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Reliance PetroleumRs269.60 - UNDERPERFORM
Find CLSA research on Bloomberg (CLSA <go>), Thomson First Call, Reuters Knowledge - and profit from our powerful CLSA evalu@tor® database at clsa.com
Somshankar [email protected] (9122) 66505071
Dheeraj Vaidya(9122) 66505064
Financials
Year to 31 Mar 09CL 10CL 11CL 12CL 13CL
Revenue (Rsm) 389,647 666,538 679,901 687,042 680,706
Ebitda (Rsm) 69,529 117,003 113,879 104,040 80,214
Net profit (Rsm) 57,019 96,085 93,673 84,741 61,901
CL/consensus(NP%) 247 118 110 99 -
EPS (Rs) 12.7 21.4 20.8 18.8 13.8
EPS (% YoY) 68.5 (2.5) (9.5) (26.9)
ROAE (%) 34.9 48.9 45.4 39.4 27.8
Net gearing (%) 41.4 32.4 21.2 11.1 2.0PEx (@Rs269.6) 21.3 12.6 13.0 14.3 19.6
Price/book (x) 6.3 6.0 5.8 5.5 5.4
EV/Op Ebitda (x) 18.6 10.9 11.0 11.9 15.2
Source: CLSA Asia-Pacific Markets
3 November 2007
IndiaPetroleum & Chemicals
Reuters RPET.NSBloomberg NRPET IN
Priced on 2 November 2007
India Sensex @ 19,976.2
12M hi/lo Rs295.00/58.10
12M price target Rs195.00
±% potential -28%
Target set on 05 Nov 07
Shares in issue 4,500.0m
Free float (est.) 20.0%
Market cap US$30,861m
3M average daily volume
Rs5,176.4m (US$128.9m)
Major shareholders
Reliance 75.0%Chevron 5.0%
}}Stock performance (%)
1M 3M 12M
Absolute 69.1 145.3 319.0
Relative 46.7 84.0 174.6
Abs (US$) 71.1 151.7 377.8
56
102
148
194
240
May-06 Nov-06 May-07
0
50
100
150
200
250
Reliance Petroleum (LHS)
Rel to Sensex (RHS)
(%)(Rs)
Source: Bloomberg
www.clsa.com
Barrels and bubblesAfter quadrupling since our initiation in April-07, RPL now trades at an asset value
of $4,129/complex-bpd – 2.4x that of its peers in the US and a 50-70% premium
to even the most expensive refinery new-builds quotes. While such a premium
recognizes its superior earnings potential because of lower capital costs and taxes,
even on earnings-based multiples RPL appears fully priced relative to its peer-
group at 10.9x P/CE and tax-benefit-adjusted 9.9 EV/Ebitda calculated on our
upgraded top-of-consensus FY10 estimate. Risk reward is unfavourable. U-PF.
RPL trading at 2.4x the asset valuations of US peer-group
Reliance Petroleum has quadrupled since our initiation in Apr-07 and now implies an
asset value of $4,129/complex-bpd – 2.4x those of its US-peers and a 50-70%
premium to even the most expensive refinery new-build quotes in the market
($2,500). Its premium valuations ($57,800/bpd) are justified to an extent, however,
given its higher earnings potential because of (a) lower capital costs ($740/complex-
bpd, reflected in lower interest, depreciation), (b) tax savings due to SEZ-unit status
and (c) savings from substitution of liquid fuels with lower priced natural gas.
Upgrading estimates to build in higher GRM potential of RPL
In hindsight, our Apr-07 earnings estimates now appear too low and we are upgrading
FY09-12CL EPS by 52-71% to reflect higher GRMs ($16.2/bbl in FY10) albeit offset by
a stronger rupee (Rs40/$). The refinery remains well-ahead of schedule as well and
our FY09CL estimate builds in a phased start-up from 2QFY09 (60% overall utilization).
The risk to refining margins is on the downside
While a delay in start-up poses a near term risk, the most significant earnings variable
remains refining margins – each $/bbl change impacts EPS by 9-10%. Our forecastsbuild in a $0.5/bbl moderation in GRMs each year till 2010 but the GRM trajectory may
over-react downwards as fundamentals weaken. Primary capacity additions in 2008-9
will exceed oil demand growth by 25-30%, upgrading capacity at refineries is rising
and the risk to demand growth remains on the downside.
RPL is richly valued on all parameters, downgrading to UNDERPERFORM
In this context we find 2008E global refining valuations high at 11x PE, 8x P/CE and
6.5x EV/Ebitda. RPL trades at a further 20-50% premium to these multiples calculated
on our top-of-consensus FY10 estimate. Our DCF-based fair value estimate for RPL is
Rs158/share but the market is likely to look at alternate methods like earnings
multiples, replacement costs, asset valuations, and M&A benchmarks. Depending on
the framework chosen, we find a wide-range of “fair-values” at Rs103-233/share but
even the highest estimate implies a 14% downside. Our target price of Rs195/share isbased on an average of the earnings-multiples and replacement cost benchmarks. Both
methods overstate value, in our view, but still imply a 28% downside. Downgrade to
U-PF.
U p gr a d i n g e ar ni n g s an d
t ar g e t pr i c e , d own gr a d i n g
r e c omm en d a t i on
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Barrels and bubbles Reliance Petroleum - U-PF
2 [email protected] 3 November 2007
Reliance Petroleum is thrice as expensive as ValeroReliance Petroleum (RPL) has quadrupled since out initiation in April-2007 as
its earnings and cashflow potential were factored in (consensus earnings
upgrades) and on anticipation of an earlier than target commissioning of the
580kbpd 14x-Nelson refinery. Resilient global refining margins, buoyant
sentiment towards refiners (led by continued delays to some announcedprojects) and ample liquidity support in the Indian markets have also helped.
After this surge, RPL now trades at an asset value of $57,800/bpd and
$4,129/complex-bpd making it the most expensive refinery asset in the
world. On complexity adjusted asset valuations, it now trades at 3.1x that of
the largest pure refiner in the world (Valero, 3.1mbpd, 11.2x Nelson).
