>RELIANCE INDUSTRIES: Refinding growth

■ Petrochemical margins unlikely to sustain: We believe petrochemical margins would be under pressure in FY11E and FY12E due to increased supplies, particularly from Middle East. We arrive at the petrochemical margins by estimating operating rates based on global and Indian demandsupply, considering Middle East capacity additions and adding a domestic manufacturer ‘premium’. Annexure 7 lists the estimated margins and operating rates in petrochemicals business.

■ Refining margins to improve gradually: Refining margins have been under pressure over the last c. six quarters due to decline in demand and negligible refinery shutdowns (c.1.9mnbbl refinery capacity shutdown in CY09 while addition of c.1.5mnbbl capacity). However, we believe the margins seen in CY09 are unsustainable based on simple refinery economics and margins are
unlikely to decline from the levels seen in 3QFY10E. We factor in a slow revival in GRMs and estimate GRMs at $9bbl and $10bbl for FY11E and FY12E respectively based on light heavy spread and global demand-supply scenario.

■ High margin E&P business to start contributing substantially: The full impact of cash flow from KG is expected to be reflected in FY11E as production ramps up to 80mmscmd. With clarity on gas sales case between RIL-RNRL, we believe that full potential of the Exploration and Production business will ensure visible growth. Further, Reliance has started scouting for opportunities in unconventional energy (shale gas, oil sands) which could provide longer term benefits. Given the visibility in gas price, we value known predominant gas fields (KG D6, NEC and Coal Bed Methane blocks) on DCF basis and other fields on EV/BoE or EV/EBITDA.

■ Initiate with BUY: With two large businesses – refining and E&P – likely to show an improvement, we initiate with a BUY rating and target price of Rs1,260. This indicates an annualized upside of 18% on previous closing price. We use the SOTP method - valuing refining and petrochemicals business at 7x EBIDTA - and arrive at a value of Rs269 for petrochemicals business and Rs379 for refining business. We value E&P business at Rs572/share.

To read the full report: RELIANCE INDUSTRIES