>RELIANCE INDUSTRIES (BNP PARIBAS)

■ Upgrade to HOLD and raise SoTP-based TP to INR1010/sh.
■ 3Q results suggest refining has bottomed, recovery likely to be slow.
■ Switch to Cairn for near-term; prefer ONGC for the long term.
■ Our concerns on weak refining and delay in gas issue play out.

Refining bottoms out, but don’t expect a sharp uptick
3QFY10 results showed refining bottoming out for complex refiners like Reliance. 3Q refining margins came in higher than we expected, at USD5.90/bbl, on strong utilization rates of 107% for both the refineries. The new refinery impressed with utilization of 115% supported by strong exports. Singapore complex margins increased in the past couple of weeks to ~USD5.5/bbl as oil prices cooled off and product cracks remained stable. While we believe the worst is over for global complex refiners, we do not share the view that there could be a strong recovery in refining. Product demand, especially for high-margin products like gasoline and diesel in US and Europe, remains muted. While China and India are seeing consumption grow at a rapid pace, on a global scale, the incremental demand doesn’t move the needle to enable a refining revival. In addition, greenfield capacity/unit upgradation continues to be a concern.

E&P should be the value driver
RIL has one of most prospective acreages within the Indian E&P space. Its landmark KGD6 field is currently producing 60mmscmd of gas and is capable of producing 80mmscmd, depending on fall-back demand and
additional allocations. In addition, drilling is on schedule at the D3 & D9, the other prospective blocks within the KG basin. However, investors will have to be patient for reserve accretion and for RIL’s E&P story to unravel. While we believe RIL’s acreage within the KG basin to be prospective, we do not assign any value to the KGD3 & D9 blocks as exploration activity is still in the early stages.

Valuation
We are upgrading Reliance Industries to HOLD from Reduce. Since our downgrade on 24 April, 2009 (“All priced in: time to get out”), RIL shares have gained by 14.9% compared to Sensex at 42.6%. Our concerns of continued downturn in refining, delay in the resolution of the gas issue and no E&P surprises all played out. We do not expect to see the same degree of under-performance going forward for RIL as refining shows signs of bottoming and as the outcome of the court case closes on. We raise our TP from INR815/sh to INR1010/sh as we value refining at a higher multiple as refiners move from trough valuations. We value the refining & petchem business at 8x EV/EBITDA, KGD6 Oil & Gas fields using DCF and CBM, NEC-25 & KGD6 satellite fields at EV/boe of USD5. Key upside risk to our TP is a sudden turnaround in refining.

To read the full report: RELIANCE INDUSTRIES