On Reliance-Aramco deal being called off
As far as the implications are concerned, it depends on what value is being attributed to the O2C (oil to chemicals) segment. If it was closer to the $75 million EV that was speculated when the deal was first announced, the announcement of the deal being called off is likely to be a disappointment. That is because even if one assumes some improvement in margins from here on in over the next couple of years and give it a 7.5 to 8 times multiple, a more likely or a more reasonable value of this business is closer to about $65 billion. So to that extent, if one were very optimistic on the deal providing a higher multiple to this business, then the disappointment is there. Otherwise, there is no implication on the business.
The supply arrangements of crude continues to remain in place, the Saudi Chairman is likely to continue in the board and therefore some extent of collaboration will continue with Aramco. So, we do not see it as a huge strategic setback.
Reliance seems to want to look at the O2C and the renewable business as basically one basket of energy business and migrate some portions of the O2C to the renewable portfolio. They would probably again relook at unlocking in value once they have created some more value from the renewable side.
The second implication is that as far as leverage is concerned, when the deal was announced two years ago, the requirements from a balance sheet perspective were very different from Reliance’s side. Now given the unlocking that has happened and the funds that have flowed in via retail and Jio divestment, obviously the funding requirement has changed dramatically.
Remember that from an ESG context, the funding costs for the renewable business are also at extremely attractive levels. Therefore the urgency to raise money from the O2C segment is definitely far less today than it was two years ago. So Reliance can afford to look back and say we want to position this business very differently. If we do want a strategic investor and perhaps that is what has motivated a relook at the context, in which this deal will probably go ahead sometime in the future or not at all.
We do not know right now but that is where we are. So from a stock perspective, my sense is a little bit of negative reaction would be there because a lot of bullish estimates probably point to a much higher value of the O2C segment which will probably normalise a bit. But barring that reaction, it is more of a neutral impact at this point of time from a six month perspective and focus will more be on the tariff increases that may come in the industry from the telecom business as well as the reactions and initial reports of the Jio Next phone in terms of how well it is received. So those will be the triggers for the next six months.
Have you changed your price target on Reliance and do you not believe that the stock could further underperform after the consolidation that has already played out this year?
Our stance on the company has been a bit cautious purely from a valuation perspective and the fact that every new business is already being priced in at a close to fair value — be it Jio, retail or even the renewable energy business — which despite not having any meaningful numbers to show, right now is already given a fairly healthy two to two and a half times EV to capital employed in our target price.
Our estimate of fair value is closer to between Rs 2,400 and 2,500 and we have had an add rating for sometime. That is unlikely to change with this development because our O2C value is on a reasonable 7.5 to 8 times closer to about $60-65 billion and therefore we will not really be building in that premium that people were implying as far as Aramco deal is concerned. So no real change in our recommendation or values.