Reliance Industries. Neutral. Result Update. Strong show by petchem boosts RIL s operational performance, KG D6 continues to disappoint

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1 October 14, 2014 Neutral Reliance Industries Industry : Oil & Gas Result Update Strong show by petchem boosts RIL s operational performance, KG D6 continues to disappoint RIL s Q2FY15 operating profit (standalone) was of Rs82.4bn was ahead of our estimate while net profit of Rs57.4bn was in line with our estimate of Rs53.4bn due to higher interest cost and depreciation charge. GRM for the quarter at $8.3/bbl was marginally higher than our estimate while RIL s premium over Singapore complex GRM increased from $2.9 to $3.5/bbl due to higher crude differentials. Petchem EBIT for the quarter increased by 27.5% sequentially to Rs24bn (yoy -4%) driven by strong rebound in polymers, fibre intermediates and aromatics margins. Petchem EBIT for the quarter was 13% higher than our estimate. Gas production from KG-D6 decreased sequentially to 12.5mmscmd (yoy/qoq -1.8/-0.6mmscmd). Other income increased by 4.6% yoy to Rs21.4bn (29% of PBT). We maintain our NEUTRAL rating on the stock with a revised target price of Rs950. At the CMP, the stock is trading at 11.4x and 7.9x FY16e earnings and EV/EBITDA respectively. Net revenues for the quarter decreased by 7% yoy RIL s Q2FY15 net revenues stood at Rs965bn (yoy -7%, qoq +0.1%). Refining revenues during the quarter decreased by 5.8% yoy to Rs917bn (qoq +0.9%) driven by strong rupee which appreciated by 2.1% yoy while crude throughput declined by 2.3% yoy. Refining capacity utilization stood at 112%. Petchem revenues for the quarter increased by 5.1% qoq to Rs249bn driven by strong performance of polymer segment. The Oil and Gas segment revenue witnessed a decline of 5.7% yoy to Rs13.8bn due to fall in crude oil price and falling production of both oil and gas. Gas production from KG-D6 declined to 12.5mmscmd (yoy/qoq -1.8/-0.6mmscmd). Strong show by petchem during the quarter RIL s Q2FY15 operating profit witnessed a sequential increase of 9.4% to Rs82.4bn driven by 27.5% qoq increase in petchem EBIT while refining EBIT of Rs37.9bn was constant on a sequential basis (yoy +19.3%). During the quarter, Singapore complex GRM decreased by 17.2% qoq to $4.8/bbl on account of weakness seen in gasoline and gasoil cracks. RIL s GRM decreased by $0.4/bbl to $8.3/bbl which was marginally higher than our estimate of $8.3/bbl. Consequently, RIL s premium over Singapore GRM increased to $3.5/bbl. Petchem EBIT for the quarter increased by 27.5% sequentially to Rs24bn (yoy -4%) driven by strong rebound in polymers, fibre intermediates and aromatics margins. Petchem EBIT for the quarter was 13% higher than our estimate. Oil and Gas EBIT for the quarter decreased by 31.8% qoq to Rs3.3bn due to lower production and fall in crude oil price. Revise our target price to Rs950 We expect the refining business to face headwinds going forward on account of higher capacity additions compared to demand. Lack of demand growth has weighed down on RIL s other key business vertical petchem. To our mind, lack of demand growth would have a negative impact on RIL s petchem margins. RIL s upstream foray has been reeling under uncertainty with gas production from KG D6 falling to 12.5mmscmd. Add to it the uncertainty with respect to quantum and timing of gas price increase would further weigh down