Morgan Stanley has come out with a report on reliance Industries on the news of fixing of gas price in KG Basin by the EGOM. The report is as follows:
EGOM (Empowered Group of Ministers) has come out with a circular on gas pricing which will enable Reliance (RELI) to sell gas at a well head price of US$ 4.2/mmbtu at a crude oil price of US$ 60/bbl and above. In our view, this is a positive for the industry as it removes the uncertainty on gas pricing and it provides a benchmark for all new gas discoveries. The removal of uncertainty on RELI’s gas pricing should be a positive for the stock.
However, there are a few unaddressed issues:
1) Gas prices are decided for the first five years, but the circular does not suggest what happens to pricing thereafter. Industry feedback suggests that there are two possibilities: a) 5% escalation in gas prices every five years; or b) gas pricing being linked to inflation with a reset clause every five years.
2) The circular doesn’t mention the dollar parity assumption for the gas pricing. We see the following possibilities: a) current exchange rates; or b) a fixed exchange rate, with or without annual revisions. An earlier EGOM report had suggested an exchange rate of Rs 45/US$ 1, but the EGOM circular that gives a dollar-denominated gas price is silent on this issue.
We have assumed a flat weighted average price of US$ 4.17/mmbtu for the entire life of RELI’s gas fields (without any escalation). The weighted average price calculation assumes that RELI sells 40mmscmd of its gas to RNRL/NTPC at US$ 2.75/mmbtu and 86mmscmd at GoI-determined prices to calculate the weighted average price of gas. We have valued RELI’s E&P business at Rs 811 per share on the basis of the above assumptions.
There are four possible valuation scenarios for RELI’s E&P business as a result of the EGOM’s unclear stance on the exchange rate and escalation clause.
1. Fixed Exchange Rate
a) At the government’s proposed price of US$ 4.2/mmbtu and assuming a Rs exchange rate of Rs 45/US$ 1, the weighted average price for RELI’s gas would come to US$ 4.1/mmbtu. At US$ 4.1/mmbtu and without considering any escalation in gas pricing, we would value RELI’s E&P business at Rs 789 per share.
b) However, assuming escalation of 5% in gas prices, the weighted average price for RELI’s gas would be near our gas price assumption and we would value RELI’s E&P business at Rs 836/share.
2. Current Exchange Rate
a) Considering the current exchange rate of Rs 40.3/US$ 1 without any escalation, the weighted average price of gas would equate to US$ 3.8/mmbtu and we would value the E&P business at Rs 705 per share.
b) However, assuming escalation of 5% in the gas price from current exchange rates, we arrive at a value of Rs 748 per share for the E&P business.
We believe that, since the gas prices mentioned in the circular are dollar-denominated, RELI’s gas price realization will most likely be determined based on actual exchange rates. As far as we can see, RELI requires no further government approvals to sell its gas.
Consensus View:
Investor feedback suggests that the consensus is valuing RELI’s E&P business at Rs 250-300 per share and see a strong probability that the consensus valuation will double going forward.
Issues for Other E&P Players:
At the US$ 4.2/bbl, the gas price equates to US$ 30/bbl of crude oil prices. The government allows a free gas pricing policy for production from fields awarded under the NELP (New Exploration and Licensing Policy) rounds. Hence, a cap on gas prices at US$ 60/bbl of crude oil prices would be a potential deterrent to new entrants in NELP-VII round. Should oil prices rise to US$ 100/bbl, operators would want the gas prices to be raised. However, yesterday’s step by the government to allow gas prices to move towards global average levels is a clear positive move for the industry, in our view.
The RNRL/NTPC case with RELI on gas pricing will not be impacted by this circular, but we believe that, going forward, this circular will be a benchmark for the Indian Courts (currently the matter is sub judice with the Indian courts) as well.
We maintain our Overweight rating on RELI stock with a price target of Rs 2,522 per share. Our price target is based on a sum-of-the-parts valuation.
1) The R&M business valuation is based on an average one-year forward EV/EBITDA multiple of 7.6x for the US and Asia R&M (ex India).
2) The Petrochemical business valuation is based on an average one-year forward EV/EBITDA multiple of 9.0x for global comps.
3) RELI’s 75% stake in Reliance Petroleum Industries (RPL, Rs130) is valued at our price target of Rs 120 per share.
4) Pending further clarity on the exchange rate and escalation issues highlighted above, we maintain our valuation of RELI's E&P business unchanged for now. With the first oil production just one year away, we use a P/E target multiple-based valuation for RELI’s E&P business. Global E&P companies are trading at an average P/E of 11x F2010E earnings (calendar 2009E). To this, we apply a 14% discount YoY over one-and-a-half years, since the first oil is one year away and we think steady-state earnings from the E&P business are a year and a half away, to arrive at a target P/E multiple of 9x. We expect the E&P business to generate US$ 3.5 billion of profits over F2010-15, and we arrive at a fair value of US$ 31.5 billion, or Rs 811 per share, for this E&P business.
Key risks to our price target include a possible slowdown in global economic growth that could compress margins; a delay in execution of RELI’s business plan; and the stock’s historical correlation with the market.
No comments:
Post a Comment