Investor's Eye
[December 30, 2013] | | |
| Summary of Contents
STOCK UPDATE Reliance Industries
Recommendation: Buy
Price target: Rs1,010
Current market price: Rs883 Conditional approval for higher gas price Key points -
Event: gas price hike but with conditions: The Cabinet Committee of Economic Affairs (CCEA) approved the gas price revision for Reliance Industries Limited (RIL), only on a condition that RIL and its partners in the Krishna-Godavari D-6 (KG-D6) gas block should furnish a bank guarantee which is equal to the incremental revenue it would generate from the increase in the gas price. The bank guarantee will be encashed if the charges that the firm had been hoarding gas and deliberately suppressing production at the D6 oilfield, are proved later. RIL and its partners, British Petroleum (BP) Plc and Canada's Niko Resources, may have to provide US$1.2 billion (around Rs7,440 crore at Rs62 per US Dollar) of bank guarantees over the next three years. RIL which holds 60% share in the block, should provide a bank guarantee worth Rs4,465 crore. -
Impact: every US$1 per mmBtu results in 1.4% increase in earnings; we have already factored in a gas price of US$7 per mmBtu in our estimates: With this conditional approval, RIL will be able to realise higher gas price from April 1, 2014. Currently, RIL realises US$4.2 per million metric British thermal units (mmBtu) for the gas produced from KG-D6 basin. Though the revised price is not finalised yet, we believe it would be substantially higher than the current price. As per the formula recommended by C Rangarajan, the Prime Minister's economic adviser, in December 2012 suggested the revised price of around $8-8.5 per mmBtu; however the key user industries had opposed to such a significant hike. Given the uncertainty in the effective applicable gas price realisations for RIL, we have factored US$7 per mmBtu in our estimates. Also, the sensitivity analysis shows that the earning increases by 1.4% for every US$1 per mmBtu increase in gas price realisation for RIL (assuming that there is no change in the production volumes). -
View: gas price hike positive; expansion and upturn in petrochemical and refining business are key drivers of growth in earnings: The hike in gas prices is a positive development though the attached conditions (the bank guarantee factor) would be a concern for investors. However, the revenue and earnings from KG-D6 gas block contributes to just 2% and 3% of the total revenue and earnings respectively. Hence, the immediate impact on earnings of the gas price hike would be limited in the near term and would have a material impact two to three years down the line, if and when the production volumes improve considerably. Thus, the downstream businesses (petrochemical and refining) would be primary driver of earnings in the interim period; especially given the on-going expansion of projects (petroleum coke gasification project, polyester capacity expansion and refinery off-gas cracker) along with expectations of an upturn in the petrochemical cycle. We maintain our price target of Rs1,010 (based on sum-of-the-parts method) and continue with our Buy recommendation.
MARKET OUTLOOK Hope rises again, this time on wings
Market participation may turn broad-based amid improving macros and headwinds for competing asset classes 2013-back to square one: Two thousand and thirteen began with a lot of hope after the strong rally towards the end of 2012 triggered by all the right noises made by the new finance minister, P Chidambaram. Unfortunately, the rally faltered in 2013 as the government fell short of expectations, domestic macros deteriorated (with the Reserve Bank of India [RBI] turning hawkish in response to persistent inflationary trends and a changing global environment) and the global environment turned negative with the US Federal Reserve (Fed) starting to prepare the global financial markets for the tightening of its liquidity tap through a slower monthly bond-buying programme after numerous rounds of liquidity infusion. Hope turned into pessimism. Finally, market sentiment recovered significantly before the end of the year with the benchmark indices rising to all-time high levels. 