11 May 2020
New Delhi: "Buy 2, get 3" is the word from Kotak Institutional Equities as it reckons that the sharp correction in Reliance Industries Limited (RIL) amid market upheaval offers an excellent opportunity to buy the stock, with the stock pricing in only two out of the three large and robust business segments.
According to a research by Kotak Institutional Equities, the market's knee-jerk reaction on lower-oil-price-led-concerns on the transaction with Saudi Aramco seems unfounded, with strategic downstream access becoming more crucial for latter; delays possible in the payout.
Higher crude discounts, weaker Rupee and potential hike in ARPUs may mitigate lower downstream margins, it said.
The report notes that the sharp correction to pre-AGM levels ignores several positive developments since then.
"We believe the sharp 29% correction in RIL over the past three months presents an opportunity to BUY as the stock has adequately factored weakness in downstream margins and ruled out deleveraging post market's knee-jerk reaction on lower-oil-price-led-concerns on the O2C transaction with Saudi Aramco, while ignoring the favorable developments in telecom business", it said.
The stock has come back to pre-AGM levels wherein the leverage-related concerns were high, capex run-rate was elevated and visibility of any improvement in telecom economics was not imminent.
Since then, the report says RIL has benefited from meaningful hike in telecom tariffs amid weaker balance sheet of competition post SC judgment on AGR, commencement of FCF generation with OCF exceeding a declining quarterly capex in 3QFY20, cut in corporate tax rates and sustained growth in retail business; lower downstream margins has been the only meaningful negative development, partly mitigated by a weaker rupee.
On the Aramco deal, the report says that downstream access is more crucial for Saudi Aramco, even as delays cannot be ruled out.
"We are surprised by the market's knee-jerk reaction in effectively ruling out RIL's targeted deleveraging exercise post a sharp fall in crude oil prices, which may have raised some concerns on proposed stake sale in O2C business to Saudi Aramco", it added.
"In our view, the strategic access to downstream capacity has become more crucial for Saudi Aramco post the recent developments in oil markets, wherein it has increased discounts on its crude to gain market share after OPEC plus discord on required production cuts", it added.
Aramco's ability to acquire inorganic access is no lesser given its strong balance sheet and falling global yields, notwithstanding lower profits and cashflows in the near term. "We do not rule out delays and possibility of staggered payout like Aramco's recent acquisition of SABIC. Lest it is necessary, RIL can consider divesting stake in telecom and retail businesses through strategic sale and/or IPO to deleverage its balance sheet", according to the report.
A supply-led-correction in crude price is generally a positive for downstream conversion margins, given its implication in the form of higher crude discounts as well as light-heavy differentials amid surplus supplies, lower fuel and loss in value terms and possible cushion to the persisting weakness in downstream demand.
"These benefits for RIL outweigh negative impact from lower margins on 3-4 million tons of gas-based petchem production and higher, albeit immaterial, loss from the US shale business. The recent weakness in Rupee against US Dollar may also mitigate earnings downside from ongoing weakness in downstream margins", the report said.