Figure 1
Comparing Reliance Petroleum and Valero
RPL Valero Comments
Market Cap ($m) 30,839 38,590 Valero’s market cap is 25% higher
Price (local) 269 70
# shares (m) 4,500 554
Net Debt ($m) 2,684 4,585 Net debt for RPL is based on peal level as of end-FY08
EV ($m) 33,524 43,175
Adjustments 3,627 1,800
Tax benefits ($m)2,907 0
NPV of tax benefits on our margin profile is $2.6bn
(Rs23/share). On static margins, this is $3.6bn (Rs32/share)
Non refinery assets720 1,800
RPL has a 900kta PP plant while Valero runs 5800 fuel retailand wholesale outlets ($300m ebitda). Both at 6x EV/Ebitda
Adjusted EV ($m) 29,897 41,375
Capacity (mbpd)0.58 3.10
Valero's capacity is five times that of RPL. Its throughputaverages 2.8mbpd.
Nelson Complexity (x)14.0 11.2
Valero does not disclose complexity; calculated based onestimates for individual refineries
Asset valuation ($)
EV/bpd 57,799 13,927 RPL is 4.2x Valero
EV/complex-bpd 4,129 1,244 RPL is 3.3x Valero
Adjusted EV/bpd 51,546 13,347 RPL is 3.9x Valero
Adj EV/complex-bpd 3,682 1,192 RPL is 3.1x Valero adj. for tax-benefit, complexity.
Source: CLSA Asia-Pacific Markets
A premium asset with premium profitability
Some of the premium complexity-adjusted asset valuation is justified because
of its higher earnings power because of its
Lower capital costs ($740/complex-bpd ex of utilities which are inprivate enteritis) which is reflected in lower interest costs, depreciation;
Income tax savings due to its SEZ-unit status which allows it a tax-
holiday for five years followed by concessional rates over next ten years;
Savings from substitution of liquid fuels (fuel-oil, naphtha) used for the
refinery’s power and steam requirement with lower priced natural gas.
Upgrading FY09-12CL estimates by 52-71%In hindsight, our original April-07 earnings estimates now appear too low and
we are upgrading FY09-12CL estimates by 51-71% to reflect 27-43% higher
GRMs on the back of a higher crude-advantage assumption and savings fromnatural gas usage ($1-1.9/bbl). Our terminal GRM assumption for RPL (in
FY13CL) is now higher by $3.6/bbl at $12.1/bbl reflecting a $6.9/bbl premium
to regional Singapore margins ($5.3/bbl based on 16-year averages).
RPL is up nearly 4x in thelast eight months
Asset valuation is 3.1xthat of Valero
A premium assetvaluation is justified to an
extent
Upgrading GRM estimatesby 29-43% due to RPL
specific reasons
RPL trades at thrice thecomplexity adjusted asset
multiples of Valero
Valero has five times thecapacity of RPL
Valero’s market cap is25% higher than RPL
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Barrels and bubbles Reliance Petroleum - U-PF
3 November 2007 [email protected] 3
Figure 2
Upgrading RPL earnings estimates on higher GRMs
FY09CL FY10CL FY11CL FY12CL FY13CL
GRM ($/bbl)
Old 12.4 11.8 11.2 10.4 8.5
New 16.0 16.2 15.9 14.8 12.1
% change 29 38 42 43 43
Rupee/US$
Old 45.0 45.0 45.0 45.0 45.0
New 40.0 40.0 40.0 40.0 40.0
% change (11) (11) (11) (11) (11)
Throughput (kbpd)
Old 290 551 551 551 551
New 348 580 580 580 580
% change 20 5 5 5 5
Ebitda (Rsm)
Old 49,246 87,632 81,499 73,438 55,605
New 69,529 117,003 113,879 104,040 80,214
% change 41 34 40 42 44
Other Income
Old 1,000 1,000 1,000 1,000 1,000
New 3,412 5,021 6,399 8,036 9,503
% change 241 402 540 704 850
Profits (Rsm)
Old 37,029 63,256 57,692 49,483 31,709
New 57,019 96,085 93,673 84,741 61,901
% change 54 52 62 71 95
EPS (Rs)
Old 8.2 14.1 12.8 11.0 7.0
New 12.7 21.4 20.8 18.8 13.8
% change 54 52 62 71 95
Source: CLSA Asia-Pacific Markets
The project remains well-ahead of schedule as well and our FY09CL estimate
builds in a phased start-up from 2QFY09 with a 60% overall utilization. We
have also increased other income estimates (based on 8% yield on cash).
While a delay in start-up poses near term risks to our estimates and the
every 1% rupee appreciation impacts earnings by 1.2%, the most significant
variable is the gross refining margin. Each $/bbl change in GRM impacts
earnings by 9-10% in the interim years and by 14% in the normalized year.
Figure 3
Sensitivities to key variables
FY09CL FY10CL FY11CL FY12CL FY13CL
CLSA Base Case
GRM ($/bbl) 16.0 16.2 15.9 14.8 12.1
Rupee (Rs/US$) 40.0 40.0 40.0 40.0 40.0
Throughput (kbpd) 348 580 580 580 580
Ebitda (Rsm) 69,529 117,003 113,879 104,040 80,214
Profit (Rsm) 57,019 96,085 93,673 84,741 61,901
EPS (Rs) 12.7 21.4 20.8 18.8 13.8
% change for $1/bbl lower GRM
Ebitda (7.4) (7.2) (7.4) (8.1) (10.6)
EPS (9.3) (9.0) (9.3) (10.3) (14.2)
% change for 1% stronger rupee
Ebitda (1.0) (1.0) (1.0) (1.0) (1.0)
EPS (1.2) (1.2) (1.2) (1.3) (1.3)
% change for 5% lower throughput
Ebitda (5.0) (5.0) (5.0) (5.0) (5.0)
EPS (5.0) (6.2) (5.5) (5.6) (5.8)
Source: CLSA Asia-Pacific Markets
Every $/bbl GRM changein changes EPS by 9-10%
We are assuming a start-
up in 2QFY09
Upgrading GRM estimatesby building in natural gas
savings and a lower crude
intake API (24)
52-71% EPS upgradesover FY09-12CL
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Barrels and bubbles Reliance Petroleum - U-PF
4 [email protected] 3 November 2007
Risk to GRMs is on the downsideOur forecasts build in only a softening GRM environment over the next three
years for RPL with margins reducing at $0.5/bbl annually on average. The
margin trajectory may well over-react downwards as market fundamentals
weaken on the back of (a) a more relaxed demand-supply outlook and (b)
lower margin premiums for complex refiners given the slew of upgrading(cracking) projects being implemented by refiners.
