Coronavirus impact: RIL's stock pricing in a worst-case scenario

Higher telecom earnings can help amid fears of weak refining & petrochemical margins

Not long ago, Reliance Industries (RIL) was the most fancied stock among investors. It was the first Indian company to touch a market value of Rs 10 trillion on November 28, 2019. But a chain of recent events, many of which impacted the broader markets as well, led to a sharp correction of 40 per cent in the stock from February highs.

Concerns on margins in its refining and petrochemical businesses, the potential impact of Covid-19 on retail sales, and a possible delay/call-off of its deal with Saudi Aramco and hence debt reduction are the key reasons for the fall. Analysts now say that the worst seems to be factored in, and the downside from here on appears limited.

 

In its core refining and petrochemical businesses, refining margins remain weak and the expected gains from the 2020 International Maritime Organization (IMO) Fuel Sulphur Regulations have not materialised because of the coronavirus spread, taking a toll on demand. Singapore complex gross refining margin (GRM) around $1.6 per barrel in Q4FY20 has slipped further, from $3.2 per barrel in the year-ago period and around $2 in the December 2019 quarter. Further, because of lower demand and higher supplies, polymer prices, which had bottomed out in December and were showing some recovery, are expected to see delayed gains.

The telecom/digital business, however, is among a few triggers that could support the stock. Analysts say near-term headwinds to RIL’s earnings come from lower downstream (petrochemical) margins amid a worsening macro environment. However, it may be partly mitigated by a plausible hike in telecom tariffs at an opportune time. The fact that consumer businesses (telecom, retail, etc) are now seeing increased contribution (now about a third) to RIL’s earnings provides comfort.

 

 

Analysts are of the view that the stock price nevertheless factors in most of the negatives. In fact, analysts at HSBC say that after a sharp fall in the share price, the market is discounting a 40 per cent decline in downstream refining and chemical Ebitda margins — the lowest in 10 years, and assigning a zero value for its E&P (exploration and production of oil and gas) and real estate assets, and predicting a 40 per cent decline in retail business valuations and also a peak net-debt of $43 billion (Rs 3.2 trillion), including part of liabilities associated with fibre InvIT. In simple words, the Street is pricing in an extreme down-case outcome across its businesses.

It is in this backdrop, most analysts feel that valuations offer a long-term opportunity for investors, and the downside may be limited from the current levels. Analysts at BNP Paribas say with China somewhat stabilising after the Covid-19 pandemic and a widespread prevention measures globally, refining and chemical margins may recover in the second half CY20.

Analysts, drawing a parallel between the current and the Global Financial Crisis of 2008-09, say oil & gas stocks are trading below the financial crisis levels in terms of valuations. To justify the current valuations, FY21 earnings should see up to 75 per cent cut, and the oil price should average at $25 a barrel. Not surprising, analysts at HSBC say pessimism leaves room for surprises, while BNP Paribas expects fast recovery for RIL once the scenario changes.

 

On debt reduction, while the Street is now expecting a delayed or no deal with Saudi Aramco amid weak oil prices, reports indicate that Facebook (FB) is in discussions with RIL to take a minority 10 per cent stake in the latter’s digital business under Jio. Analysts at Kotak Institutional Equities say that FB’s interest, if at all, may perhaps be driven to enhance the addressable opportunity in its largest market in terms of subscriber base. Jio’s engagement levels with its own subscribers through the digital ecosystem may have an appeal. The deal, if happens, can help reduce debt.

Analysts, such as Abhijeet Bora at Sharekhan, say the stock factors in the recent market meltdown, lower refining and petrochem margin assumption, and a delay in potential re-rating given concerns over the likely deferment of RIL-Saudi Aramco deal. However, Bora adds that it also ignores the positive of improving growth prospects for the telecom business (potential ARPU hikes) and sustained high growth for the retail business.

Analysts at Emkay Global on Thursday cut their FY21/22 estimated EPS by 25 per cent and 14 per cent, respectively, to building in lower earnings in petrochem and refining. Despite the cuts, earnings are expected to grow about 10 per cent each in FY21 and FY22. While they also reduced their target price by 25 per cent to Rs 1,310, they have maintained ‘buy’ on the stock. “RIL remains well-poised to outperform a market recovery and we remain overweight,” they note.