INDIA Reliance Industries Defying gravity? We resume coverage of Reliance Industries (RIL) with an Underperform recommendation and Rs.1350 one-year price target with 15% potential downside. To justify today’s share price, in addition to the growth from RIL’s new refining and petchem projects and a constructive refining margin view, we need to ascribe US$12 billion option value for JIO (burgeoning telecom business)—with not a single $ of revenue booked we consider this optionality premature. RIL IN Underperform “Growth is life” In-sync with RIL’s motto, EBITDA has grown 1.4x over the past five years and is Price (at 15:23, 24 Jul 2017 GMT) Rs1,615.00 set to increase 1.9x over the next five years underpinned by the ramp-up of Valuation Rs 1,340.00 several new projects—refinery petcoke gasification, off-gas cracker, paraxylene - DCF (WACC 9.0%, beta 0.9, ERP 6.9%, RFR 2.5%, TGR 4.0%) capacity addition, ethane imports, retail expansion, and JIO (page 10-30). This 12-month target Rs 1,350.00 EBITDA growth is however fully captured in consensus estimates in our view. 12-month TSR % -15.7 GICS sector Energy FCF and returns to improve… but underwhelm Market cap Rsbn 5,252 Market cap US$m 80,048 While RIL is transitioning this year from the funding to harvest phase for its Free float % 47 refining and petchem projects, in our opinion consensus cash capex estimates 30-day avg turnover US$m 297 for FY18-20e are light by 35%. We attribute this difference to JIO, R-series Number shares on issue m 3,252 deepwater gas, and repayment of vendor financing. For FY18-20e we project an average 1% FCF yield and 9% ROCE versus consensus at 5%-12%. Investment fundamentals Year end 31 Mar 2017A 2018E 2019E 2020E Amazon-esque optionality? EBITDA bn 461.9 559.8 618.5 691.3 EBITDA growth % 10.7 21.2 10.5 11.8 EBIT bn 345.5 358.3 393.6 431.2 RIL shares have de-coupled from the historically strong returns versus multiple EBIT growth % 14.6 3.7 9.8 9.6 framework as the market has been willing to price the optionality for JIO (fig 1). Reported profit bn 299.0 288.8 297.7 326.5 To the extent valuing JIO akin to Amazon or Alibaba is appropriate and if we Adjusted profit bn 299.0 278.0 297.7 326.5 CFPS Rs 140.80 162.47 177.09 198.79 apply 5x EV-Sales on FY5 estimates then the optionality on offer is a significant CFPS growth % 12.9 15.4 9.0 12.3 US$23 billion or Rs.500/sh above our base case. For perspective this would be PGCFPS x 11.5 9.9 9.1 8.1 EPS rep Rs 101.33 97.88 100.87 110.66 equivalent to the size of India’s largest telecom incumbent. We ascribe EPS adj Rs 101.33 94.19 100.87 110.66 c.Rs.90/sh value for JIO in our base case valuation (fig 3). Our Rs.1350 price EPS adj growth % 18.6 -7.0 7.1 9.7 PER adj x 15.9 17.1 16.0 14.6 target implies 9.0x FY19E EV-EBITDA, 13.5x P/E, and 1.3x P/B. For Total DPS Rs 11.00 12.00 13.00 14.00 downstream exposure our top pick is Indian Oil (IOCL IN, TP: Rs.550, +45%). Total div yield % 0.7 0.7 0.8 0.9 ROA % 5.3 5.0 5.3 5.8 ROE % 11.9 9.8 9.5 9.8 Fig 1 Rs.1350 RIL fundamental base case with 15% downside; current EV/EBITDA x 14.2 11.7 10.6 9.5 Net debt/equity % 67.8 56.2 56.5 54.4 share price already implies meaningful option value for JIO P/BV x 1.8 1.6 1.5 1.4 Reliance 3-Year Bull-Bear Outcomes Also see: 2,000 Rs/sh India Refining & Marketing – Who says elephants can’t dance? 1,700 Current price Global Refining – Expansions outweighed 1,400 by demand 1,100 800 Analyst(s) Aditya Suresh, CFA +852 3922 1265 [email protected] 25 July 2017 Macquarie Capital Limited Source: Company data, Macquarie Research, July 2017 Please refer to page 38 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. Macquarie Research Reliance Industries Inside Reliance – In a page Fig 2 Core growth and JIO optionality already in the price Base Valuation & Bull-Bear Outcomes 3 Versus Consensus 4 Consolidated Earnings Outlook 9 (1) Refining 10 (2) Petchems 17 (3) Telecom (JIO) 25 (4) Upstream Oil & Gas 30 (5) Organized Retail, Other 33 Residual Income & Sensitivities 34 Financial Summary 35 Macquarie Quant View 36 RIL IN rel BSE Sensex performance, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, July 2017 (all figures in INR unless noted) Company Profile Reliance Industries (RIL) is India’s largest listed conglomerate with operations in refining, petrochemicals, telecoms, upstream oil and gas, organized retail, media, etc. Refining and petrochemicals combined account for over 90% of group EBITDA today. The contribution of RIL’s burgeoning telecom business could rise to one-fifth of group EBITDA in five years, from zero today, we estimate. 