Figure 4
Reliance Petroleum gross-refining-margin build up
4.02.9 3.1
5.6
8.3 7.9 7.4 8.27.1 6.3 5.9 5.6 5.3
1.3
1.1 1.0
1.7
3.1 3.9 4.13.6
3.1
2.7 2.22.0 2.11.2
2.51.1
0.5
1.5
5.26.5 5.7
4.96.1
6.45.6
2.8
1.0 1.21.4
1.7
1.9
6.6 6.4
5.2
7.8
12.9
17.0
18.117.5
16.0 16.2 15.9
14.8
12.1
0
4
8
12
16
20
FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 Norm
Singapore Product premium Crude advantage Natural Gas savings
Building RPL's GRMs ($/bbl)
Source: CLSA Asia-Pacific Markets
Capacity additions will exceed demand growth in 2008-09 Refining companies are responding to margin signals and distillation
capacity additions in 2008-9 (4mbpd) will exceed oil demand growth by
25-30%. Projects in Asia (2.6mbpd) and the Middle East (0.3m) will make
up 72% of this additional capacity. Over the next five years, we expect
10.8mbpd of additional capacity to come onstream.
Further, with oil prices at US$90/bbl, the risk to global oil demand
growth remains on the downside. The IEA, for example, has consistently
overstated growth in 2006-7; it has halved its 2007 demand growth
estimate to 1.2mbpd since its first estimate, for example. We see a
similar pattern evolving for its 2008 estimate (+2.4%) which we find
optimistic given the slowdown in OECD and the reasonable, but not
explosive, growth in developing economies.
Figure 5 Figure 6
Supply addition will exceed demand growth in 2008-9 IEA has consistently overstated demand growth
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
2002 2004 2006 2008 2010 2012
Incremental demand
Capacity expansion
(m bpd)
0.8
1.0
1.2
1.4
1.6
1.8
J u l - 0
6
A u g - 0
6
S e p - 0
6
O c t - 0
6
N o v - 0
6
D e c - 0
6
J a n - 0
7
F e b - 0
7
M a r - 0
7
A p r - 0
7
M a y - 0
7
J u n - 0
7
J u l - 0
7
A u g - 0
7
S e p - 0
7
O c t - 0
7
Oil demand growth in 2007 (m bpd)
Source: CLSA Asia-Pacific Markets
We model softeningGRMs, but not a crash
RPL can process cheapercrude, make more
premium products andwill save from gas use
Capacity additions willexceed demand growth in
2008-2009 by 25-30%
Risk to demand growth ison the downside
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Barrels and bubbles Reliance Petroleum - U-PF
3 November 2007 [email protected] 5
Complexity premiums will reduce impacting complex refiners more At the same time, refining system complexity is also increasing as
refineries add upgrading capacity which may impact both product spreads
as well as light-heavy crude differentials. Over the next five years, we
expect 1.1mbpd of cracking capacity to come onstream annually on
average. This is 55% of the incremental new distillation capacity.
Given the cracking upgrades and capacity additions, we also see a more
relaxed outlook for light products. This may reduce the margin
premiums that complex and coking refineries have enjoyed over simpler
ones due to lower crack spreads along with narrowing fuel-oil discounts.
In addition, while not built into our estimates, global crude pool quality
may also improve marginally over the next couple of years (before
deteriorating again). The bulk of non-OPEC production growth (in places
like West Africa and Sakhalin) is of superior quality crude while growth in
OPEC and FSU NGLs is also lightening the mix. This may also reduce the
complexity premiums by impacting light-heavy crude differentials.
Figure 7 Figure 8
Refineries are investing in cracking capacity Complexity premiums may reduce
0
1020
30
40
50
60
70
80
90
100
2007 2008 2009 2010 2011 2012
Incremental capacity
Avg cracking ratio 07-12
Current cracking ratio
0
2
4
6
8
95 96 97 98 99 00 01 02 03 04 05 06 07
Cracking over Simple Coking over Cracking
Singapore GRM complexity premiums ($/bbl)
Source: CLSA Asia-Pacific Markets
We find global valuations rich in this contextIn this context, we find current global refining valuations of 10.8x P/E, 8.0x
P/CE and 6.5x EV/Ebitda (both on 2008 estimates) rich. With margins
expected to come under pressure in 2008, while consensus estimates itself
may be too high, we foresee a contraction in valuation multiples as well.
Figure 9 Figure 10
Global refining valuations appear rich Valero’s P/CF are near previous peaks
P/E (x) P/CE (x) EV/ebitda (x)
2007E 2008E 2007E 2008E 2007E 2008E
US 9.3 11.1 7.3 8.7 5.4 6.2
Europe 13.9 10.3 8.1 7.0 8.3 6.4
Asia ex-Japan, India 12.4 12.1 10.2 9.3 7.9 7.6
India 8.3 9.2 5.9 4.8 5.7 5.4
Japan 14.0 14.4 7.4 7.5 8.8 8.3
Average 11.9 11.7 7.8 7.6 7.4 6.9
Avg ex Japan India 11.4 10.8 7.7 8.0 6.9 6.5
-1sd2.0x
avg3.9x
+1sd5.8x
0
1
2
3
4
5
6
7
8
1997 1999 2001 2003 2005 2007
Valero 12m rolling P/CF multiple (x)
Source: Bloomberg, IBES, CLSA Asia-Pacific Markets
Upgrading capacity isrising which will narrow
complexity premiums
A more relaxed outlookfor light products
The crude pool qualitymay also improve near
term
Global valuations do notreflect an impending
downturn
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Barrels and bubbles Reliance Petroleum - U-PF
6 [email protected] 3 November 2007
Reliance Petroleum even more expensiveOn our upgraded top-of-consensus FY10 estimates, we find RPL priced 17-
53% ahead of these global multiples at 12x PE, 10.6x P/CE and 9.7x
EV/Ebitda (adjusted for tax-benefits). These multiples appear rich given that:
Earnings will decelerate each year from FY10CL as GRMs soften; and
Long term earnings potential of RPL is ~42% lower than FY10 estimates
due to (a) lower long term GRMs and (b) scaling back of the tax-benefits.
