Monday, September 28, 2009


Balance sheet leverage to drive future growth; initiate with a Buy

Source of opportunity
We initiate coverage on Reliance Infrastructure (RELI) with a Buy rating and a 12- m TP of Rs1,404, or 20% upside potential. The Indian government’s focus to attract investment of c. US$500bn for the 11th plan (FY08-FY12E) to build infrastructure through the public-private partnership route will augur well for the private sector, in our view. We believe that RELI, with 1) its in-house EPC arm & 2) strong balance sheet strength (capacity to build infrastructure order book up to US$8bn) is well placed to benefit from emerging opportunities in the infra segment. Moreover, our scenario analysis on the RIL-RNRL court case suggests that resolution of the dispute would offer RELI asymmetric risk to the upside.

(1) News flow on RELI being awarded infrastructure projects currently in the pipeline, particularly in relation to the road segment; (2) visibility of gas supplies upon the resolution of a court dispute leading to the commencement of work on gas-based plants in Dadri and Shahapur; and (3) completion of financial closure of the Krishnapatnam power project.

We value RELI using SOTP methodology (DCF for its power/infrastructure segments, EV/EBITDA for its EPC business). We value RELI’s 45% stake in Reliance Power using DCF and factoring in a holding company discount of 20% and remove it from the Conviction Sell List. Our bear/bull-case scenario analysis on RELI indicates potential down/upside of 15%/70%. Although the stock is trading close to its mid-cycle multiples, we believe these do not capture the earnings potential of RELI’s infrastructure business which we estimate will constitute about 20% of operating profit by FY12E.

Key risks
(1) Deployment of cash in unprofitable infrastructure projects; (2) delays in commissioning of projects under construction; (3) lower-than-expected EPC margins; and (4) court case outcome in favor of Reliance Industries.