>RELIANCE INDUSTRIES (KARVY)

Resilience through vertical integration

Reliance Industries Ltd (RIL) continues to move forward on growth trajectory with the commencement of gas production from Krishna Godavari (KG) Basin and commissioning of the new refinery. We believe that there could be further positive news coming from exploration & production (E & P) business, which would act as the catalyst for the stock. The company's gas based petrochemical plant helps it to weather the global downturn. We rate the stock as an Outperformer with target price of Rs 2,169.

INVESTMENT ARGUMENT

E & P business has taken off with the KG Basin gas production: RIL operates the block KG-D6 in the Krishna- Godavari basin, which is the largest natural gas discovery in India. The company commenced production of natural gas from KG- D6 block on April 2, 2009. The exploration business is expected to give a boost to the valuation of the company as the blocks under exploration / yet to be explored are likely to have significant reserves of oil and gas. We expect the exploration and production (E & P) business to contribute at least 30% of the company's total EBITDA after the commissioning of KG basin gas production.

Refining earnings to be boosted once the new refinery stabilizes: After the merger of RPL with RIL, RIL's refining capacity has increased from 33 mn tonnes per annum to 62 mn tonnes per annum. The new refinery i.e. RPL has a distillation capacity of 580,000 barrels per day (bpd). Such a large scale of operations should provide economies of scale, leading to a relatively lower operating cost base. The new refinery has been designed to have a Nelson Complexity Index of 14.0, which makes it amongst the most complex refineries in Asia. Since the new refinery is located in special economic zone (SEZ), it will have significant tax benefits.

Petrochemical cycle down, but gas based cracker limits the impact on RIL: Though the global petrochemicals cycle is down, gas based petrochemical plants are less affected due to their lower input cost as compared to the plants, which use naphtha as the input. Gas based plants have the cost advantage as the gas price is generally 0.5x of naphtha. The merger of IPCL has helped RIL in acquiring a gas based cracker having vastly superior economics of these plants as against naphtha-based ones. RIL is also building the largest integrated petrochemical complex based on gas as a feedstock with capacity of 2 million tonnes per annum at Jamnagar SEZ. The project is expected to be commissioned by FY2010-11.

Valuation: RIL is currently trading at a P/E of 11.2x and EV/EBIDTA of 7.8x based on our FY2011E estimates. We have analyzed one year forward multiples of P/E, EV/EBIDTA and P/BV for RIL in the last firve years. Based on the same, we arrive at target price of Rs2,169. At our target price, the stock would trade at one year forward P/E of 13x and EV/EBIDTA of 9x based on FY2011E estimates, which is in line with its normal range except for the brief spurt between June 2007 to January 2008. We rate the stock as an Outperformer.

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