on the valuation of its domestic E&P business. We maintain our NEUTRAL rating on the stock with a revised target price of Rs950. At the CMP, the stock is trading at 11.4x and 7.9x FY16e earnings and EV/EBITDA respectively. Stock Data Current Market Price (Rs) 963 Target Price (Rs) 950 Potential upside (%) (1) Reuters Bloomberg What s Changed RELI.BO RIL IN 12 month PriceTarget (Rs) From Rs 994 to Rs 950 FY2015 EPS (Rs) From Rs 79.6 to Rs 73 FY2016 EPS (Rs) From Rs 90.4 to Rs 84.4 Key Data Market Cap (Rs bn) 3, Week Range (Rs) 1,143 / 794 Avg Dly Trading Value last 6 mts (Rs.mn) 3,815 Promoters (%) FII Holding (%) DII Holding (%) Public & Others Holding (%) Fiscal YE YE Mar FY13 FY14 FY15e FY16e Total sales(rs bn) 3,971 4,345 3,983 4,014 EBITDA margins(%) PAT margins(%) EPS(Rs) P/E(x) P/BV(x) EV/EBITDA(x) ROE(%) ROCE(%) Dividend yield( %) Relative Price Performance Oct-13 Feb-14 Jun-14 Oct-14 Reliance Ind One Year Indexed S&P Bse Sensex (%) 1 Month 3 Months 12 Months Absolute (5) (4) 10 BSE Relative (3) (7) (17) Chirag Dhaifule chirag@lkpsec.com Disclaimer: The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true and is for general guidance only. While every effort is made to ensure the accuracy and completeness of information contained, the company makes no guarantee and assumes no liability for any errors or omissions of the information. No one can use the information as the basis for any claim, demand or cause of action. LKP Securities Ltd., and affiliates, including the analyst who have issued this report, may, on the date of this report, and from time to time, have long or short positions in, and buy or sell the securities of the companies mentioned herein or engage in any other transaction involving such securities and earn brokerage o compensation or act as advisor or have other potential conflict of interest with respect to company/ies mentioned herein or inconsistent with any recommendation and related information and opinions. LKP Securities Ltd., and affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past.

2 Actual v/s Estimates Y/E, Mar (Rs. m) Q2FY15 Q1FY15 qoq (%) Q2FY14 yoy (%) LKP Estimates Deviation (%/bps) Revenue 964, , % 1,037, % 915, % EBITDA 82,350 75, % 78, % 74, % EBITDA (%) 8.5% 7.8% 72 bps 7.6% 97 bps 8.1% 39 bps PAT 57,420 56, % 54, % 56, % Result Table Y/E, Mar (Rs. mn) Q2FY14 Q1FY15 Q2FY15 yoy (%) qoq (%) H1FY14 H1FY15 yoy (%) Net Revenue 1,037, , , % 0.1% 1,914,030 1,928, % Raw Material Consumption 881, , , % -0.7% 1,611,630 1,571, % Purchase of products 1,160 17,160 17, % 1.2% 5,080 34, % Employee Cost 8,080 9,290 9, % 0.3% 17,070 18, % Other Expenditure 68,050 73,300 73, % -0.3% 131, , % Total Operating Costs 959, , , % -0.6% 1,764,790 1,770, % EBITDA 78,490 75,300 82, % 9.4% 149, , % EBITDA (%) 7.6% 7.8% 8.5% 97bps 72bps 7.8% 8.2% 38bps Depreciation 22,330 20,240 22, % 10.0% 43,710 42, % Interest 8,050 3,240 7, % 134.0% 16,150 10, % Other Income 20,600 20,460 21, % 4.6% 45,950 41, % PBT 68,710 72,280 73, % 2.2% 135, , % Tax 13,810 15,790 16, % 4.4% 26,910 32, % Tax Rate (%) 20.1% 21.8% 22.3% 220bps 45bps 19.9% 22.1% 219bps Adj PAT 54,900 56,490 57,420 5% 2% 108, , % Rep PAT 54,900 56,490 57, % 1.6% 108, , % Shares outstanding (mn) 3,231 3,233 3,234 3,231 3,234 Reported EPS (Rs) % 1.6% % Segmental Breakup Y/E, Mar (Rs. mn) Q2FY14 Q1FY15 Q2FY15 yoy (%) qoq (%) H1FY14 H1FY15 yoy (%) Segment Revenue Petrochemicals 248, , , % 5.1% 468, , % Refining 