upside of Rs137/share for upgrade in prospective resources in KG D9 and D3 blocks. After a 70% rally over 5 months RIL looks over-valued on our PO and on fair value in most other scenarios (Table 2). It is not cheap at 15.5x FY10E and 11.8x FY11E. Our earnings and PO do not factor all potential downsides (no tax holiday on gas output and weaker than assumed refining margins). We are therefore downgrading RIL to Underperform from Buy.

■ Share price factors lot of potential upside, not all downside
RIL has large reserve accretion potential. Our PO amply factors the reserve upside - 4bn boe valued at Rs427/share (US$13bn). We estimate RIL’s share price values reserve upside at Rs614/share (US$20bn) implying 6.2bn boe of future reserve accretion. It effectively values 10.9bn boe of reserves (PO values 9bn boe) vis-à-vis 4-5 year reserve target of 10bn boe set by RIL in October 2007. All potential downsides are not factored in. 7-year income tax holiday may be disallowed for gas production. We think the probability of it being disallowed is very low but downside to our PO if disallowed is significant at Rs300/share (16%).

■ Refining margins may be weaker for longer than assumed
Singapore refining margins are down to US$3/bbl in Jun’09 (US$5.1/bbl in Apr’09) and light-heavy crude spread has collapsed to below US$1/bbl. US refiner Valero warned of loss in 2Q. IEA forecasts 2.5m b/d decline in global oil demand in 2009E. This could keep refining margins weaker for longer than assumed by us.

To see full report: RIL