>RELIANCE INDUSTRIES: Upgrade to Buy: Cyclical Risks Priced In; Structural Gas Rewards Not

■ Weak cyclical outlook reflected in under-performance — After a 15% YTD underperformance vs. the market, we believe the unexciting refining/petchem outlook is largely priced in and reflected in RIL’s valns that now stand at a 3-year low relative to Sensex. However, structural changes we see in the rapidly developing Indian gas market could provide the trigger for stock performance from a 6-9 month perspective, driving our upgrade to Buy, while maintaining our TP and estimates.

■ Stock trading closer to bear-case value — RIL now trades close to our bear-case value of Rs930/sh (5% downside from current levels), offering attractive riskreward. Our bear-case value is based on an avg of: (1) our bear-case SOTP that assumes lower GRMs of US$8.0/8.5 over FY11/12E, steeper yoy petchem EBITDA declines of 12/7% over the same period, and E&P valued at Rs364/sh, a moderate 15% premium to NAV, and (2) our bear-case P/E-based valn methodology that assumes 8-14% lower earnings over FY11-12E and a lower 14x Sep-11E multiple.

■ Structural changes in gas sector — Following recent, higher prices set by the Gov’t for ONGC’s production from new fields (US$4.75-5.25), we expect gas prices from other domestic sources (e.g. KG) to also structurally move higher driven by: 1) cheap domestic gas (vs. expensive LNG) remaining scarce, with growth backended, 2) demand continuing to substantially exceed supply, 3) increasing acceptability of higher priced LNG (e.g. NTPC). Customers, however, will continue to benefit, with economics vs. naphtha/FO still remaining extremely compelling.

■ US$4.2 now a base price…possible price surprise? — Post the APM price hike, US$4.2 is now a base price level of domestic gas, with gas from all other sources (ex-KG) now priced higher (Figure 15). With rising E&P costs and demand for higher prices to exploit new/marginal fields, there exists a case for the benchmark to move higher. Given the Government’s recent moves, we believe any willingness on its part to implement higher prices for incremental KG production (possibly over the next 6-9 months) could lead to reserve value enhancements and potential
earnings upsides (~3-5%) for RIL, driving stock performance.

To read the full report: RIL