1600 Rs/sh 1200 800 400 0 Source: Company data, Macquarie Research, July 2017 25 July 2017 2 Macquarie Research Reliance Industries Base Valuation & Bull-Bear Outcomes Fig 3 Rs.1350 one-year price target for Reliance based on a sum-of-the-parts valuation and supported with residual income valuation work. Our target price implies 9.0x FY19e EV-EBITDA, 13.5x P/E, and 1.3x P/B. Target also supported by residual income valuation (p. 35) FY18-20e Base Base Target RIL SOTP Valuation Approach Reference Value Value Comments Multiple (INR, bn) (US$, bn) (INR/sh) Refining and Marketing EV-EBITDA 311 7.0x 33.5 738 10% premium to EM R&M median Petrochemicals EV-EBITDA 245 7.0x 26.4 582 Target at EM petchem median Organized Retail EV-EBITDA 21 15.0x 4.8 105 India retail comps used Oil and Gas EV-DACF 13 4.0x 0.8 17 Disc to EM upstream median Others (ex JIO) EV-EBITDA 6 10.0x 0.9 20 Assumed similar to group multiple LT Investments Fair Value (reported) 3.8 84 At reported fair value Net Debt, ex JIO End-FY17, ex JIO -12.3 -271 Also includes ST investments RIL Core Equity Value 1,275 EV-Invested Capital 1,817 0.7x 19.6 431 Discount to IC as ROIC<Ke EV-EBITDA (FY3) 94 7.5x 8.1 178 EM median multiple on FY3 est. EV-Sales (FY3) 344 2.3x 9.1 201 Softbank used as comps Asset Book Value 2,043 0.5x 15.7 346 Net income breakeven FY22+ Residual Income 14.0 309 ROCE<Ke across forecast period JIO Core Enterprise Value 13.3 293 Average of above approaches Optionality ∆ EV-Sales (FY5) 762 5.0x 22.8 503 Amazon, FB, Alibaba multiples Net Debt, JIO standalone End-FY17 -9.3 -206 RIL JIO Equity Value, ex optionality 87 Used in MacQ base case RIL JIO Equity Value, including optionality 590 For reference only Treasury shares 292mn Rs.1600 6.4 141 Pet Trust & holding by subsids Conglomerate Discount 10% -150 RIL Equity Valuation, ex JIO optionality 1,353 MacQ base case RIL Equity Valuation, including JIO optionality and no conglomerate discount 1,866 For reference only Notes: Net debt does not include vendor financing and other current liabilities equivalent to Rs380/sh as we consider this akin to accounts payable. We treat RIL’s short-term investments (Rs180/sh) equivalent to cash. Fig 4 Wide bear-bull range; bull case largely rests on JIO being a success Reliance 3-Year Bull-Bear Outcomes 2,000 1,700 Current price 1,400 1,100 800 Bull Case: Amazon-esque optionality for JIO assumes 5x EV-Sales on FY5 estimates Bull Refining Margin +$2 per barrel versus base case – RIL $16.0/bbl, Singapore benchmark $9.0/bbl Bear Case: $5.0/bbl Singapore benchmark refining margin 20% contraction in integrated petchem margins 30% lower revenue versus base case assuming 500bps lower market share Source: Company data, Macquarie Research, July 2017 25 July 2017 3 Macquarie Research Reliance Industries Versus Consensus EBITDA inline for FY18, downside for FY19-20e We expect RIL consolidated EBITDA to increase 21%/10%/12% y/y in FY18/19/20e, inline for FY18, but 12% below for FY19-20e. Our key modelling assumptions include: . Refining & Marketing – constructive product crack outlook and opex savings from petcoke gasification project partly offset by tighter light-heavy crude spreads. We assume RIL restarts 300 stations/pa but the impact on consolidated EBITDA is less than 1%, on our estimates. Petchems – Three new projects add to segment earnings from FY18: (1) Refinery off-gas cracker (1.7mtpa downstream capacity), (2) Paraxylene (2.2 mtpa), (3) Ethane imports / cracker feedstock reconfiguration. The incremental contribution of these projects is partly offset by negative movements in long-chain petchem margins. Telecom (JIO) – Rs.165-260 billion revenue, Rs.20-60 billion EBITDA modelled for FY18- 19e based on 26% India mobile broadband market share and better-than-peers cost structure.