2014-hopeful again but backed by improving macros; general elections another catalyst: Just like 2013, the market is high on hopes again. The hopes this time around are pinned on the economy bottoming out and corporate earnings improving in FY2014. The indication of a clear mandate to a new decisive government at the centre in the May general election is another sentiment booster for investors and is an important event for the sustenance of the rally in 2014. On the flip side, a hung parliament, uncertainty over the government's fiscal performance, inflation scare and the RBI's monetary tightening could downplay the otherwise positive sentiment in the market over the near term. Tapering fever eases, global liquidity to remain benign: Financial markets globally (especially the emerging market ones) surpassed another hurdle with the recent announcement of tapering by the Fed (which has decided to taper its quantitative easing [QE] programme by $10 billion a month) and the US central bank's accommodative stance. From India's perspective, the net inflows from the foreign institutional investors (FIIs) remain strong while the local currency has stabilised at 62 levels against the dollar. We believe the recovery in the developed world will continue to be gradual and the easy monetary conditions from the Fed, Bank of Japan (BoJ) and the European Central Bank (ECB) may continue in 2014 also. Macros in revival mode, though the pace could be painfully slow: The domestic macro variables suggest that the economy could have hit the trough (a 4.4% growth in the gross domestic product [GDP] in Q1FY2014), though a meaningful recovery may not be visible as yet. Therefore, over the next couple of quarters the economic growth could improve gradually driven by consumption and export-led sectors while the triggers for investment are still awaited. High interest rates have been a dampener and hopefully inflation would come under control by the end of the current fiscal. Corporate earnings-consensus estimates already factoring imminent concerns: An expectation of a 6-8% earnings growth in FY2014 (vs the initial expectation of a 14% growth) largely factors in the head winds faced by the economy including the higher interest rates. The revenue growth and the earnings before interest, tax, depreciation and amortisation (EBITDA) margins have stabilised at lower levels and are likely to improve with a recovery in the economy and a pick-up in demand. Therefore, the earnings downgrade cycle seems to be on its last leg unless the RBI goes for aggressive tightening to contain inflation. Moving on to FY2015, the lower base effect and reasonable momentum in the economy will support a double-digit growth in the earnings. Significant re-rating unlikely; expect new sectoral leaders and a broad-based market participation: After the recent rally, the benchmark indices are trading close to their long-term average multiple of 14.5-15.0x one-year forward earnings estimates and further re-rating would depend upon the extent of the revival in the macro-economic environment and the outcome of the general election. Moreover, volatility could persist in the stock market ahead of the general election in May and seasonal weakness in the April-June (Q1FY2015) quarter. The good part is that the market participation is expected to improve with broader participation due to investors' increasing interest in many sectors and mid-cap stocks (unlike the rally in limited stocks seen in large part of 2013). The three themes for the year 2014 are: -
businesses benefiting from a weaker rupee (both export and import substitution) and a global recovery, -
rural demand-driven consumer companies, and -
companies in cyclical sectors taking steps to repair their balance sheet through asset sale/equity infusion/debt restructuring. Picks for 2014
Large-caps: ITC, Mahindra and Mahindra, ICICI Bank, HCL Technologies, Larsen and Toubro
Mid-caps: Cadila Healthcare, Jyothy Laboratories, Sun TV, CESC, Raymond, Selan Exploration Technology
SHAREKHAN SPECIAL Monthly economy review RBI holds fire even though inflation remains high
At its December 18, 2013 monetary policy review meeting the Reserve Bank of India (RBI) refrained from raising the policy rates even though the latest data showed that inflation in the economy is higher than expected. Given the sluggish growth in the economy and the sharp correction in vegetable prices (the main cause of the rise in inflation) recently, the RBI's stance seems justified, unless headline inflation numbers turn ugly before the next policy review meeting. On the other hand, the announcement of tapering by the US Federal Reserve (Fed) has not led to any significant disruption due to some pre-emptive measures taken by the RBI. The net foreign institutional investor (FII) inflow has remained encouraging and the comfort on the current account deficit (CAD) has increased significantly on the back of a pick-up in exports and a fall in gold imports. The yields on government securities (G-Sec) have again increased to +8.9% levels on concerns relating to the fiscal deficit and inflation pressures. Therefore, going ahead inflation (the Wholesale Price Index [WPI] and the Consumer Price Index [CPI]) will be keenly watched as the RBI has taken a close call by not raising the rates during its mid quarter review and any negative surprise there would limit the options available to the central bank for dealing with inflation.
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Regards,
The Sharekhan Research Team | |
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