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Investment Guru India 2020-07-31 10:48:39

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Oil-to-chemicals – Gearing up for next orbital change?

* Reliance Industries’ (RIL) focus and determination with which it has executed its foray into digital and retail segments is highly commendable. This has resulted in our own equity valuation for digital and retail changing from INR315/share three years back to INR1,385/share currently.

* RIL’s digital segment has seen partnerships with global giants like Facebook, Microsoft, Intel and host of well known global private equity players. This has further boosted investor confidence on the company’s growth prospects and the possible synergies that could be extrapolated to retail.

* As RIL has achieved a decent foothold in both digital services and organized retail, we believe it would now turn its focus to the ‘oil-to-chemicals’ project, for which it has signed an MoU with Saudi Aramco. RIL had guided for this project in its 2019 Annual General Meeting.


Oil-to-chemicals – the theory…

* In a conventional refinery, only three products (petrol, diesel and ATF) comprising 60-70% of the product slate, command positive margins.

* As refiners increase in size and have access to more capital, they come up with complex projects like delayed coker (or petcoke gasifier). This converts low value products into high value products.

* Globally, a conventional refinery produces ~8% of naphtha, which may be used as chemical feedstock. This rises to 17-20% (examples Petro Rabigh complex of Aramco/Sumitomo, Sadara complex of Saudi Aramco/Dow) in refinery-cum-petrochemical complexes. Comparatively, RIL has 24% conversion rate of ‘oil-to-chemicals’ currently.

* In FY20, RIL’s EBITDA from refining stood at USD6.6/bbl v/s ~USD15.6/bbl in petrochemical.

* A new trend – in favor of increasing the percentage of chemicals in the overall production – is emerging. This is due to the vast difference in profitability combined with an increased threat from electric vehicles to petrol and diesel.


…and few implementations later, as much as 72% conversion possible

* ‘Oil-to-chemicals’ projects are mainly aimed at increasing the yield of light olefins or aromatics like benzene, toluene and xylene.

* Broadly, three methodologies are used. First, is the direct steam cracking of crude oil, for which, Shell and ExxonMobil have developed technologies. Another is the integrated hydro-processing/de-asphalting and steam cracking, developed by Saudi Aramco. The third is the processing of middle distillates and residues using hydrocracking, implemented at Hengli Petrochemicals, China.

* Most projects have a chemical yield of 40-60%. Saudi Aramco is also working with Chevron Lummus Global for commercializing Aramco’s ‘thermal crude-tochemicals’ technology, intended to get conversion as high as 72%. Aramco has entered into a MoU with S-Oil for USD6b steam cracker and an olefin downstream project to be completed by 2024.


A possible 15% jump in standalone EBITDA for RIL?

* Currently, chemical conversion stands at 24% for RIL. In its Annual Report, the company has reiterated that discussions with Saudi Aramco are still on. The advancement of Saudi Aramco in this technology could be the main reason RIL is looking at a partnership with the former.

* Currently, the what (% of conversion), when (timeline) and wherewithal (capex) of the targeted ‘oil-to-chemicals’ for RIL are not clear. However, the domestic retail auto fuel market is pretty saturated with OMCs having ~90% of the retail infrastructure and market with extensive expansion planned. It already exports ~60% of its refined products. ‘Oil-to-chemicals’ would wean RIL away from an already flooded global refining industry.

* According to our estimate, a 10% rise in chemical production from the current slate and improvement in EBITDA for the refinery-cum-petrochemical complex could be as much as USD476m or 5.7% of the standalone FY22E EBITDA. Most global ‘oil-to-chemical’ projects appear to have 40-60% conversion. With increase in conversion to 50%, impact on standalone/consolidated e.g. FY22E EBITDA could be 15%/7.6% (Refer Exhibit 1). The increase in EBITDA may add another INR108/share to the valuation of RIL.


Valuation and recommendation

* RIL has attained a dominant position in both digital services and organized retailing. We believe the focus on the ‘oil-to-chemicals’ project would lead to huge potential upside from the standalone business as well.

* Although the project could take a few years to get completed due to the sheer size of the complex, our estimates suggest that 10% increase in conversion would increase the FY22E standalone/consolidated EBITDA by ~5.7%/2.9%.

* Given the recent closures of raising INR1,159b through stake sale in Jio Platforms as well as INR531b through rights issue, the company would become net debt free once the cash comes in.

* Considering the company would become a net debt free, we have raised the multiple for refining and petrochemical from 6x to 7.5x. Consumption of petroleum products also appears to be normalizing. Making adjustments for the same, our valuation for refining and petrochemical increases from INR617/share to INR791/share.

* Also, for every 10% change in petchem margins or refining GRMs, EBITDA sensitivity stands at 5-6% on standalone and 3% on consolidated basis.

* Currently, RIL’s global refinery and petrochemical peers are trading at 8.9x FY21 EV/EBITDA. The stock is trading at 11.3x FY22E consolidated EBITDA and 17.7x FY22E consolidated EPS.

* We value RIL using SOTP. Valuing the standalone refining and petrochemical segments at 7.5x FY22E EBITDA and adding equity valuation of INR885/share for Jio and INR500/share for retail, we raise our target price from INR1,743/share to INR2,000/share. We reiterate RIL as one of our top picks.


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