974, , , % 0.9% 1,789,140 1,827, % Oil & Gas 14,640 15,570 13, % -11.4% 29,180 29, % Others 3,300 1,930 2, % 14.5% 9,460 4, % Segment EBIT Petrochemicals 25,040 18,850 24, % 27.5% 43,920 42, % Refining 31,740 37,730 37, % 0.4% 61,250 75, % Oil & Gas 3,560 4,870 3, % -31.8% 7,080 8, % Others % 26.9% 1,260 1, % EBIT Margins Petrochemicals 10.1% 7.9% 9.6% -42bps 169bps 9.4% 8.8% -56bps Refining 3.3% 4.1% 4.1% 87bps -2bps 3.4% 4.1% 71bps Oil & Gas 24.3% 31.3% 24.1% -26bps -722bps 24.3% 27.9% 362bps Others 12.7% 26.9% 29.9% 1714bps 292bps 13.3% 28.5% 1518bps LKP Research 2

3 Refining GRM decreases to $8.3/bbl Refining revenues during the quarter decreased by 5.8% yoy to Rs917bn (qoq +0.9%) driven by strong rupee which appreciated by 2.1% yoy while crude throughput declined by 2.3% yoy. Refining capacity utilization stood at 112%. Singapore complex GRM decreased by 17.2% qoq to $4.8/bbl on account of weakness seen in gasoline and gasoil cracks. RIL s GRM decreased by $0.4/bbl to $8.3/bbl which was marginally higher than our estimate of $8.3/bbl. Consequently, RIL s premium over Singapore GRM increased to $3.5/bbl. Higher crude throughput negated the effect of fall in RIL s GRM. RIL s refining EBIT of Rs37.9bn was constant on a sequential basis (yoy +19.3%). RIL s GRM at $8.3/bbl decreased by $0.4/bbl on sequential basis 12.0 ($/bbl) Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 RIL GRM Singapore Complex GRM RIL s refinery utilization and crude processed for Q2FY % 115% % 109% % 103% 15 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 100% Crude Processed (mmt) RIL's Refinery Utilization Rate LKP Research 3

4 Strong Petchem performance during the quarter RIL s petrochemicals revenue for the quarter increased by 5.1% qoq to Rs249bn driven by strong performance of polymer segment. Petchem EBIT for the quarter increased by 27.5% sequentially to Rs24bn (yoy - 4%) driven by strong rebound in polymers, fibre intermediates and aromatics margins. Petchem EBIT for the quarter was 13% higher than our estimate. Petchem s EBIT margin for the quarter increased by 169bps qoq to 9.6% (yoy - 42bps). Lower naphtha prices due to decline in crude oil prices also helped petchem margin expansion. Petchem margin increased by 169bps sequentially to 9.6% 30 (Rs bn) 14% % 15 10% % 0 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 6% Petrochemicals EBIT (Rs bn) Petrochemicals EBIT (%) Petchem volumes trend 5.8 (mmt) Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 LKP Research 4

5 Upstream business affected by lower gas production from KG D6 and lower oil price Gas production from KG-D6 averaged 12.5mmscmd during Q2FY15 as against 13.1mmscmd in Q1FY15. Total gas production (incl PMT) averaged 19mmscmd during the quarter. Crude oil production from KG-D6 decreased by 2.2% yoy to 5,435bpd (qoq - 6.7%) while oil production from PM fields was constant at 22kbpd. Tapti field fields continued to witness natural decline during the quarter. Oil and Gas EBIT for the quarter decreased by 31.8% qoq to Rs3.3bn due to lower production and fall in crude oil price. We have modeled gas production at 15/20mmscmd and gas price of $4.2/6.5mmbtu for FY15e/16e. KG-D6 gas production at 12.5mmscmd Prodn at PM during the quarter 30 10, , , , , , ,000 Q2FY13 Q4FY13 Q2FY14 Q4FY14 Q2FY15 KG - D6 Gas Prodn (mmscmd) KG - D6 Oil Prodn (bpd) ,000 Q2FY13 Q4FY13 Q2FY14 Q4FY14 Q2FY15 PM Gas Prodn (mmscmd) PM Oil Prodn (bpd) Tapti gas prodn continues to fall due to natural decline E&P segment EBIT at Rs3.3bn in Q4FY , , Q2FY13 Q4FY13 Q2FY14 Q4FY14 Q2FY15 Tapti Gas Prodn (mmscmd) Tapti Condensate Prodn (bpd) 0 Q2FY13 Q4FY13 Q2FY14 Q4FY14 Q2FY15 Oil & Gas EBIT (Rs bn) LKP Research 5

