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Reliance and RPL aren't quite overvalued

I hear a lot nowadays about how Reliance, the biggest loser on the Index, has been overvalued, had doubled for no reason etc. etc. I would like to present my view on this topic.

Reliance Industries is growing at 30-40% on EPS.
It’s being given a forward P/E of 25. This is not considering that
it’s sitting on a pile of cash, and is also growing inorganically, and
has an unvalued reliance retail, a majority stake in RPL and RPL is
worth 78000 cr. , building huge coke gasification and paraxylene
plants of the size no one else has in the world, and of course it has
all the gas finds, the SEZs and all that. Throw out all of that stuff,
and we still have a growth rate of 30-40% this quarter, and forward
P/E is 25.

This is one of India’s largest companies by turnover. They make more
revenues than Infy, TCS, Wipro, and Satyam ADDED UP, quarterly. And
they have recently grown faster on profits than all of these companies.

Take this quarter. They have a P/E of 26, which is consolidated with
IPCL. This is not including an unrecorded forex gain of Rs. 515 cr.
(which other companies like Tata Steel and Airtel are recording) which
is about Rs. 4 per diluted share. Let’s just take Rs. 2 of that for this quarter. That’s a total of Rs. 28 earnings per share. If you take Q2 last year and consolidate with IPCL, you get an EPS of 19 for RIL and 2.5 for IPCL (12.4 is IPCL’s EPS, but divide by 5 since the merger was 5:1) That’s 21.5 last year. About 33% growth
on EPS. Going forward they are close to an EPS of about Rs. 100 on the
year. The price is 2,500. P/E? 25.

They call that expensive? Note that we are paying Infy a P/E of 25
forward, on a growth rate of 20% and even their one year guidance is
only 20% growth. They are EXPECTED to earn Rs. 79.9 (the highest end
of their guidance) per share. Last year they did Rs. 67 or so. The
growth rate? Less than 20%. At current price of Rs. 1900, that’s a P/E
of 23.

I have heard a lot of things about Reliance and the promoters. But
they have created more shareholder wealth in the last five years (and
earlier too but ditch that for now) than most other companies. In fact
if you had bought one share of Reliance pre-brother-split in 2005, you
would have paid Rs. 800 or so, and got one share of Reliance, one
RNRL, one RCOM, and some parts of REL and Reliance Capital. The net
value of these shares today is around Rs. 4,000, a five fold increase
in less than three years.

And this is India’s most valuable company, by market cap. The biggest
company in India grows your money 5 fold in 3 years. Very few in the
top 10 can claim to do so – closest perhaps is Airtel, and that’s
valued at, let’s see, a p/e of 40+.

Yes, today people say RIL it’s “overvalued”. But have they considered
that all this time, it has just been undervalued severely? They gave it
a P/E of 15 when it grew at twice that rate. Today it’s doubled and
the P/E is still lower than its forward growth rate. And it’s
expensive because it’s doubled in value?

I know that Reliance will participate just as much in a crash as
anyone else. Yet, they are the guys you want to buy, because from
here downwards, they are more valuable than most other large caps.

Let’s also look a little bit at RPL, Reliance Petroleum Limited. People say it’s WILDLY overvalued for a company that hasn’t even started production yet.

It’s coming up on schedule in Dec 2008. (Reliance has have said it’s earlier than
schedule, but ditch that, let’s say it comes on schedule). It will
process 580,000 barrels per day of heavy crude. Reliance Industries
does about the same ammount, actually RIL does about 40,000 barrels a
day less than RPL. But let’s assume similar margins for the RPL
businesses and work it out. The half yearly (net) profit of reliance
on the refining segment as of Q2, 2008 was about 3859 cr. as gleaned
from the quarterly report. Multiply that by 2 to get annual figures you
get about 7700 cr.

Now if RPL can do exactly that, it earns an EPS of about Rs. 17.1 per share.

Now if we add the 0.9 million ton polypropylene plant in RPL, with
current margins, the EPS may square off at around Rs. 20 per share.

The current value of RPL is around 170, which is pretty reasonable for
what is effectively one of the world’s largest refineries. Perhaps a
little higher can be given for higher margins (with a stabilised
dollar, margins will be higher than now) and the fact that the
project is a little ahead of schedule. So it’s not “over” valued, it’s
perhaps got to a reasonable valuation as of current market pricing. It will
get re-rated as refinery margins change and heavy-light crude
differential (currently $5) changes.

Hope that helps. Value is obviously a very difficult thing, but I
present my simplistic view. Please feel free to correct me if I’m
wrong.

Disclosure: I am long RIL and RPL.

  • Crick_Love says:

    >Good job Deepak..keep it going..and I although I have done the similar conclusions but it is heartening to see the data behind more conviction of mine. We have to think that the markets at times are irrational,,for example when Reliance ran to 2900+ and swung lower almost 500 bucks – all in the space of few hours,,the so called investors behaved like kids, denied a candy promised (no bouns/split)…i guess water will find its level, when sanity prevails..

  • Anonymous says:

    >There is no doubt whatsoever that you MUST hold RIL at the heart of your portfolio. As they say ¨what is good for India, is good for RIL¨. And I will say vice-versa.
    I would not be surprised if the stock price reaches 5K in years to come. I am especially very curious about E&P business that it has – in MDA´s own words – It will be creating an unprecedented value for the shareholders. This one is a lottery, with the winning ticket number written on it for all to see!! Who needs a midcap?

  • Kunal Bhasin says:

    >I would just like to add that..

    In RPL, it is been said that Mukesh Ambani has internally setup an completion target of Mar’08 for the new refinery commencement.