Figure 11 Figure 12
RPL’s cashflow multiples are 37-53% higher RPL’s mid-cycle potential is 42% lower FY10 estimates
11.1
8.7
6.2
10.3
7.06.4
12.1
9.3
7.6
10.8
8.0
6.5
12.6
10.9
9.9
3
5
7
9
11
13
15
PE P/CE EV/Ebitda
US Europe AxJ Average RPL FY10
2008E (x) 17% higher 37% higher 53% higher
8.210.3 10.0 9.8 9.8 10.1
3.65.3 4.9 3.60.9
5.7 5.95.4
4.0 2.3
0
5
10
15
20
25
09CL 10CL 11CL 12CL 13CL 14CL
Long term Higher interim margins Tax benefits
EPS build-u (Rs
42% lower
Source: CLSA Asia-Pacific Markets =
Estimating fair value for RPLWe have used a range of methods to estimate the fair value of RPL.
Depending on the framework chosen (DCF, earnings-multiples, replacementcosts), RPL’s fair value estimates ranges from Rs103-232/share. Even so, the
“highest” fair value estimate suggests an 11% downside.
Discounted cashflow on expected margin profile: Our discounted
cash-flow fair value estimate is Rs158/share based on our explicit GRM
profile, a 3% terminal growth and a 10.8% WACC. A DCF remains the
best measure because it factors in the expected near term margin profile
as well as the change in fiscal terms for RPL (zero tax ends in five years).
Discounted cash flow on static margins: Recalculating the DCF on a
static margin profile (in effect assuming that current margins remain to
perpetuity, clearly over-optimistic) shows a fair value of Rs212/share.
Peer earnings multiples: Despite the rigor of a DCF, the market is more
likely to focus on RPL’s earnings and cashflow potential. We see current
global refining stocks as overvalued in the context of likely softening
GRMs but using the global average multiples (10.8x PE, 8.0x P/CE and
6.5x EV/Ebitda) on RPL’s FY10 earnings estimates indicates a fair value
range of Rs173-218/share. We re-iterate that an earnings-multiple based
approach overstates value given that RPL’s normalized earnings potential
is 42% lower than FY10 estimates due to lower long term margins and
the scaling back of tax-benefits.
Peer asset valuations: Current refinery stocks across the world trade in
a range of $6800-40,000/bpd (ex Japan and India) with a simple mean of US$18,200/bpd (weighted mean of US$15,900/bpd). This would imply a
fair value range as wide as Rs45-207/share with the mean implying a fair
value estimate of Rs103/share.
RPL’s earnings multiplesare 17-53% higher
DCF fair value isRs158/share
DCF on constant marginsis Rs212/share
Earnings based fair valueof Rs173-218/share
Peer asset valuations
indicates Rs103/share
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Barrels and bubbles Reliance Petroleum - U-PF
3 November 2007 [email protected] 7
Complexity adjusted asset valuations: Based on the disclosures made
by respective companies, global refining companies trade in a complexity
adjusted asset value range of $1200-3800/complex-bpd with a simple
mean of $2,200/complex-bpd (weighted average of $1,710/complex-bpd).
This would imply a fair value range of Rs94-271/share with the mean
implying a fair value estimate of Rs164/share.
Replacement costs: Project costs have risen sharply in the last year
with several refining projects delayed or put on hold. Our survey of recent
costs indicates that a highest quoted asset cost of $30,000/bpd for
Essar’s proposed 300kbpd refinery in Iran (reportedly scrapped now)
which is expected to cost US$8-10bn. On a complexity adjusted basis, the
615kbpd Al-Zour refinery in Kuwait which recently received quotes of
$15bn and above appears to be the most expensive at $2400/complex-
bpd. This would indicate a fair value range of Rs160-178/share.
Replacement costs adjusted for interim free cash flow: A more
benign valuation indicator would suggest that replacement costs shouldbe adjusted for the free cashflow profile to enable a like-to-like
comparison with refineries already in production. For example, given that
new refineries would likely come up only in Mar-12, we should add the
net-present-value of the cashflow for RPL over FY09-12CL to current
replacement cost valuations for a proper comparison. This increases RPL’s
replacement cost benchmark by Rs58/share to Rs215-233/share.
Recent M&A benchmarks: Recent refinery acquisitions have been priced
at $4000-19000/bpd and $500-1800/complex-bpd (and at 3-5x
EV/ebitda). The upper end of these multiples ($19,000 for Lyondell’s
acquisition of Citgo’s 41% stake in the 12.2x Nelson 268kbpd Houston
refinery and $1800/complex-bpd for the Harvest-NA and Western-Giant
deals, all in 2006) would imply a fair value of Rs108-137/share for RPL.
Figure 13
RPL – a wide range of fair values but all show downsides from current levels
0 50 100 150 200 250 300 350
DCF CLSA
DCF Static GRM
PE
P/CE
EV/Ebitda
Comp asset value
Asset value
Replacement costs
Repl. cost NPV adj
M&A (Rs/share)
Currentmarket
price
Source: CLSA Asia-Pacific Markets
RPL’s market price ishigher than all fair value
estimates
Complexity adjusted assetvaluations of Rs164/share
High end of replacementcosts indicates Rs160-
178/share
Adjusted replacementcost benchmark of Rs215-
233/share
M&A benchmarks atRs108-137/share
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Barrels and bubbles Reliance Petroleum - U-PF
8 [email protected] 3 November 2007
Downgrading to U-PF on unfavourable risk-rewardOur DCF-based fair value estimate of RPL is Rs158/share but the market is
likely to look at alternate benchmarks like replacement costs and earnings
multiples – both of which overstate value for RPL, in our view. Nonetheless,
our target price of Rs195/share (based on an average of these methods) still
implies a 28% downside from current levels
Figure 14
Target price of Rs195/share
158
212 218
186173 164
103122
169
224
195
0
50
100
150
200
250
300
D C F
C L S A
D C F
S t a t i c
G R M P
E
P / C E
E V / E b i t d a
C o m p
a d j .
a s s e t
A s s e t
v a l u e
M & A
R e p l .
c o s t
R e p l .
c o s t N P V
a d j
T a r g e t
P r i c e
RPL Fair Values (Rs/share)Current market price
Source: CLSA Asia-Pacific Markets
We reiterate that these measures may overstate value in the last stages of a
typical cyclical peak given elevated expectations. For example, earnings will
deteriorate over time given lower margins and increasing taxes. Further, it
may be premature to assume that the recent increases in replacement costs
will be structural. A large part of those are based on high commodity prices,
shortages of contractors and manpower and rising “uncertainty premiums”
charged by contractors based on recent experiences with fixed price
contracts. There have been cases (LNG in the 90s, for example) when
markets tighten and then recede as cost pressures soften.
