Faster deleveraging, recovery in energy, retail could spur RIL re-rating

Further re-rating of the Reliance Industries Limited (RIL) stock could be spurred by faster deleveraging and the next leg of growth and surprises should be from volume and margin recovery in energy and retail, according to US broking house, Morgan Stanley.

"Deleveraging has played out faster than expected, fueling rerating. The next leg of growth and surprises should be from volume and margin recovery in energy and retail, driving a 23% EPS CAGR in F20-F23. Clarity on the digital ecosystem should spur further re-rating," Morgan Stanley said.

Morgan Stanley has argued that debt reduction was key to RIL's outperformance. Over the past two months, it has announced the sale of $ 14 billion of assets, completed a $7 billion rights issue and slowed the run rate of new investment by a quarter.

"We expect this to cut net debt in half by end-F21e, and once the remaining asset monetisation comes to fruition, net debt could be near zero," it said.

The next leg of debt reduction surprise will be driven by energy, as cashflows outperform Street expectations. Also, RIL has started to hive off its oil to chemicals entity. The pace of deleveraging YTD has surprised, but the re-rating is similar to that seen in past deleveraging cycles (2002,2007). Reduced investor skepticism about the balance sheet was reflected in the 33% P/E re-rating year to date, it said.

Refined product demand in India and globally is picking up more quickly and petrochemical demand has been more resilient than expected.

The report argues that RIL's refinery run rates had remained high in the last quarter as it shifted volumes to export markets. "We believe the rise in domestic sales should normalise margins in coming quarters apart from improving utilisation rates. QTD trends point to petrochemical margins well above mid-cycle levels. Our F21/F22 Earnings estimates are slightly above the Street," it said.

"We see a significantly better cycle in petrochemicals emerging after Covid-19 and faster recovery in refining product demand. Hence, we estimate $2-$2.5 billion in FCF in F21 despite the current challenges in retail demand and lower oil prices," it added.

With its partnership with Microsoft, its MoU with Facebook,and its offline retail infrastructure, RIL is looking to capitalise on the untapped market of small and medium scale enterprises, which may look at digitising after Covid-19. This will not only raise revenues for digital, but also support retail business gain share of the consumer wallet, the report said.