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Down, But Not Out

Despite being down substantially this year, Reliance Industries can be a good stock to accumulate…

Reliance Industries is down quite a lot this year. What are the prospects of RIL? Should I invest in the stock at current levels?
- Subhash Jain

The Reliance Industries (RIL) stock has lost 30 per cent of its market cap year to date, compared to the BSE Sensex which is down nearly 20 per cent over the same period.

From being a hot stock RIL has turned into a hot potato. Concerns abound. Factors such as lower-than-expected output from the KG-D6 basin and run-ins with the Comptroller and Auditor General (CAG), who claims that the company was unduly favoured, are exerting downward pressure on the stock. Add to that cash that is building up without any sign of effective allocation.

The hammering that the stock has received has, however, opened up a window of opportunity for potential investors. Current valuations imply a gross refining margin (GRM) of only $6.5/bbl, says a recent report from JP Morgan. That is low — the Singapore (benchmark) margin stands at $7.8/bbl. RIL itself reported GRM of $10.2/bbl during Q1FY12.

Moreover, RIL’s revenue from refining and petrochem are derived mainly from demand in non-OECD regions, excluding US and Europe, so the current slowdown in those regions is not likely to have much of an adverse impact on the company.

RIL has guided that it will turn debt free this year. Cash from the BP deal ($5.2 billion) coupled with operational cash flows is expected to total near about `44,158 crore (JP Morgan’s estimate), which translates into Rs. 135 per share (18 per cent of the current market price). This is both a boon and a bane. While on the one hand RIL has yet to show how it will effectively deploy its cash trove, on the other, it gives the company sufficient ammunition to ride out financially troubled times such as these.

At the current market price, you can buy RIL’s exploration and production (E&P) assets at a significant discount to what BP paid for them. The BP deal ascribed a value of $14.4 billion to its E&P assets whereas the current market price implies a net present value (NPV) of only $7.6 billion. Even on asset valuation basis, RIL at $12.8k/bpd is trading below its replacement cost of $15k/bpd, signalling undervaluation.

RIL trades at 11.5 times its FY11 earnings. The stock could remain in limbo for some time with media reports speaking of the CAG breathing down its neck, and no visibility regarding an increase in production from the KG-D6 basin.But Mukesh Ambani is known to be a shrewd value creator. The excess cash flow will also provide ammunition for a large acquisition, should Ambani decide to take that road.

Reeling under the impact of the global turmoil, the RIL stock is now available at reasonable valuations. For those who believe that Ambani’s business acumen counts among the best in the country, this is a good time to accumulate the stock.

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