RIL's revamp paves way for O2C stake sale, next leg of growth: Analysts

Reorganisation won't impact RIL's consolidated financials or shareholding. Analysts say the de-merger will be done at tax networth of O2C assets, making transaction tax neutral for RIL

Reliance Industries' (RIL) investors remained largely unfazed by the company’s proposal to hive off the oil-to-chemical (O2C) business into a 100 per cent subsidiary of RIL as most had anticipated the move. Shares of RIL closed 0.8 per cent higher on the BSE on Tuesday, having rallied 2 per cent at the bourses in the intra-day trade.

Yet, the latest announcement, RIL's focus on 'new energy and net materials' business (dedicated towards development of a green energy ecosystem) and gradually improving outlook for O2C vertical could provide triggers for the stock going ahead.

Late on Monday, RIL said it has initiated the process of reorganisation of O2C business into a new subsidiary, which is expected to complete by Q2FY22. As per the proposal, RIL will transfer its refining and petrochemicals businesses along with fuel marketing joint venture (RIL holds 51 per cent) with BP, elastomer joint venture (74.9 per cent) with Sibur, Recron/RP Chemicals Malaysia, trading subsidiaries, ethane pipeline and all other related assets to the O2C entity.

In all, RIL will transfer $40 billion of long-term assets and $2 billion of net working capital to the O2C entity for a consideration of $25 billion of long-dated loan, $12 billion of equity and $5 billion of non-current liabilities.

Notably, the reorganisation will not have any impact on RIL's consolidated financials or shareholding. Moreover, analysts at Nomura say, “The O2C de-merger would be done at tax networth of O2C assets, making transaction tax neutral for RIL...The loans will make up-streaming of potential stake sale in O2C more tax efficient.”

Analysts also see the proposal as a structural shift in RIL's focus as the new O2C entity would invest in the next-generation carbon capture and storage technologies to convert carbon dioxide (CO2) into useful products and chemicals.

“While the new proposal was in-line with our expectations, the focus to use or capture CO2 stood out and implies carbon capture investments ahead,” notes Mayank Maheshwari, equity analyst at Morgan Stanley.

The new energy and new materials business intends to achieve net carbon zero for the group by 2035, while working along with the O2C entity to focus on carbon capture and hydrogen production technologies.

The de-merger, Maheshwari says, may also accelerate its new energy and material plans into batteries, hydrogen, renewables and carbon capture. Morgan Stanley estimates the addressable new energy or renewables market alone at $50-plus billion.

In this backdrop, Deven Choksey, managing director of KRChoksey Shares and Securities, considers the hive off as a way to streamline the clean energy as well as O2C business so that new – whether strategic or financial – investors get an option to put their money in individual verticals rather than an umbrella firm.

One such big investment – by Saudi Aramco – may now see the light of the day, hope analysts. “Key benefit from the deal is that it would ease out its stake sale to strategic investors like Saudi Aramco. In line with Reliance Retail Ventures and Jio Platform stake sale, we expect it to pare 20-25 per cent stake to strategic investors,” said a note by IDBI Capital.

This will then enable RIL to invest big in the new vertical going forward. Morgan Stanley estimates that RIL may need investment worth $13-15 billion in new energy vertical and $50-60 billion across businesses over next 10 years. However, it adds, RIL's net debt in the next investment cycle will be a lot more measured as against the past cycle as it takes the partnership/JV route.

That said, the break-down of RIL into four subsidiaries may not affect the firm’s overall valuation, say analysts.

“Theoretically, RIL could have attracted a ‘holding company discount’ but if the P/E expands on a consolidated basis, the hit on valuation may be cushioned,” says Deepak Jasani, head of retail research at HDFC Securities.

Moreover, valuation from the telecom (Jio) and retail (Reliance Retail) should support the overall valuation, he adds.

Meanwhile, in O2C, with global economic growth and oil prices improving, its prospects too are looking better. This also could help RIL bargain for a better value for its stake.

Nischal Maheshwari, chief executive officer for institutional equities at Centrum Broking, says that the near-term valuations are guarded as long as Jio and Reliance Retail don’t get listed.

Morgan Stanley maintains an ‘overweight’ rating on the stock with a target price of Rs 2,252 while IDBI Capital and Kotak Institutional Equities have a ‘Buy’ and ‘Add’ calls, respectively with a target price of Rs 2,475 and Rs 2,050.