Morgan Stanley today upgraded its rating on Reliance Industries amid expectations of annual cash flows of USD 6-8 billion in the next three years from stronger petrochemical and refining business.
Morgan Stanley upgrade RIL to “equal-weight” from “underweight”,maintaining its target price at Rs 703,citing attractive valuations.
Despite taking “unconstructive” view on RIL’s core business,the brokerage firm in its report said the company was trading at multi-year lows,making its valuations “compelling.”
It saw little downside for the stock with the company’s ongoing buyback programme also gaining momentum.
“RIL’s stock price has lagged the Sensex by 10 per cent since January’s announced share buyback,and by 18 per cent in past 12 months. It is now at multi-year lows. But the buyback has gained momentum,especially below Rs 700 per share. Thus,while unconstructive on the core,we now see little downside,” it said.
Morgan Stanley said RIL repurchased about USD 271 million worth of its share (16 per cent of its overall committed programme),with most of its purchases at levels under Rs 700 per share,which could cushion downside.
But RIL’s core business of oil and gas exploration could “still be an issue” with natural gas production from its eastern offshore KG-D6 fields “now at 35 million standard cubic meters per day,down from 80 mmscmd peak”.
While the company plans to submit an integrated field development plan to boost reserves and production,”key hurdles seems to be capex and pricing issues,” it said,adding that the contribution from shale gas could partially offset the negatives.
“We expect shale gas to start contributing meaningfully from this year onwards,” it said.
Petrochemical and refining look lackluster,but it saw limited downside to margins. The key would be “stronger-than-expected petrochemical and refining cycle”.
It said “RIL has strong cash flows from operations of USD 6-8 billion per annum in the next three years. It has announced plans to spend USD 10-12 billion in petchem over five years,and a similar amount in its E&P business,implying capex of USD 4-5 billion annually”.
On the downside was the risk of government deciding toput a penalty on RIL for declining production and a sharp decline in global economic growth that would likely compressprojected petrochemical and refining margins.
Investments in telecoms and retail could fill the gap but these would be longer gestation projects and are highly exposed to competitive landscapes.
RIL ventured into retail in 2006,and Morgan Stanley has estimated that RIL may have spent USD 2.5-3 billion so far in building over 1,000 stores. However,”we believe this business is still below the break-even level.”
The telecom space is highly competitive,with over 12 operators,and tariffs are among the cheapest,at 1 cent globally. Though RIL is focusing on the fast-growing data business,it is still in the build-out phase,which could take a couple of years.
It has already invested about USD 2.8 billion to acquire 20 MHz unpaired band spectrum in the 2.3 GHz space,it said.
The brokerage said recent investments by RIL suggest unrelated diversification.
“RIL recently has forayed into hotels/insurance/aviation/sports marketing/financial services industry and the media industry. While these are small in terms of size of investment,they are very diversified compared to existing core businesses,which are predominantly energy/chemicals-focused.”