RPL would trade at 9.6x FY10 EPS (16.6x Normalized EPS) on our target
price. The implied asset multiples ($37,000/bpd and $2,647/complex-bpd
adjusted for the 900kta PP plant and tax benefits) are also higher than most
peer valuations today and well above historical benchmarks and recent M&A.
Figure 15
Asset valuations of peers in the US, Europe, AxJ, Japan and India
1.21.4 1.4
2.1
2.9
1.7
2.8
3.8
1.8
1.2
2.2
1.8
1.3
2.6
2.22.3
3.43.7
2.1
2.5
1.6
2.2
1.21.1
2.6
3.2
1.1
2.6
1.3
2.0
1.5
4.1
0
1
2
3
4
5
V a l e
r o
S u n o
c o
T e s o
r o
F r o n t
i e r
H o
l l y
W e s t e
r n
P K N
N e s t e
T u p r a s
P e t r o p l u s
S a r a s
H e l l e n i c
E R G
S K -
E n
S -
O i l
G S H o l d
T h a i
O i l
C a l t
e x
R a y o
n g
I O C
B P
C L
M R
P L
H P
C L
C h e n n a i
N -
O i l
N - M i n i n g T G
I d e m i t u s
S h o w a
C o s m
o
A O C
R
P L
EV/complex-bpd ($000)
Source: CLSA Asia-Pacific Markets
RPL is the most expensiveasset in the universe we
evaluated
Intrinsic fair value of Rs158/share
Replacement costs arecyclical as well
$2,647/complex-bpd onour target price
DCF: Rs158/shareTarget: Rs195/share
Target is based onaverage of earnings
multiples andreplacement costs
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Barrels and bubbles Reliance Petroleum - U-PF
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Figure 16
M&A benchmarks for refinery assets
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 RPL
Range of M&A multiples (EV/complex-bpd in $000)
Source: CLSA Asia-Pacific Markets
In this context, we see further risk on the downside as the market prices in
(a) softening market fundamentals and (b) RPL’s own earnings profile as the
tax-benefits scale back even if market fundamentals do not soften. We see
risk reward as unfavourable and are cutting our recommendation to U-PF.
Figure 17
Global summary valuation matrix
Mcap EV EV/bpd P/E (x) P/CE (x) P/BV (x) EV/Ebitda (x)
($bn) ($bn) (000 $) 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E
US 65.6 74.1 18.1 9.3 11.1 13.0 7.3 8.7 9.7 3.5 2.8 2.4 5.4 6.2 6.3
Europe 45.1 54.7 19.2 13.9 10.3 10.2 8.1 7.0 6.4 2.0 1.8 1.6 8.3 6.4 6.1
Asia ex-Japan, India 54.8 56.8 19.2 12.3 12.0 14.9 10.1 9.2 10.7 2.2 2.0 1.9 7.9 7.5 8.1
India 25.1 27.3 10.3 8.6 9.5 10.8 6.1 5.0 6.3 1.8 1.6 1.4 5.8 5.6 5.7
Japan 41.9 71.3 15.9 14.0 14.4 15.2 7.4 7.5 7.3 1.3 1.2 1.2 8.8 8.3 8.6
Avg ex Japan, India 165.5 185.5 16.8 11.4 10.8 12.1 7.7 8.0 8.0 2.4 2.1 1.9 6.8 6.5 6.7
Simple Mean 18.3 12.0 11.4 12.8 8.4 8.2 8.8 2.5 2.1 1.9 7.3 6.8 6.9
Weighted Mean 15.8 10.7 10.6 11.5 7.2 7.3 7.9 2.3 2.0 1.8 6.4 6.2 6.5
Median 16.2 11.5 10.4 12.1 7.6 8.4 7.2 2.4 2.1 1.9 6.9 6.4 6.6
Average 232.5 284.1 16.7 11.9 11.7 13.0 7.8 7.6 8.1 2.1 1.9 1.7 7.4 7.0 7.1
RPL 30.8 33.5 57.8 nm 21.3 12.6 Nm 18.5 10.9 9.0 6.3 6.0 nm 16.9 9.9
Source: CLSA Asia-Pacific Markets
Risks to our viewWhile company specific newsflow anticipation remains a positive trigger for
the stock, we see most of the upsides already priced into the stock.
Nevertheless, we see the following risks to our view:
Earlier than anticipated start-up: The project is running ahead of its
Dec-08 commissioning target. While management has confirmed this, it
has not crystallized a date. We are building in a 2QFY09 (July-08) phased
start-up implying 60%-utilization in FY09. We see this as realistic but
given the stock’s valuations, there is minimal impact on fair value even if we assumed full operations in FY09 (Rs5-8/share increase). A formal
announcement of an earlier start-up may be a sentiment driver, though.
We are building in a2QFY09 start-up
Recent M&A has been at3-5x EV/Ebitda and sub
$2000/complex-bpd
We see little scope forupside surprises
We are cutting ourrecommendation to U-PF
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Stronger than expected GRMs: We are building in $0.5/bbl moderation
in margins for RPL each year in the next three years. A delay in capacity
additions or stronger demand growth may put these assumptions at risk.
Each $/bbl change impacts EPS by 9-10% and we would need to upgrade
estimates. Further, stronger GRMs may also see an increase in the sector
valuation multiples which would add to market value.
Figure 18 Figure 19
CLSA benchmark refining margin assumptions Asian GRMs have stop up in 4Q-2007
0
2
4
6
8
10
12
14
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Simple Cracking Coking
Singapore refining margins ($/bbl)
0
3
6
9
12
15
Jan Feb Mar Apr May Jun Jul Aug Sep Oct NovDec
2005 2006 2007
Singapore complex GRM (US$/bbl)
Source: CLSA Asia-Pacific Markets
Chevron buy-in: Chevron has an option to buy up to an additional 24%
in RPL from Reliance at a 5% discount to the market price. A buy-in by
Chevron at current valuations will be seen as a strong vote of confidence
by one of the largest global oil companies and may re-rate the stock.
