While Reliance is seen gaining on various counts from its deal with BP, clarity on deployment of cash could provide further trigger to its stock.
Reliance Industries’ (RIL) $7.2-billion deal with the UK-based BP Plc for the sale of 30 per cent stake in 23 oil and gas production sharing contracts that the former operates in India was received positively by the markets.
While RIL’s stock surged 5 per cent in the opening trade on Tuesday, it ended with net gains of 3 per cent vis-a-vis a 0.9 per cent fall in the BSE Sensex.
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The deal is seen as positive on various counts, though it also leaves some questions unanswered from the markets’ perspective. On the one hand, it provides a valuation benchmark to RIL’s exploration and production (E&P) assets (now around Rs 350 per share), thereby providing downside support to its stock. Second, the market hopes that given BP’s enormous expertise in deep-water exploration, gas output at RIL’s prolific KG-D6 block, which has dipped in recent months, could be boosted providing further trigger to the stock. Third, it also helps de-risk its business to an extent, while making RIL almost debt-free. The concern though stems over the use of the estimated $22 billion worth cash and equivalents that RIL would have by the end of March 2012.
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In Rs crore | |||
Nevertheless, from an overall perspective, the deal appears positive for RIL, which is also witnessing an improvement in its other key businesses of refining and petrochemicals. Thus, most analysts have a positive or hold rating on the stock with a one-year price target ranging Rs 965-1,250.
| SOTP | |
| Rs/share | |
| Refining & Marketing | 384 |
| Chemicals | 277 |
| E&P | 350 |
| Others | 114 |
| TOTAL | 1,125 |
| All figures are average estimates SOTP - Sum-of-the-parts, Source: Analyst reports | |
Boost to E&P business
BP is the leading operator in the deepwater Gulf of Mexico and one of the largest E&P firms in the world. Analysts believe its vast technical expertise should enable RIL resolve the complexities in the KG D6 block, wherein gas production has slipped from 60 mmscmd in June 2010 quarter to about 55 mmscmd in the December quarter (compared to target levels of 90 mmscmd). While they expect gas production from KG basin to get ramped up to 80 mmscmd in the medium-term, most of them haven’t yet assumed a higher production in their estimates. Should it happen, it would boost RIL’s earnings estimates by eight-ten per cent. Further, with BP on board, RIL could also speed up exploration in its other key blocks.
However, post the E&P stake sale deal RIL's share in the 23 blocks will dip from 90-100 per cent levels to 60-70 per cent, thereby, pruning its revenues as well as profits. However, lower interest expense (due to no debt) would offset the impact on earnings, which analysts estimate will be marginal. Thus, they have lowered their estimates by one-three per cent for 2012-13 and 2013-14.
Most importantly, the deal with BP translates into a valuation of $24 billion for the 23 blocks, value of RIL’s 90 per cent stake in these blocks works out to $22 billion. Though analysts believe the deal could have fetched RIL some more, the potential gains of $1.8 billion, which is based on exploration success and performance, could provide further upsides to its earnings, and hence, stock.
Cash deployment
Before this deal, RIL’s management had indicated that its capex for 2010-15 will be at $30 billion as against investible funds of $55-60 billion.
For now, with Rs 30,000 crore in cash in its books and annual cash profit generation of Rs 35,000 crore, RIL is seen ending the next financial year with cash in hand worth almost Rs 1,00,000 crore ($22 billion, including $7.2 billion from BP). Experts believe efficient deployment of these funds would be a key monitorable, as returns from treasury (interest income) results in subdued overall returns.
While RIL could consider investing part of this for its emerging businesses like retail, telecom, etc, experts believe increasing dividend payout from historical levels of 11-13 per cent could also enhance shareholder value. For now, they are awaiting clarity from management about the uses of these funds.
Outlook
While the deal with BP is seen in positive light, RIL’s other core businesses are also doing well. While its refining business is witnessing robust gross refining margins (GRMs), the petrochemical business, too, is expected to post healthy growth. Although clarity regarding deployment of cash and tax liabilities (capital gains tax sale of stake to BP) is awaited and could prove to be an overhang, analysts believe near term upsides of five-nine per cent from current levels cannot be ruled out. Thus, most of them have upgraded their target price for RIL by four-eight per cent.
