| More a play on global cycles than on India. We suggest investors trim positions in RIL stock after its strong absolute performance over the past month. Chemical and refining margins have retreated from February highs led by weak fundamentals and start of new chemical plants; a stronger rupee poses additional risks to earnings. 4QFY10E results will likely be good but this is largely known. We do not see any other short-term triggers barring continued strong liquidity conditions.
A global play rather than India bellwether stock; margins have retreated of late
We note that RIL's performance would depend ultimately on the strength of global commodity cycles and not so much on its presence in India and/or liquidity. A large portion of RIL's earnings (~60% of EBIT in FY2012E) comes from its chemical and refining segments. We highlight that both chemical and refining margins have retreated from their February highs. We see weak fundamentals persisting for another 18-24 months in the case of both chemicals and refining.
4QFY10E results likely strong but stronger rupee, weak margins challenges for FY2011E earnings
We estimate RIL's 4QFY10E net income at Rs46.8 bn (+17% qoq and +21% yoy) led by strong chemical margins, US$8. 7/bbl refining margin and KG D-6 gas production of 60 mcm/d. We estimate 4QFY10E EBITDA to grow 11% qoq but a strong 60% yoy; however, higher DD&A charges will likely lead to more sedate growth in PBT on a yoy basis. We would watch for DD&A charges given the limited disclosures on information required to compute the same. Weak fundamentals of chemicals and refining and lack of fundamental triggers constrain view We are constrained to take a more positive view on RIL's FY2011E and FY2012E earnings given continued weakness in core chemical and refining businesses and known price/volume drivers for the E&P business. The recent strength in rupee poses additional risks to earnings. Also, we note that the stock is trading well above our fair valuation of Rs950 and 1,095 based on FY2011E and FY2012E estimates and we do not think that our assumptions are unduly conservative. Use of cash, new E&P discoveries and balance sheet issues key imponderables The key question would be the use of large cash flow generated over the next few years—we expect RIL to generate US$14 bn of gross cash flows in FY2011-12E. RIL has historically used its cash flows to fund new projects. However, its new initiatives in India haven't been very successful and it is looking at overseas acquisitions to drive future growth. Any large new E&P discovery will automatically consume some of the aforementioned gross cash flows and also create value. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints. Nothing in this article is, or should be construed as, investment advice. |
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