Chevron has up to July-2009 to make it decision which will depend on
“commercial issues” and “economics of investment”. Chevron alsoindicated in its post 3Q-2007 analyst call that it is yet to sign some key
agreements (related to crude sale and product purchase) on which its
option to buy is contingent. In this context, we see a decision by Chevron
to buy into RPL as unlikely in the near term.
Further, with RPL at 4.5x the levels at which Chevron bought its initial 5%
stake and with RPL trading at an implied value of $56,000/bpd and
$4000/complex-bpd, the economic rationale may also have deteriorated
significantly from Chevron’s point of view.
A buy-in may still be possible should there be a quid-pro-quo between
Reliance and Chevron in other segments of the energy chain – forexample, a farm-out of Reliance’s upstream blocks to Chevron. Chevron
indicated in its analyst call that it remains interested in the KG-Basin but
that there has been no headway in negotiations.
Fund raising: Announcements of equity and quasi-equity fund raising
appear to lift stock-price sentiment in today’s Indian equity markets. A
fund-raising that sets an elevated price target (for example an FCCB with
a 40-50% conversion premium) may be seen as positive.
Building in $0.5/bblannual reduction in
margins over the nextthree years
The economic rationalefor a Chevron buy-in has
deteriorated
A high market benchmarkmay support the stock
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Appendix 1: Fair value estimates of RPL
Figure 20
Target price of Rs195/share
End FY09
(Mar-09)
fair value
(Rs/sh) Comments
PE on
FY10
EPS (x)
PE on
Norm
EPS
(x)
EV/co
mplex-
bpd
($)
12m fwd
fair
value
(Rs/sh)
From
current
price
(%)
DCF
On CLSA GRM profile167
Based on 10.8% WACC, our
explicit margin estimates
with a $12.1/bbl normalizedGRM + 3% terminal growth
7.8 13.4 2,105 158 (41)
On static GRM224
Above but with static GRMs
of $16.1/bbl ion horizonperiod, 3% terminal growth
10.5 18.1 2,901 212 (21)
Peer earnings multiples
10.9x PE230
2008E global average exIndia, Japan on FY10 est.
10.8 18.6 2,987 218 (19)
8.0x P/CE197
2008E global average exIndia, Japan on FY10 est.
9.2 15.9 2,523 186 (31)
6.5x EV/Ebitda183
2008E global average ex
India, Japan on FY10 est.
8.6 14.8 2,333 173 (36)
Peer asset valuations
$2,200/complex-bpd173
Based on the weightedaverage of global refinery
peer asset multiples
8.1 14.0 2,200 164 (39)
$18,200/bpd108
-do- but complexity adjusted5.1 8.7 1,300 103 (62)
Replacement Cost
$2400/complex-bpd
188
Based on highest recentquote (Al-Zour in Kuwait)
8.8 15.1 2,400 178 (34)
$30,000/bpd169
Based on the highest recent
quote (Essar in Iran)
7.9 13.6 2,143 160 (40)
$2400/complex-bpd adj.246
Above adjusted for FY09-
12CL cashflow NPV of RPL
11.5 19.8 3,201 233 (14)
$30,000/bpd adj.227
Above adjusted for FY09-12CL cashflow NPV of RPL
10.6 18.3 2,944 215 (20)
M&A
$1,800/complex-bpd145
Based on the Harvest-North
Atlantic and Western-Giant
deals in 2006
6.8 11.7 1,807 137 (49)
$18,200/bpd114
Based on Lyondell’s buyout
of Citgo’s residual stake in
the Houston refinery in 2006
5.3 9.2 1,371 108 (60)
Summary
Max246
NPV adj. replacement cost11.5 19.8 3,201 233 (14)
Min108
Based on $18,200/bpd EV5.1 8.7 1,300 103 (62)
Average182
Simple avg of all methods8.5 14.7 2,324 173 (36)
Target price206
Avg of replacement cost
and earnings-multiple
based valuation methods
9.6 16.6 2,647 195 (28)
Source: CLSA Asia-Pacific Markets. Note: All numbers for Reliance Petroleum are adjusted for the NPV of
tax benefits and the value of its non refining assets (900kta PP plant).
DCF = Rs158
A 28% downside to our12m forward target price
Peer multiples = Rs173-
218
Asset value = Rs103-164
Repl. cost = Rs160-233
M&A = Rs108-137
Target price = Rs195
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Appendix 2: Refining valuation matrix
Figure 21
Global refining valuation matrix
Price Mcap EV EV/bpd P/E (x) P/CE (x) P/BV (x) EV/Ebitda (x)
(lcy) ($bn) ($bn) (000 $) 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E
US
Valero 69.7 38.6 43.2 13.9 8.1 8.6 8.8 5.9 6.3 7.2 2.3 2.0 1.8 4.6 5.2 5.6
