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Buy Reliance Industries Ltd For Target Rs.2,330

Reiterate our faith in the businesses

O2C margins to enhance; Retail, Telecom hold long term opportunity

* Although oil prices have risen 24% to ~USD61/bbl in CY21YTD, refining margins are yet to show any recovery due to the continued lack of demand on account of COVID. However, Petrochem demand has been strong, resulting in high margins across most products. PE/PP/PVC margins are at a strong USD737/785/779/mt in CY21YTD compared with the last 10-year average of USD627/601/300/mt.

* In the last six months, RIL has underperformed Nifty by ~35%, largely due to poor refining margins, uncertainty in retail, and slowing growth in the Telecom biz. However, the ongoing O2C restructuring may open up strategic partnership opportunities similar to those seen in other businesses.

* Additionally, the fast pace of vaccinations across the globe would soon normalize demand for petroleum products, thus boosting refining margins. Market leadership in Telecom may help capture the opportunity in Digital and Fiber as the market consolidates within the top two telcos, while the launch of low-cost smartphones may help accelerate subscriber growth.

* JioMart’s strong traction, supported by a widening reach and product categories, should accelerate growth in the Retail biz.

* Reiterate Buy, with Target Price of INR2,330.

Poor refining margins likely to improve going forward

* Since 2HFY20, SG GRM has averaged at USD1.5/bbl, well below the average of USD5.7/bbl for the past decade. COVID-related lockdowns resulted in degrowth of ~8.7mnbopd in oil demand in CY20, while CY21 is expected to witness growth of ~5.6mnbopd.

* With the closure of ~3mnbopd refining capacity globally in CY20/CY21, we expect refining margins to bounce back to USD5–6/bbl over the next few months, boosting RIL’s margins. A change of USD1/bbl in refining margins impacts FY22 standalone/conso EBITDA by 7%/3%.

* We expect oil prices to stabilize at USD50–60/bbl, which would also stabilize the Arab Lt-Hv differential at USD2–2.5/bbl, boosting the margins of complex refiners.

Petrochem has been shining

* As refiners continue to battle poor refining margins, petchem supply from refinery-based producers has been affected adversely. This, combined with stable demand from sectors such as Packaging, Retailing, and Pharmaceuticals, has boosted petrochemical margins – PE/PP/PVC gross margins stood at 18%/31%/160%, above the average of the past decade.

* COVID has also resulted in delays in the commissioning of new petchem plants, especially in China and the Middle East, which would keep margins high. We build in a moderate blended margin of USD99/mt for FY22/FY23.

Consumer biz offers huge potential

* The growth and dominance of both the Consumer businesses – RJio and Reliance Retail, in their respective sectors should hold them in good stead.

* RJio’s revenue growth has decelerated in the last few quarters to the mid-single digits v/s the double digits – given the moderation in subscriber adds and no tariff hikes since the last one four quarters ago. However, a) the recent launch of JioPhone, b) spectrum investment, and c) consolidation in the market toward the top two telcos should augur well for RJio over the next two years, irrespective of a price hike. We have factored in core revenue/EBITDA growth at 20%/34% over FY20–23E to reach INR941b/INR513b, not considering a material price hike.

* Reliance Retail has been severely afflicted by COVID-led store closures in the last year. However, JioMart’s a) quick scale-up less than a year since its launch and b) widening reach and expanding product categories have cushioned the impact and offer a strong growth opportunity. We have factored in core revenue/EBITDA growth at 21%/22% over FY20–23E to reach INR1,629b/INR155b

Valuation and recommendation

* RIL, in the last year, has seen strong deleveraging on the back of value unlocking in the Consumer business – which has aided valuations. However, weakness in earnings has resulted in the stock underperforming the Nifty by 35% in the past six months.

* The Consumer biz – RJio and Reliance Retail are richly valued given their strong growth potential. We see price hikes in the Telecom business and revival in the Retail business – led by strong growth potential in JioMart – as key levers for the stock over the next two years.

* The ongoing O2C restructuring augurs well for the company as it opens up the possibility of strategic partnerships with global majors – as witnessed in the Telecom and Retail segments. However, poor profitability due to low oil prices and continued poor refining margins may result in further delays.

* Vaccination drives appear to be gaining momentum all over the globe, with large economies such as the US and India inoculating more than 4m daily. This is expected to soon revive demand for transportation fuels, thus boosting GRMs. Since the company has stopped disclosing GRMs separately, we build in EBITDA of USD108/123/mt for FY22/FY23E (vis-à-vis USD72/mt reported in 3QFY21) – on the back of improvement in refining and petchem margins.

* RIL is trading at 8.1x FY23 EV/EBITDA and 15.7x FY23 EPS. Using SOTP, we value the stock at INR2,330 and reiterate Buy on the stock.

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