Reliance Industries - Rating Under Review - Motilal Oswal

RELIANCE INDS: Sells 30% stake in 23 NELP blocks to BP; to receive US$7.2b cash in FY12; Expect upside of Rs51/sh to our SOTP; Rating Under Review

Reliance Industries announced sale of 30% stake in 23 NELP blocks (excludes Pre-NELP and 4 NELP blocks) to British Petroleum Plc (BP/ LN, Mkt Cap US$150b) at a consideration of (1) US$7.2b to be paid by FY12 and (2) future performance payment of US$1.8b to accrue to RIL based on exploration success resulting in development of commercial discoveries. Also, RIL-BP partnership aims an investment of US$11b towards exploration and development at these E&P blocks. Further, RIL & BP are forming a 50:50 JV for sourcing, transporting and marketing natural gas in India.

Both RIL and BP to gain from the deal: (1) We believe RIL's reason for the deal was driven by the need to partner with a global energy major with proven expertise in deepwater exploration. This deal may help RIL to overcome the recent technical challenges in its producing KG-D6 block. Production at KG-D6, after reaching 60mmscmd, has declined to 52mmscmd now. (2) With this deal, BP gets a strong foothold in the Indian oil & gas space. (3) Together, this partnership is targeting the entire gas value chain - from sourcing to distribution and marketing in the high growth Indian market.

Expect minimal tax impact, given ‘Block of Asset Concept', but further clarity awaited: The transaction would attract capital gain tax if applicable on this transaction. However, we understand that the part of E&P expenditure not yet charged to P&L, can be set-off against the receipts. For RIL's E&P assets, the cumulative capex works out to ~$10b and the DD&A already charged is ~$2.5b. Hence, a total of $7.5b can be set-off against the deal receipt, implying a minimal tax incidence. We await further clarity on the mechanics of the taxation.

Timelines and key things to watch in deal: This deal is expected to be completed in FY12, subject to the government approvals. We await more details in terms of (1) reserves considered by BP, (2) tax implications on the deal receipts.

Our FY12 EPS declines by ~1% to Rs70.7 and FY13 EPS increases by 1.8% to Rs86.4 respectively. Our SOTP based price target increases by Rs51 to Rs1,022.

During 9MFY11 period, refining and petchem businesses contributed 36% each to RIL's EBIT, while 28% was contributed by E&P. RIL's reported petchem margins during the last few quarters have been at its historical highs and since our FY12 petchem EBIT is flat YoY; there remains little room for any further upside in our view. In E&P, our KG-D6 volume assumption at 55mmscmd is higher than the current 52mmscmd and RIL management is yet to provide any guidance on further ramp-up.

We believe this deal, apart from giving RIL access to BP's deepwater expertise, will also help in diversifying its E&P risks. Based on our current capex assumptions, RIL will have a cash balance of US$15b by end-FY12, which opens up significant investment opportunities, returns on which are currently not captured in our valuation. Adjusted for treasury shares, RIL trades at 13.5x FY12E EPS of Rs70.7. Our SOTP currently will see a revision to Rs1,022 (earlier Rs975). We put our Rating Under Review.

Source : Equity Bulls

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