Oil shock: Goldman Sachs, Morgan Stanley see Reliance weathering the current storm

KS Badri Narayanan Chennai | Updated on April 16, 2020 Published on April 16, 2020

Retail, telecom sectors likely to add strength: Analysts

Shares of Reliance Industries took a beating since crude oil prices plunged to under $30 a barrel. Marketmen feared that this could affect RIL’s refinery margin and thus, its leveraged balance sheet. Besides, the current shutdown due to Covid-19 could put pressure not only on oil consumption but also on the retail segment. All these took a toll on RIL’s shares.

RIL shares crashed from ₹1,550-level in December-end to ₹875 by March 23. However, they have recovered partly since then. On Thursday, RIL shares jumped 1.3 per cent at ₹1,165.75 on the BSE.

Most analysts now see RIL withstanding the current pressure, thanks to healthy fundamentals. Besides, they feel retail and telecom will add strength to RIL, going forward.

According to Morgan Stanley, RIL’s net debt might not decline if asset sales are pushed out, but it might still not rise in FY21. “Our bottom-up work on the basis of FY19 disclosures suggests limited liquidity challenges even if RIL’s utilisation rates and margins remain challenges in its cash cow energy business,” Morgan Stanley said, while maintaining an overweight stance on the company with a 12-month price target of ₹1,544.

“We expect Reliance to gain market share with better profitability as the current demand decline is driving global refiners and oil majors alike to reassess growth plans to conserve cash. This provides a significant headstart for RIL, which has expanded and upscaled its capabilities over the past five years and is now among the top quartile on the cost curve,” it added.

The decline in global energy demand and expansion in credit default swap (CDS) spreads for RIL, to 290 bps over the past month, have raised investor questions about RIL’s balance sheet leverage. “RIL’s net debt (including other liabilities) would remain stable in FY21, if the Covid-19 situation were to persist for six months (our base case: three months), and recover only slowly thereafter,” said Morgan Stanley, and added, “We estimate a $1.2-1.8 billion reduction in operating cash flow (OCF), with near-zero free cash flow, if weak demand were to continue for six months.”

Goldman Sachs believes the market still does not fully appreciate the “unique” hedges in its hydrocarbon business driven by feed and product diversity and asset complexity, which would drive positive cash margin even during a recession with limited volume risk.

“We believe contribution from the fast-growing consumer businesses will also reach nearly 50 per cent over the next fiscal year with the ability to gain market share in the current downturn from highly-levered peers. All in, we expect a rapid earnings recovery and a significant step-up in free cash flow (FCF) even under the current challenging macro environment as capex intensity will continue to decline,” it added.

Goldman Sachs reiterates ‘buy’ on RIL with 30 per cent upside potential to its ₹1,550 SOTP-based 12-month price target.

Domestic brokerage firm Anand Rathi said RIL has received strong interest from strategic and financial investors in their consumer businesses, Jio and Reliance Retail. “The company will induct leading global partners in these businesses in the next few quarters, and move towards listing of both these companies within the next five years which will result in significant value unlocking.”

Oversupplied oil markets as chemical/ refinery markets tighten are a significant tailwind, as well. Its strong energy-backed cash-flows should help gain market share faster in offline retail and telecom segments, as competition conserves cash, said Morgan Stanley.

Published on April 16, 2020

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