Sunoco 71.4 8.4 10.6 11.8 8.6 9.1 10.3 5.6 5.4 6.2 3.0 2.5 2.0 4.8 4.8 5.3
Tesoro 57.4 7.9 9.3 14.0 10.9 10.1 11.9 6.6 6.5 7.1 2.4 2.0 1.7 5.7 5.3 6.0
Frontier 45.3 4.9 4.5 24.5 10.1 13.9 14.2 9.4 11.6 11.7 4.8 3.6 3.2 5.5 7.5 5.8
Holly Corp 64.1 3.5 3.2 29.0 10.7 15.0 18.8 9.5 13.0 14.1 5.9 4.4 3.7 5.9 8.1 7.8
Western 35.0 2.4 3.3 15.0 7.5 10.2 14.2 6.6 9.3 12.0 2.9 2.3 2.2 6.0 6.1 7.5
Mean 65.6 74.1 18.1 9.3 11.1 13.0 7.3 8.7 9.7 3.5 2.8 2.4 5.4 6.2 6.3
Median 14.5 9.3 10.1 13.0 6.6 7.9 9.4 3.0 2.4 2.1 5.6 5.7 5.9
Europe
PKN (Poland) 56.6 9.6 13.4 25.0 11.8 10.3 10.4 5.3 4.7 4.5 1.1 1.0 1.0 6.5 5.8 5.6
Neste Oil (Finland) 25.6 9.5 10.6 42.4 11.9 10.5 10.7 9.2 7.8 8.1 2.7 2.3 2.1 7.8 6.9 6.9
Tupras (Turkey) 31.5 6.7 6.6 11.6 8.5 8.1 9.0 6.7 9.3 6.4 2.3 2.1 1.9 6.6 6.1 5.6
Petroplus (Europe) 96.0 5.7 7.2 8.4 23.2 8.8 9.3 13.9 6.4 5.4 2.6 2.1 1.8 14.8 6.7 6.3
Saras (Italy) 4.1 5.7 5.7 19.0 12.9 11.3 10.7 7.3 7.4 7.0 2.6 2.4 2.1 6.1 5.6 5.4
Hellenic (Greece) 10.9 4.8 6.4 17.3 13.6 13.7 13.2 8.4 8.3 8.7 1.4 1.3 1.3 9.2 9.0 8.6
ERG (Italy) 13.9 3.0 4.9 11.0 15.2 9.6 7.9 5.5 4.8 4.3 1.6 1.4 1.3 6.9 4.9 4.2
Mean 45.1 54.7 19.2 13.9 10.3 10.2 8.1 7.0 6.4 2.0 1.8 1.6 8.3 6.4 6.1
Median 17.3 12.9 10.3 10.4 7.3 7.4 6.4 2.3 2.1 1.8 6.9 6.1 5.6
Asia ex-Japan
SK-Energy (Korea) 200k 20.2 20.8 19.0 15.5 18.7 23.0 nm 10.5 21.9 2.9 2.6 2.3 11.4 12.5 16.2
S-Oil (Korea) 81k 10.0 8.5 15.1 12.0 12.9 17.7 18.8 9.4 11.9 2.2 2.2 2.2 6.4 6.8 8.9
GS Holdings (Korea) 67k 6.8 7.3 11.3 18.4 10.5 13.0 nm nm nm 2.2 1.9 1.7 8.7 4.5 5.1
Thai Oil (Thailand) 96 5.7 6.5 28.8 11.3 10.0 12.2 7.4 8.5 7.2 2.5 2.2 2.1 7.6 6.2 6.9
Caltex (Australia) 21.2 5.3 5.7 25.9 11.6 11.8 12.6 8.6 8.4 8.3 2.1 1.9 1.8 7.0 7.4 7.0
SPC (Singapore) 8.7 3.1 3.2 23.1 10.0 9.6 20.7 7.9 8.6 5.4 2.4 2.1 2.0 7.9 7.5 7.0
Rayong (Thailand) 25.8 2.2 2.6 18.3 8.7 13.3 12.7 8.9 9.9 12.8 1.5 1.4 1.4 7.1 9.6 8.8
Petron (Phillippines) 7.0 1.5 2.1 11.8 10.8 9.1 7.5 9.4 9.0 7.3 1.8 1.5 1.3 6.9 5.9 5.1
Mean 54.8 56.8 19.2 12.3 12.0 14.9 10.1 9.2 10.7 2.2 2.0 1.9 7.9 7.5 8.1
Median 18.7 11.5 11.1 12.8 8.7 9.0 8.3 2.2 2.0 1.9 7.3 7.1 7.0
India
IOC 496 15.0 16.2 14.9 8.9 8.1 9.7 6.9 4.2 5.6 1.4 1.3 1.2 6.4 4.7 5.1
BPCL 343 3.2 3.7 8.6 6.4 6.4 7.5 6.3 4.0 4.4 1.0 0.9 0.8 4.4 3.8 4.0
MRPL 82 3.7 4.0 15.6 14.5 17.8 18.3 8.6 9.2 10.0 4.1 3.5 3.1 8.2 8.8 8.3
HPCL 239 2.1 1.9 5.5 6.6 5.4 7.4 3.1 2.4 3.9 0.8 0.7 0.7 5.9 5.2 5.5
Chennai 325 1.2 1.5 6.9 6.5 9.9 11.1 5.6 5.2 7.4 1.5 1.4 1.3 4.2 5.3 5.5
Mean 25.1 27.3 10.3 8.6 9.5 10.8 6.1 5.0 6.3 1.8 1.6 1.4 5.8 5.6 5.7
Median 8.6 6.6 8.1 9.7 6.3 4.2 5.6 1.4 1.3 1.2 5.9 5.2 5.5
JapanNippon Oil 1,036 13.2 22.7 21.4 11.6 15.1 16.1 5.5 6.0 6.2 1.1 1.1 1.0 7.4 7.8 8.0
Nippon Mining 1,102 8.9 15.1 28.1 9.5 10.1 10.1 6.1 7.0 6.3 1.4 1.3 1.2 9.0 9.2 9.1
TonenGeneral 1,163 5.9 6.6 8.7 20.5 20.6 20.0 12.5 13.2 13.3 2.5 2.4 2.3 9.5 9.3 10.4
Idemitusu 13,370 4.7 10.9 17.9 15.4 13.8 13.5 4.8 4.4 4.3 0.9 0.9 0.9 7.9 7.4 7.3
Showa Shell 1,323 4.3 5.8 11.3 12.9 14.9 14.8 8.1 7.9 7.8 1.3 1.3 1.2 7.9 7.8 7.7
Cosmo 491 3.6 8.1 12.8 11.0 12.8 16.1 5.3 6.2 6.2 0.9 0.9 0.8 8.3 8.6 9.0
AOC Holdings 1,794 1.2 2.2 11.3 16.8 13.3 15.8 9.7 7.5 7.3 0.9 0.9 0.9 11.8 8.4 9.0
Mean 41.9 71.3 15.9 14.0 14.4 15.2 7.4 7.5 7.3 1.3 1.2 1.2 8.8 8.3 8.6
Median 12.8 12.9 13.8 15.8 6.1 7.0 6.3 1.1 1.1 1.0 8.3 8.4 9.0
Ex-Japan ex-India 165.5 185.5 16.8 11.4 10.8 12.1 7.7 8.0 8.0 2.4 2.1 1.9 6.8 6.5 6.7
Simple Mean 18.3 12.0 11.4 12.8 8.4 8.2 8.8 2.5 2.1 1.9 7.3 6.8 6.9
Weighted Mean 15.8 10.7 10.6 11.5 7.2 7.3 7.9 2.3 2.0 1.8 6.4 6.2 6.5
Median 16.2 11.5 10.4 12.1 7.6 8.4 7.2 2.4 2.1 1.9 6.9 6.4 6.6
Global 232.5 284.1 16.7 11.9 11.7 13.0 7.8 7.6 8.1 2.1 1.9 1.7 7.4 7.0 7.1
RPL 269.4 30.8 33.5 57.8 nm 21.3 12.6 nm 18.5 10.9 9.0 6.3 6.0 nm 18.6 10.9
Source: CLSA Asia-Pacific Markets
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Appendix 3: Key financialsFigure 22
Key assumptions
FY06 07CL 08CL 09CL 10CL 11CL 12CL 13CL
Capacity Data (kbpd)Nameplate capacity 580 580 580 580 580 580 580 580
Crude intake 0 0 0 348 580 580 580 580Secondary intake 0 0 0 0 0 0 0 1