6 Valuation & View Reliance Industries SOTP valuation - FY16e basis RIL is investing heavily in its core businesses to increase its capacities over the next few years. In its refining division, RIL is setting up a petcoke gasification plant at an estimated cost of $4bn while in its petchem division, RIL is spending $8bn to a) set up a refinery off-gas cracker and b) expand capacity. We estimate RIL s operating profit to grow at 12.4% cagr over FY14-17e period as against a muted growth of 3% over FY10-14, while we expect RIL s operating profit margin to increase by 521bps to 13.2%. We expect the refining business to face headwinds going forward on account of higher capacity additions compared to demand. Lack of demand growth has weighed down on RIL s other key business vertical petchem. This, to our mind, would maintain pressure on RIL s petchem margins. RIL s upstream foray has been reeling under uncertainty with gas production from KG D6 falling to 12.5mmscmd. Add to it the uncertainty with respect to quantum and timing of gas price increase would further weigh down on the valuation of its domestic E&P business. We value RIL using SOTP method valuing each of its businesses separately. We have valued RIL s Refining and Petrochemicals business using EV/EBITDA. To value the E&P business, we have valued the producing and developing assets on NPV basis. Other new ventures have been valued at book value or acquisition cost as they are still in a nascent stage and some time away from any meaningful contribution to the company. We maintain our NEUTRAL rating on the stock with a revised target price of Rs950. At the CMP, the stock is trading at 11.4x and 7.9x FY16e earnings and EV/EBITDA respectively. Business Segments Method Multiple Value (Rs mn) EV (Rs mn) (Rs/sh) Refining EV/EBITDA 6.5x 189,042 1,228, Petrochemicals EV/EBITDA 6.5x 148, , E&P business NPV & EV/boe 606, Shale Gas Assets EV/boe 177, Retail Book Value 1x 112, , SEZ Book Value 1x 49,910 49, Infotel Book Value 1x 230, , Total EV 3,368,329 1,146 Net Debt / (Cash) 576, Equity Value 2,791, CMP 963 Upside / (Downside) -1% LKP Research 6

7 Financials Income statement Y/E, Mar (Rs. m) FY13 FY14 FY15e FY16e Net Sales 39,70,620 43,44,600 39,82,674 40,14,421 yoy (%) 10.8% 9.4% -8.3% 0.8% Raw Materials Exp 32,18,250 34,59,310 30,88,827 30,62,746 Purch - traded goods 1,04,250 1,70,910 1,70,321 1,70,280 Mfg Exp 1,43,011 1,67,102 1,50,409 1,49,233 Gross Profit 5,05,109 5,47,278 5,73,117 6,32,162 Employee Cost 51,790 55,720 51,933 51,667 Other Expenditure 1,22,869 1,43,568 1,31,473 1,30,622 Total Expenditure 36,40,170 39,96,610 35,92,964 35,64,548 EBITDA 3,30,450 3,47,990 3,89,710 4,49,873 EBITDA margin 8.3% 8.0% 9.8% 11.2% yoy (%) -4.2% 5.3% 12.0% 15.4% Depreciation 1,12,320 1,12,010 1,33,962 1,47,866 Core EBIT 2,18,130 2,35,980 2,55,748 3,02,007 Core EBIT margin 5.5% 5.4% 6.4% 7.5% Other Income 78,000 89,110 89,610 90,110 EBIT 2,96,130 3,25,090 3,45,358 3,92,117 EBIT margin 7.5% 7.5% 8.7% 9.8% Interest 34,630 38,360 44,334 44,334 PBT 2,61,500 2,86,730 3,01,024 3,47,783 Tax 53,310 62,150 65,148 74,954 Tax rate (%) 20.4% 21.7% 21.6% 21.6% Adj PAT 2,08,190 2,24,580 2,35,876 