A leaf from its own book – reiterate huge value unlocking
* RIL in a recent presentation announced initiation of the formal process of carving out the O2C business into a wholly owned independent subsidiary.
* The company has clearly become a case study at many ivy leagues after raising INR2,202b during the COVID-19 pandemic. After selling stakes in both RJio and Retail, it now used a leaf from its own book. The move to merge the Refining and Petchem businesses, coupled with its net cash status, may attract investments in the O2C business as well (a perfect replica of RJio deals).
* In our report, Oil-to-chemicals – Gearing up for next orbital change? we highlighted potential upside for the company with the integration of its Oil-toChemicals business. In FY20, RIL’s EBITDA from Refining stood at USD6.6/bbl v/s USD15.6/bbl in Petrochemical. As per our assumptions, a 10% rise in O2C conversion from ~24% at present, would result in EBITDA improvement of ~USD476m, or 6.8% of standalone FY23E EBITDA.
* We remain optimistic on the prospects of huge value unlocking in the O2C segment as well and reiterate Buy.
Top three snippets from the presentation
* The management reorganized the Refining and Petrochemical businesses into Oil-to-Chemicals (O2C) to: a) facilitate holistic and agile decision making, b) pursue attractive opportunities for growth with strategic partnerships, and c) drive its downstream business.
* Exhibit 1: Reliance O2C (RIL O2C) will be a wholly-owned subsidiary of Reliance Industries (RIL). All the Refining, Marketing, and Petchem assets will be moved to this subsidiary (along with other trading and manufacturing subsidiaries held aboard).
* Exhibit 2: The O2C transfer came into effect from 1 Jan’21, and approvals from SEBI and stock exchanges are in place. The management expects the consent process (from shareholders and creditors) to be completed by 1QFY22, with NCLT approval (from Mumbai and Ahmedabad) expected in 2QFY22.
* Exhibit 3: RIL will fund the O2C assets of USD42b (USD40b in long-term assets and USD2b in net working capital) via an interest bearing loan of USD25b. RIL O2C will pay off this loan at a floating rate interest linked to the one-year SBI MCLR rate. Rest will be balanced in equity (USD12b) and noncurrent liabilities (USD5b). There will be no impact on RIL’s consolidated financials and the transfer of assets to the O2C business will be tax neutral. RIL will also receive payouts from the O2C business via dividends in addition to interest and debt repayments.
Segment profile for RIL v/s O2C now
* The standalone entity will retain the new energy and materials business – a segment which will focus on RIL’s vision to become net carbon free by CY35. The company will envisage building a portfolio of reliable, clean and affordable energy (in Renewables and the Hydrogen space) and develop a portfolio of advanced and specialty materials.
* The goal for the O2C business will be to maximize conversion of crude to chemicals by reducing its carbon footprint, creating a recycling economy, and adopt next gen tech to make new monomers and derivatives. The management has time and again highlighted that the company will continue to focus on catering to the growing demand for materials and products in India.
Better integration means higher margin
* After the reorganization of the Refining and Petchem business in 3QFY21, the management no longer provides key operational parameters such as Refining and Petchem margin. We reiterate our stance that higher integration would result in better margin.
* Refining margin continues to record a gradual uptick, with SG GRM for Feb’21 (till date) at USD1.9/bbl (up from USD1.4/bbl in Jan’21 and USD1/bbl in 3QFY21). The improvement is primarily due to Gasoil and Gasoline cracks (stands at USD6.5-7.1/bbl on a daily basis v/s USD3.8-4/bbl in Jan’21). This is beneficial for RIL as it already has higher middle distillate yields.
* On the Petchem side, PE/PP/PVC margin continues its robust streak, up 51/35/73% YoY (although flat sequentially) as downstream Petchem demand continues to stay strong.
* The better margins at present would be tested as the impact of the Arctic blast on US refiners fades and as new Petchem capacity in China come onstream.
* RIL has one of the most complex and integrated units, with ~24% conversion in FY20. While the conversion may not increase in the medium term, we reiterate our belief in its plan to integrate O2C to generate better margin going forward (especially in a subdued refining margin environment, further weighed by huge capacity additions in Petchem).
RIL SA remains imperative
* At the end of 3QFY21, consolidated Dec'20 debt/cash and equivalents stood at INR2,574b/INR2,205b. Considering balance commitments of INR398b, ceteris paribus, its net cash stood at INR30b.
* The stake sale in Jio and retail platforms to globally renowned brands has opened up a plethora of opportunities. As RJio's growth slows, Jio Platforms (its holding company) is keen to replicate the success of Wireless in other business streams. With aggressive plans and product launches in place, Jio Platforms is creating multiple monetization opportunities in the Digital space. For Retail, our premium valuation multiples capture the opportunity for rapid expansion and aggressive rollout of the JioMart platform.
* RIL recently commissioned gas production from its R-series cluster. KG basin is expected to achieve peak production of ~30mmscmd over the next two years (v/s current production of ~4.5mmscmd). Also, RIL-BP’s JV aims to increase the number of outlets to 5,000 from 1,350 now.
* We believe the recent move of creating an O2C segment will invite various new avenues for RIL in terms of both opportunities and upside. Using the SoTP-based valuation, we value the Refining and Petrochemical segment at 7.5x FY23E EVto-EBITDA to arrive at a valuation of INR780/share. We ascribe an equity valuation of INR900/share to RJio and INR645/share to Reliance Retail. We reiterate Buy with a target price of INR2,325/share.
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