RIL: Expect a disappointing quarter

We expect Q4FY12 net profit of Reliance Industries to be down 20 and 3 q-o-q at R42.9 bn.

We expect the Q4FY12 net profit of Reliance Industries RIL to be down 20 y-o-y and 3 q-o-q at R42.9 bn. RIL would be hit in Q4 mainly by 43 y-o-y and 15 q-o-q fall in refining Ebit earnings before interest and taxes and 22 y-o-y and 5 q-o-q fall in petrochemical Ebit.

Oil amp; gas Ebit is also likely to be y-o-y and q-o-q lower hit by a decline in KG D6 gas volume. Our earlier FY12 EPS earnings per share estimate implied Q4 profit at R50.2 bn while we expect it to be just R42.9 bn. We have therefore cut our FY12 EPS by 3 to R61.2 from R63.4 earlier. We have also cut RILs PO price objective by 2 to R831 per share from R844 per share earlier.

The main reason for the cut in PO is we now expect RILs net debt at the end of FY12 at R106 bn as against R70 bn expected earlier. Our earlier net debt estimate was based on year-end exchange rate of R49.1 while the actual closing exchange rate was R50.9. RILs consolidated net debt stood at R205 bn at the end of December 2011. Thus we are assuming R99 bn reduction in net debt in Q4. We retain Neutral on RIL mainly due to the buyback programme,which may support the share price.

GRM amp; petrochemical margin fall in Q4: We expect RILs Q4 refining margin at 6.5/bbl to be 1.1/bbl below Reuters Singapore GRM of 7.6/bbl.

It would also be down 30 y-o-y and 4 q-o-q. The three-week shut down of one of the two CDUs crude distillation units at its SEZ refinery would mean lower volume and hit its GRM gross refining margin by 0.2/bbl.

RILs petrochemical Ebit would be hit by 30 y-o-y and 14 q-o-q fall in its blended petrochemical margin 6-quarter low due to the fall in polyester chain,PE-naphtha and PP-propylene margin.

Margin recovery crucial for FY13; gas price,if hiked,positive: We have kept RILs FY13 EPS unchanged at R66.9 implying a 9 y-o-y growth. RILs FY13 EPS estimate is based on a GRM of 8/bbl. If RILs FY13 GRM is at expected Q4FY12 level ignoring shutdown of 6.7/bbl,its FY13 EPS at R59.6 would be 11 below our estimate of R66.9. GRM and petrochemical margins improving from current level is thus crucial to achieve our FY13 estimate.

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Hike in KG D6 gas price would be positive but recovery in margins is still critical,in our view.

Investment Thesis: We expect RILs earnings to be flat in FY13 and EPS CAGR compound annual growth rate in FY08-13 to be just 6,which is much lower than EPS CAGR of 36 in FY03-08. RIL will generate strong free cash flows and turn net cash for the first time by the 2012 end. RIL has not made any significant discoveries in the last few years and has been hit by production problems,which has led to de-rating of Eamp;P exploration amp; production. However,it has large unexplored prospective acreage and,thus,large reserve-accretion potential.

Price objective basis amp; risk: Our PO of R831 GDR 33.28 is based on a sum-of-the-parts valuation. It includes EV enterprise value of RILs three businesses of R867 per share and net debt of R35 per share. The EV of the refining,petrochemical and Eamp;P business is calculated on a DCF discounted cash flow basis,using a WACC weighted average cost of capital of 11.8. Refining and marketing R367 is 42 of the EV,Eamp;P valuation R162 is 19,and petrochemicals R338 is 39.

Downside risks are i refining and petrochemical margins being lower than expected due to global economic slowdown ii seven-year income tax holiday being disallowed on gas production,which would mean lower cash flow,profit and fair value,iii lower-than-expected oil price,and iv large acquisitions that are value dilutive.

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Upside risks are i refining and petrochemical margins being better than expected,ii higher-than expected oil price,iii significant reserve accretion in the next 12 months and iv large acquisitions that increase fair value significantly.

BofA ML