2,72,829 Minority Interest Adj PAT after MI 2,08,790 2,24,930 2,35,876 2,72,829 EOIs Reported PAT 2,08,790 2,24,930 2,35,876 2,72,829 Cash Flow Y/E, Mar (Rs. m) FY13 FY14 FY15e FY16e Profit after Tax 2,08,790 2,24,930 2,35,876 2,72,829 Add : Depreciation 1,12,320 1,12,010 1,33,962 1,47,866 Add : Non cash -49,633-22, Add : Misc exp w/off changes in Inventory -79,090-13,960 39,830-3,494 changes in debtors 71,890 3,390 9, changes in other CA 17,780-14, changes in L & A -29,850-84,810 36,843-3,232 changes in CL & prov 1,67,770 1,86,410-88,660 7,777 Net changes in WC 1,48,500 76,320-1, CFO 4,19,977 3,90,760 3,68,177 4,20,841 Capital expenditure -3,04,937-6,06,730-2,73,633-2,65,800 Investments -42,520-1,84, CFI -3,47,457-7,91,500-2,73,633-2,65,800 Increase in debt 56,080 3,08, Issue of Shares Share Premium dividend paid -30,920-32,680-32,680-32,680 CFF 24,730 2,76,020-32,680-32,680 Net cash generated 97,250-1,24,720 61,864 1,22,361 Opening balance 4,07,310 5,04,560 3,79,840 4,41,704 Closing balance 5,04,560 3,79,840 4,41,704 5,64,065 Free Cash flow 1,15,040-2,15,970 94,544 1,55,041 Balance sheet Y/E, Mar (Rs. m) FY13 FY14 FY15e FY16e Equity share capital 29,360 29,400 29,400 29,400 Reserves & surplus 17,91,190 19,57,470 21,60,666 24,00,816 Networth 18,20,550 19,86,870 21,90,066 24,30,216 Minority Interest 9,490 9,590 9,590 9,590 Secured Loans 65,876 94,531 94,531 94,531 Unsecured Loans 6,43,724 9,23,729 9,23,729 9,23,729 Loan Funds 7,09,600 10,18,260 10,18,260 10,18,260 Total Liabilities 25,39,640 30,14,720 32,17,916 34,58,066 Gross Block 26,39,690 32,46,420 35,12,220 37,78,020 Less: Depreciation 10,58,930 11,70,940 13,04,902 14,52,768 Net block 15,80,760 20,75,480 22,07,318 23,25,252 Capital WIP 2,53,630 2,53,630 2,61,463 2,61,463 Investment 4,28,480 6,13,250 6,13,250 6,13,250 Current Assets 13,60,700 13,46,070 13,20,936 14,50,928 Inventories 5,46,010 5,59,970 5,20,140 5,23,634 Sundry debtors 97,500 94,110 84,217 85,084 Cash & bank bal 5,04,560 3,79,840 4,41,704 5,64,065 Other assets 17,830 32,540 32,108 32,146 Loans & advances 1,94,800 2,79,610 2,42,767 2,45,999 Curr. Liab & Prov 9,68,050 11,54,460 10,65,800 10,73,577 Current liabilities 9,17,170 11,07,100 10,22,306 10,29,744 Provisions 50,880 47,360 43,494 43,833 Net current assets 3,92,650 1,91,610 2,55,136 3,77,351 Net Def tax liability -1,15,880-1,19,250-1,19,250-1,19,250 Misc expenditure Total Assets 25,39,640 30,14,720 32,17,916 34,58,066 Ratios Y/E, Mar FY13 FY14 FY15e FY16e Profitability Gross profit margin 12.7% 12.6% 14.4% 15.7% EBITDA margin 8.3% 8.0% 9.8% 11.2% Core EBIT margin 5.5% 5.4% 6.4% 7.5% APAT margin 5.3% 5.2% 5.9% 6.8% Tax Rate 20.4% 21.7% 21.6% 21.6% Per Share (Rs) EPS CEPS Book Value Per Share Dividend Per Share Valuations Ratios (x) PER P/CEPS P/BV EV/EBITDA EV/Sales M-Cap/EBITDA M-Cap/sales Financial ratios ROCE 9.6% 9.2% 8.7% 9.2% ROIC 13.6% 12.2% 11.1% 12.0% ROE 11.9% 11.8% 11.3% 11.8% Debt/Equity Dividend yield (%) 0.9% 0.9% 0.9% 0.9% Growth Net Sales 10.8% 9.4% -8.3% 0.8% EBITDA -4.2% 5.3% 12.0% 15.4% Core EBIT -1.3% 8.2% 8.4% 18.1% APAT after Min int 5.9% 7.7% 4.9% 15.7% LKP Research 7

8 Team LKP Pratik Doshi Director S. Ranganathan Head of Research Ashwin Patil Research Analyst Chirag Dhaifule Research Analyst Hardik Mehta Sales Varsha Jhaveri Sales Hitesh Doshi Sales Bharat Shah Dealing Kaushik Doshi Dealing LKP Securites Ltd, 13th Floor, Raheja Center, Free Press Road, Nariman Point, Mumbai Tel Fax