RIL: Brokerage upgrades trigger upmove

As company completes its capex, analysts expect its earnings and free cash flow to grow meaningfully

Reliance Industries (RIL) shares have surged almost five per cent in March so far on the back of earnings upgrades from various brokerages with the latest one coming from Morgan Stanley. The brokerage in its report dated March 1, 2016 raised RIL's FY17 and FY18 earnings per share estimates by three per cent and eight per cent, respectively.

They believe as the company nears completion of its capex cycle ($46 billion over F14-17), its earnings as well as free cash flows will improve significantly. In this backdrop, they estimate the stock’s market capitalisation could double to $100 billion over the next three to four years.

Notably, another foreign brokerage CLSA had upgraded the stock in January stating that RIL’s earnings before interest, taxes, depreciation and amortisation (Ebitda) should rise 50 per cent in the next two years to $10 billion on the back of its downstream expansion plans.

Morgan Stanley’s optimism is pegged on expectations of a revival in crude oil prices to $60 a barrel over the next few years and a telecom break-even. “Based on our FY20 estimates of $7 billion of revenues and 132 million subscribers, we project Ebitda of $2.9 billion. This could lead investors to raise the valuations for its telecom business,” wrote analysts led by Vinay Jaising of Morgan Stanley.

Subscriber additions will be the key factor determining the break-even of RIL's telecom business. Although most analysts believe telecom business will weigh on RIL's earnings in the near term, they have varied estimates on this business' contribution to RIL's sum-of-the-parts valuation.

For instance, BNP Paribas assigns zero value to the telecom business, while Citi and Bank of America Merrill Lynch peg it at 10 per cent and nine per cent, respectively, of their target price for RIL. UBS and Morgan Stanley are much more bullish on the telecom business and expect this business to contribute 21 per cent and 29 per cent of RIL’s target price.

Overall, the per-share fair value estimates of telecom business varies between Rs 102 and Rs 380. This indicates the divergent views amongst analysts on the potential break-even of this business. Notably, RIL had invested about $15 billion in its telecom business till December 2015.

Analysts also remain positive on RIL's oil & gas business. Morgan Stanley analysts believe if crude oil prices rebound to $60 a barrel levels, RIL’s Ebitda could increase 14 per cent. RIL’s consistent out-performance to peers on the gross refining margin (GRM) front is a key positive and is likely to continue going forward as well.

“With the likely commissioning of the petcoke gasification project by end-FY16, RIL’s GRMs could further increase by $1-1.7 a barrel in FY17 from the current level of $11.5 a barrel,” believes Amit Shah, analyst at BNP Paribas. Analysts are also constructive on the company's petrochemicals business and believe margins will remain strong on the back of subdued oil prices.

In its retail business, RIL plans to foray into e-commerce for fashion and lifestyle segment. Contribution of retail to overall financials, though, is expected to be smaller than other businesses going forward. Lower oil prices are favourable for the company as it can source cheap crude and the higher complexity of its refinery enables it to use a larger variety of crude oil. Any potential setback in its telecom business is a key downside risk.

In this backdrop, most analysts are positive on RIL and expect upsides of about 17 per cent from current levels.