Rebalancing refining market, faster asset monetisation to drive RIL upside: Morgan Stanley

New Delhi: Reliance Industries' faster asset monetisation, together with the rebalancing of oil refining market and cheaper feedstock, could help drive upside in company's price-to-earnings (PE) ratio, Morgan Stanley said in a report.

Including Reliance Industries (RIL) in its 'Three in Three' report for Asia Pacific, the brokerage firm upgraded the company stock to 'overweight'. The other two to feature in the August 18 report were Ping An Bank and NTT Docomo.

"RIL has corrected 12 per cent in three months as both refining and chemical industry margins hit cash cost (or operational cost)," Morgan Stanley said in the research report. This was primarily due to weakness in refining margins and spreads in key chemicals. Also, RIL's telecom per user revenue has corrected in the last quarter.

The refining market is rebalancing, cheaper ethane feedstock could drive upside in PE, and faster asset monetisation could surprise, it said. "P/B (price-to-book) valuations are near 20-year average on below mid-cycle margins - compelling, in our view, as supply-side rebalancing helps refining markets improve, significant fall in costs of feedstock like ethane reduces challenges for RIL's petrochemical division, and downside risks ease in the aromatic value chain," it said.

RIL's announcement at its annual general meeting last week also provided a path to deliver the balance sheet (debt/liabilities account for a third of RIL's enterprise value). "This should address investor concern about the balance sheet," it said.

RIL announced USD 16 billion in energy asset sales during the AGM. It also highlighted a plan to lower debt by monetising fiber infrastructure assets. "Overall, committed asset sales account for about 38 per cent of RIL's net debt plus liabilities," it said.

Other takeaways from the AGM were the end of the investment cycle in telecom - a first in five years, bringing debt to zero in 18 months, value-unlocking options for real estate and financial assets, listing of telecom and retail in five years, and focus on dividends.

RIL announced agreeing to a non-binding letter of intent from Saudi Aramco regarding proposed investment in its refining, petrochemicals, and fuel marketing business. It plans to sell a 20 per cent stake at an enterprise value of USD 75 billion. At the same time, it will source 500,000 barrels per day of oil (about 36 per cent of its total requirements) from Saudi Aramco.

"Once completed, we estimate the stake sale will make RIL's energy business nearly debt-free, but it will lower RIL's FY21 consolidated earnings by 9 per cent and operating cashflow by 14 per cent," Morgan Stanley said. The Aramco deal is expected to close this fiscal.

"We upgrade RIL to overweight after the near 12 per cent decline in the past three months and 8-10 per cent cut in earnings expectations for FY20 and FY21," it said. "We believe the expectations are a lot more moderated, and with both refining and petrochemical industry margins touching cash cost quite quickly in the past quarter, the downside risks are now well flagged."

While the recovery in energy margins will be slow (especially against the backdrop of weak global demand), there will be support from slowing supply growth in polyethylene and refining. Also, monetisation of energy assets (fuel retail to BP and oil to chemicals to Saudi Aramco), coupled with the announcement of an end to the investment cycle in telecom, should help deliver the balance sheet after nearly seven years, it said.

"RIL has highlighted plans to go to zero debt by end-F21, but we saw announcements that could lower debt/liabilities by a third and await more details on its future plans," it said. "We raise our FY21 and FY22 earnings estimates and maintain our price target of Rs 1,349 per share, implying 16 per cent upside."

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