  • Ranjit kumar says:

    >Hi Deepak,

    Please can you do a similar post if time permits on RNRL because i cant understand what it has and its plans.

    Regards,
    Ranjit kumar

  • Anonymous says:

    >Hello Deepak,
    Me the BBL guy. Do you recommend a buy on RPL with a 3-5 year horizon at current prices or are you recommending a buy at dip strategy which as you would agree could be quite frustrating for a retail guy since he’s got a day job to handle.

    Regards

  • Chandra says:

    >Hi Deepak,

    I second Ranjit’s comment. Can you do an analysis of RNRL and explain the rapid rise of the stock from 40 levels to 90 levels overnight? More importantly..whats your take on the stock, from a fundamental perspective? Especially…the dramatic rise from 65 to 95 all in one day. Isnt it too much of exuberance?

  • Siva says:

    >Thanks for your analysis. Yes. u can do analysis of other Reliance Cos.It will be beneficial to all of us

  • Sumeet says:

    >Hi Deepak,

    Great analysis as always. And yes, I would request you to look at other reliance stock as well time permitting (especially reliance capital and RNRL).
    Just a thought though, you are saying that RPL is not overvalued and a good story should unfold there going forward. But in your post on P-Notes, you have mentioned “Some good buying opportunities will come, just avoid the folks that have been taken sky high already like REL, RPL and so on.”
    Are you saying that from a short term perspective prolly RPL is not good but for long term is a good buy. If so, then would it imply that we can wait for a fall to occur in RPL and then enter or now is as good a time as any to enter RPL (long term >3 year horizon).

    Cheers,
    Sumeet

  • Ranjit kumar says:

    >Hi Deepak,

    I wanted to add a few things to your analysis.

    RPL has 5500cr of debt on its balance sheet which bears an interest cost of 660 crores/year. So the eps might be affected by 9% or so.

    The refinery might start production in stages so full profits might be coming later than expected

    I think companies which earn a certain amount constantly with little growth in earnings will trade at a discount.(I think RPL falls in this category)

    Regards,
    Ranjit kumar

  • Deepak Shenoy says:

    >Everyone, thanks for the comments. I won’t do an analysis of RNRL anytime soon as that is something I don’t yet understand, and will probably take time to figure out their biz model.

    Sumeet: RPL is not a great counter to trade now, but you want to avoid for the short those that can’t necessarily rise much higher.

    Ranjit: Good points. I didn’t consider interest. that’s about a Rs. 2 hit on their bottom line per year (but to be honest, RIL has around the same amount of debt, or more, so the np amounts should match up)

    Plus capacity will increase, as RIL has plans to invest about 8-10 billion over hte next 10 years. If oil prices go up, and they can increase their overall business by the up-and-downstream capabilities, they should benefit going forward as well..

  • Harsh says:

    >Great great analysis…but I m a little bit late…as RPL is over 250 n same for other stocks…can u recommend some entry prices in these reliance stocks…shud i wait for correction or can go long on these stocks even on these valuations…

  • Deepak Shenoy says:

    >harsh: no issues hang on a bit for RPL – right now the value looks higher than my estimates also. 290 is high, I would not enter unless it’s a trading call. Levels wise I can’t say but 200 looks good, above that is just momentum right now.

    Reliance is still on, I would buy at 2500-3000, for a two-three year period, of course placing a stop loss at 2000 or so.

    Note: This is my opinion, not financial advise or a recommendation.

  • raghu says:

    >what abt stocks like rpl, they are the sharks who eat fishes liek us. remember the 4% stake story

    RPL under SEBI Scanner.. the drop from 290 to 195 has been completely operated. thats the news all over.. check this link of financial express and live mint

    http://www.financialexpress.com/news/Smart-operators-in-RPL-futures-make-a-cool-Rs-1-000-cr/244312/

    Between November 1 and November 6, 2007, a particular group made short sales of 10crore shares of Reliance Petroleum in the futures segment of National Stock Exchange costing Rs.3,000 crores approximately. they made a cool Rs 1,000 crores in less than a month, because the Reliance Petroleum shares have now crashed from Rs.295 to Rs 195 per share!. These guys have made Rs.100 per share.

    isnt it ironic that someone knew that RIL was going to sell a huge quantity of shares and the prices were bound to come down?

    My 2nd question is Who financed these traders for their margins? Where has this profit gone? and who bore the loss???

    Its innocent small investors who bought Reliance Petroleum shares at the high prices, not knowing that this unholy alliance was indulging in insider trading and making illegal profits while Mukesh Ambani’s own company RIL was selling shares without disclosing this to investors!!

  • Manju says:

    >Dear Deepak

    What is your opinion now on RPL @188. is it good time to enter?.

    What is your experience on this?

    Thank you for your comments earlier. I would like to ask you Can the story repeats if RPL go high at @260 I mean selling 4% stake story.

  • Manju says:

    >Dear Deepak

    What is your opinion now on RPL @188. is it good time to enter.

    What is your experience on this?

    Thank you for your comments earlier. I would like to ask you can the story repeats if RPL go high at @260 I mean selling 4% stake story

    Thank you in advance

  • Deepak Shenoy says:

    >manju: I got out of most of my RPL stock at 220.

    150 was a great level to reenter but I ditched that opportunity. Still, I think RPL will go down with the market and give you more entries – a potential exit point is still 210 or 220.

    But certain things have become positive. The plant may be operational soon, and oil prices are high (so hopefully the heavy crude price differential is high too) and margins may be upwards of $16 per barrel. Plus dollar is at 42.

    But overall refinery output sales aer slowing (U.S. petrol/diesel etc.) and the dollar is likely to go down to below 38 in the next year. So I don’t assign a huge potential to it- 210 to 220 should be a good target.