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Why Morgan Stanley downgraded RIL to 'underweight'
Morgan Stanley has downgraded Reliance Industries to 'underweight' from 'equalweight', saying it expects the energy major's gross refining margins, exploration and production volumes to fall.
Morgan Stanley has downgraded Reliance Industries (RIL) to 'underweight' from 'equalweight', saying it expects the energy major's gross refining margins, exploration and production volumes to fall. The bank has cut its price target for the company to Rs 650 from Rs 921.
"We highlight that two of three Reliance's core divisions -- refining and petrochemicals -- face near-term headwinds," it said in a note.
Here are factors that prompted Morgan Stanley to downgrade RIL
Weak outlook for GRMs (gross refining margins) and petrochemical netbacks We believe GRMs peaked in 2011 given shutdowns from Japan and a slowdown in additions from China. We reckon the reverse will happen in 2012, with Japan production expected to ramp back up by 2H12, and China and India setting up new capacities. We remain bearish on petrochemicals in the near term as the group will be driven by demand slippage due to global slowdown. RIL has high sensitivity to both the GRMs and petrochemicals.
Exploration and Production (E&P) volumes continue to slide From a peak of 80 mmscmd (touched briefly for facilities testing purpose) in Dec-09, volume from KG-D6 has slipped to ~40 mmscmd (million metric standard cubic meter per day) currently. Although we view this as the bottom for volume slippage, the sale of a 30% stake to BP should lead to a lower contribution from E&P in F2013 as compared to F2012.
Earnings growth for the company is tapering off Our prior overweight call on RIL hinged on organic growth at the company across its energy space. We now see short- and medium-term headwinds in all the businesses, however, and have cut our F2012-14e EPS by 9%, 13%, and 19%, respectively.
Absolute stock price level seems attractive, but is not RIL is trading at a P/E of 11.5x on our F2013 estimates, implying a ~25% discount to its historical average. However, relative to the market the stock is trading broadly in line with its historical average. In the past, RIL has shown strong earnings growth compared to the current situation of virtually no growth next year.
Cash flow is greater than capex And a significant part of incremental cash flows are being driven to non-core businesses, which in our view are return dilutive. We estimate both ROCE (returns on capital employed) and RONW (return on net worth) falling from 12.5% and 14.1% in F2011 to 11.45% and 10.8%, respectively, in F2014.