Total intake 0 0 0 348 580 580 580 581
% utilization 0 0 0 60 100 100 100 100
Refining Margin ($/bbl)
Singapore Complex 7.9 7.4 8.2 7.1 6.3 5.9 5.6 5.3
RPL slate premium 3.9 4.1 3.6 3.1 2.7 2.2 2.0 2.1
RPL crude advantage 5.2 6.5 5.7 4.9 6.1 6.4 5.6 2.8Net clean fuel adv 0.0 0.0 0.0 1.0 1.2 1.4 1.7 1.9
RPL GRM 17.0 18.1 17.5 16.0 16.2 15.9 14.8 12.1
PP Plant
PP-Propylene spread ($/t) 171 184 150 155 159 164 169 174
PP production (mt) 0.0 0.0 0.0 0.5 0.9 0.9 0.9 0.9
Exchange Rate (Rs/$) 44.4 45.0 40.0 40.0 40.0 40.0 40.0 40.0
Source: CLSA Asia-Pacific Markets
Figure 23
Key financials
(Rsm) FY06 FY07 08CL 09CL 10CL 11CL 12CL 13CL
Income Statement
Revenues - - - 389,647 666,538 679,901 687,042 680,706
RM - - - (304,848) (523,322) (539,022) (555,193) (571,849)
Gross Margins - - - 84,799 143,216 140,878 131,849 108,857
Opex - - - (15,269) (26,213) (26,999) (27,809) (28,643)
Ebitda - - - 69,529 117,003 113,879 104,040 80,214
Depreciation - - - (8,686) (14,694) (14,911) (15,128) (15,345)
Ebit - - - 60,843 102,309 98,968 88,912 64,869
Interest - - - (5,585) (9,058) (9,058) (9,058) (8,927)
Other Income 0 0 0 3,412 5,021 6,399 8,036 9,503PBT 0 0 0 58,670 98,273 96,310 87,890 65,445
Taxes - - - (1,651) (2,188) (2,637) (3,149) (3,544)
PAT 0 0 0 57,019 96,085 93,673 84,741 61,901
Dividends - - - - 86,342 84,236 76,339 55,807
Appropriated 0 0 0 57,019 9,743 9,436 8,402 6,094
Balance Sheet
Networth 31,500 134,488 134,488 191,507 201,250 210,686 219,089 225,183
Debt - 54,670 122,500 122,500 122,500 122,500 122,500 118,900
Total 31,500 189,158 256,988 314,007 323,750 333,186 341,589 344,083
NFA, CWIP 19,036 187,517 240,000 261,314 250,670 239,809 228,731 217,436
Investments 7,985 2,280 - - - - - -
Cash 4,505 96 16,988 43,300 57,235 77,739 98,158 114,418
Net current assets (52) (735) - 9,393 15,845 15,639 14,699 12,230
Total 31,474 189,158 256,988 314,007 323,750 333,186 341,589 344,083
Cash Flow
From operations 52 683 (735) 61,897 113,385 117,847 109,866 88,643
PAT 0 0 0 57,019 96,085 93,673 84,741 61,901
Add interest - - - 5,585 9,058 9,058 9,058 8,927
Add depreciation - - - 8,686 14,694 14,911 15,128 15,345
W-capital change 52 683 (735) (9,393) (6,452) 206 940 2,470
From investments (27,047) (159,055) (43,400) (26,527) (4,050) (4,050) (4,050) (4,050)
Capex (19,036) (164,786) (45,680) (26,527) (4,050) (4,050) (4,050) (4,050)
Investments (7,985) 5,705 2,280 - - - - -
Others (26) 26 - - - - - -
From financing 31,500 153,824 61,027 (9,058) (95,400) (93,294) (85,397) (68,334)
Equity 31,500 102,988 (0) - 0 - (0) 0
Debt - 54,670 67,830 - - - - (3,600)
Interest costs - (3,834) (6,803) (9,058) (9,058) (9,058) (9,058) (8,927)
Dividends - - - - (86,342) (84,236) (76,339) (55,807)
Free Cash Flow (18,984) (164,103) (46,415) 35,370 109,335 113,797 105,816 84,593
Source: CLSA Asia-Pacific Markets
We are assuming a start-up in 2QFY09 with a GRM
of $16/bbl
Each $ change in GRMsimpacts earnings by 9-
11% in the initial years
We are building in anexchange rate of Rs40/$
We are building in$12.1/bbl terminal GRM
for RPL
50:50 debt/equityfunding of the $6bn
project
RPL is aiming to completeall major capex by end
FY08 itself with a view toan early FY09 start-up
$4bn in free cash flow inthe first 18 months after
commissioning
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Barrels and bubbles Reliance Petroleum - U-PF
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Recommendation history - Reliance Petroleum NRPET IN
Date Rec level Closing price Target
05 November 2007 U-PF 269.60 195.0028 August 2007 BUY 112.45 128.0009 April 2007 BUY 71.40 90.0027 June 2006 SELL 64.10 48.00
Source: CLSA Asia-Pacific Markets
Key to CLSA investment rankings: BUY = Expected to outperform the local market by >10%; O-PF = Expected to outperform the local marketby 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%.Performance is defined as 12-month total return (including dividends).
©2007 CLSA Asia-Pacific Markets (“CLSA”). Note: In the interests of timeliness, this document has not been edited.
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