Thursday, February 19, 2009

>Reliance Indsutries (CLSA)

Reliance Industries: Q&A with Somshankar Sinha, CLSA’s Oil & gas analyst - India

# Why should we buy Reliance now?

---The current weak stock price provides a very good opportunity to buy the stock. The stock is reacting to concerns about refining and petrochemical margins at this time, which are valid concerns to have. Profits from existing businesses will probably decline by 40% YoY next fiscal year. But there are four strong reasons to be positive about the stock. The first is that Reliance will enjoy an impressive earnings growth over the next two years, mainly due to
the contribution of new projects. The three main new undertakings will allow the overall EBITDA to rise 70% from the current levels in the next two years despite our negative view on the refining and chemical industry. We are estimating refining margins of US$4/bbl in 2009, a 60% decline YoY. Refining and petrochemical profits from existing plants will drop by roughly 50%. Together, the current and the new refinery will provide the same EBITDA as the
current refinery alone in 2008. Thus, on a per-barrel basis the EBITDA for refining will half. However, we expect 20% EPS CAGR each for the next 2 years (FY10 and FY11). This is very strong earnings growth versus global peers which will see earnings contraction with oil prices, refining margins and petrochemical margins going down.
Secondly, the earnings structure getting more diversified. Today, refining and petrochemicals contributes to 90% of the earnings but in the future upstream will contribute 50% of the EBITDA with downstream (even including the new refinery) only contributing 45%. Therefore, there will be less vulnerability to one variable with refining margins becoming much less significant. Reliance will be an integrated oil and gas player affected by oil prices, gas prices,
refining margins and chemical margins, providing more earnings stability. Think about natural gas. It will represent about 40% of total EBITDA. Unlike in many other markets, natural gas prices in India are fixed for long periods. For, Reliance they will not change for 5 years and after they change they will likely increase. So 40% of the business will be very stable. This is a clear contrast with global peers whose profits essentially depend on the global price outlook.
Third, their exploration venture is promising. We estimate more than 20bn barrels of unrisked resources; they are yet to explore the full potential. Finally we have valuation. The market seems to be ignoring the large earnings growth potential and the value of the stock is for the first time in a long time, well below its intrinsic value in our view.

# In your report you made a huge point about upstream. What’s so good about it?

--- Reliance has 400,000 sq km of oil concessions. It has currently explored 20% of one block and is going to produce in an area that is just 5% of that. This Krishna Godavari (KG)-D6 block is just about 7,500 sq km out of the total 400,000 sq km and one of the 57 blocks that it has in India and overseas. The upstream story that is making big waves is related to that one block only. An oil field in this block has already come on-stream and the main gas development from the block will be on by the end of February. But the geology extends much further and provides a huge potential for Reliance. For example, there are two more blocks adjacent to KG-D6 called MN-D4 and KG-D9 where partners indicate the potential is similar or higher than KG-D6. Drilling in those additional blocks will start in 2009. So this is not to say that the value of these two will become larger than KG-D6 very quickly but it clearly shows the potential Reliance has. Actually we have been a bit conservative till now for the upside potential and I think that we will be hearing news-flow about this from the middle of 2009. We value the existing known resources (2P + contingent) at US$20 bn. We value the exploration upside i.e. whatever is present in all the blocks (including the 56 blocks besides KG-D6) put together at about US$7.5 bn.

To see full report: CLSA