Reliance Industries (RIL): Profits in sight,RIL will step on the gas

Reliance hopes to improve gross refining margins for FY11 as the global industry shapes up. This, coupled with gas profits & a mature petrochem business, could make it debt-free in a few years

AS A RESULT OF THE SUPREME Court ruling that sovereign interest cannot be overridden by private agreements, Reliance Industries (RIL) gets to keep an estimated Rs 3,000 crore a year that might have gone to Anil Ambani and the 2.5 million shareholders of Reliance Natural Resources (RNRL). The end of the five-year dispute translates into a market value of Rs 35 a share for RIL, which had revenues of $45 billion last year. But for RNRL, set up to mainly deal in gas, it has to begin afresh. Buy recommendations on RIL shares are just not ending while there is no analyst coverage for RNRL. Some 14,000 megawatt of power to be produced by Anil Ambani group firm Reliance Power with fuel from RIL is under peril. RIL shares rose 2.3%, while RNRL collapsed 22.8%. Reliance Power ended 9% down at Rs 140.1.
The under-performance of the RIL stock over the past six months in anticipation of an adverse ruling will lead to a re-rating of the stock given that analysts factor in the total Krishna Godavari basin gas business to be worth between Rs 99 and 120 a share.
Now, RIL gets to sell the likely peak production of 80 million metric standard cubic metre at the KG basin D-6 block gas at $4.2 million metric british thermal unit (mmBtu). This is against the claim of RNRL at $2.34 mmBtu as per the memorandum of understanding signed between the brothers at the time of split in 2005.
It is a windfall for RIL that holds 56,000 square km of acreage in the KG basin, which is 42% of the total in the basin. Its most prolific block has estimated reserves of close to 35 trillion cubic feet of gas.
“Overall the company is moving into a trajectory of generating close to $10 billion operating cash flow per annum,” said India Infoline in a note to clients. Fiscal 2011 earnings per share growth will be close to 50% on gas production, and two-year EPS compounded annual growth rate is 35%. It recommends a buy on the stock. It values the KG basin at Rs 295 a share.
Since the market was expecting the Supreme Court to uphold the Bombay High Court ruling that ordered supply of gas as per the family MoU, the ruling came in as a surprise. The underperformance of RIL shares over the past six months compared to the benchmark Sensex was because the markets had factored in the worst-case scenario in its valuations. While RIL rose 6.9%, the index gained 10.5% during the period.
“Recent stock movements suggest the Street is largely pricing in a repeat of the previous court judgment, in which RIL was asked to start selling gas immediately at $2.34/mmBtu,” said a recent report from Goldman Sachs.
RIL may be experiencing tailwinds at this point. The refining industry is gradually seeing an uptrend globally and the company hopes to post better gross refining margin for FY11 compared to $6.5 in FY10.
This, coupled with gas profits and a mature petrochemicals business, could render it debt-free in a few years and open up more acquisition opportunities. The recently-concluded Atlas Energy stake buy for shale gas acreages in the US will contribute revenues in three years.But for some analysts it is a time to exit the stock given the prospects of renewed painstaking negotiations and the potential double-dip in the global economy. Broking house CLSA said in a note that the sum of the parts value for RIL rises to Rs 1,093 in the best case scenario, from Rs 1015. “I would be a seller of RIL into this,” it wrote.