RELIANCE PETROLEUM VALUATION

Reliance Petroleum, RPL, is entered into the capital market on April 13 with a public issue of 135 crore equity shares of Rs 10 each for cash at a premium to be decided through a 100% book building route.

 The issue was made to part-finance the Rs 27,000 crore (Rs 270 billion) export-oriented refinery being set up in a special economic zone, SEZ, at Jam agar, Gujarat. The export-oriented refinery will have a capacity to process 5,80,000 barrels per day making it the sixth-largest refinery in the world. As a part of this project, RPL is also setting up a 900,000 tonne per annum polypropylene plant. The project is likely to go on stream by December 2008. 

 The book running lead managers are Citigroup Global Markets India, Deutsche Equities India Private, DSP Merrill Lynch, Enam Financial Consultants Private, HSBC Securities & Capital Markets (India) Private, ICICI Securities, JM Morgan Stanley Private, SBI Capital Markets, UBS Securities India Private and Karvy Computer share Private is the registrar to the issue. RPL was incorporated on October 25, 2005, and as such has yet to complete a year of operations. Since the project is slated to be completed only by December 2008, revenues would flow in only from FY09. Work on the project has already started, with more than Rs 20 billion invested and orders worth Rs 150 billion already placed for long-lead items. Although the refinery is slated to start commercial production by December 2008, yet, considering RIL’s execution capabilities, positive surprises are likely. 

We recommend you subscribe to the stock at the cut-off price. <CURRENT CAPITAL STRUCTURE COMPANY HOLDINGS RIL 75% CHEVRON 5% REST 20% 

STRATEGIC ADVANTAGES HIGHLIGHTS Best of world crude oil has already been tapped and newer ones are high density with high sulfur which needs special refinery and RPL is few among the one. Most of the refineries are set to process high quality only. Norms of emissions are now becoming strict (US, EUROPE) and existing refineries are inflexible to meet these norms.

• Demand could outstrip refining capacities and existing refineries unable to process so-called dirty crude may have to be shut down
• Heavy (dirty crude) is cheaper than light crude around 5 dollars/barrel and RPL can capitalize on it.
• This leads to gross refining margin go up with the ability to produce superior products from cheaper crude.
• Some of the other refineries that plan to expand also will complete their project only on 2011.
• RPL will be one of the 5% with the ability to process heavier crude in the world.
• But the capital cost for high-tech refining set up is higher than the older method by 4 dollars/barrel/day.
• But RPL has managed itself to set up in SEZ, which has tax-redemption on exports 100% for 5 years and later 50% for next 5 years.
• Duty-free import of crude oil and capital equipment because of SEZ.
• Technology, knowledge, marketing expertise of RIL can be shared with RPL and hence synergy between both.

EQUITY VALUATION 

Since RPL is yet to start its operations we cannot use FCFE or FCFF to arrive at the value of RPL share. Hence we have used the statistical tool of multiple regression to arrive at the value of RPL. we know FCFE is a function of growth rate, share price, and cost of equity. These values for five different firms in the refinery industry are taken and multiple regression is done and the output is tested for a significance level of 5%. 

INPUT FOR REGRESSION

FCFE is a Function of ( PRICE, KE, GROWTH)

10806.85 1068 19.775 23.13 2099.97 360 15 8.6 183.74 331.5 13.16 15.7 1440.2 510 13.945 7.6 1861.17 276.5 13.85 6.2 

 LOGFCFE LOG KE LOGG

 4.033699123 1.296116 1.364176 3.32221309 1.176091 0.934498 2.264203712 1.119256 1.1959 3.158422807 1.144419 0.880814 3.269786044 1.14145 0.792392 

OUTPUT The output resulted in such a way that market price was not statistically significant and hence again regression was done using growth rate and cost of equity of all the firms. 

 The model obtained was Model R R Square Adjusted R Square Std. The error of the Estimate 1 .998 .995 .991 6.019E-02 ANOVA Model Sum of Squares Df Mean Square F Sig. Regression 1.585 2 .792 218.705 .005 Residual 7.245E-03 2 3.623E-03 Total 1.592 4 A Predictors: (Constant), VAR00004, VAR00003 B Dependent Variable: VAR00001 

COEFFICIENTS 

 Unstandardized Coefficients Standardized Coefficients t Sig. Model B Std. Error Beta 1 (Constant) -8.579 .565 -15.172 .004 VAR00003 11.599 .563 1.295 20.615 .002 VAR00004 -1.785 .166 -.674 -10.731 .009 For a significance level of 5 %, we can see both f-value and t-value are highly significant and hence the model can be taken for describing the FCFE for RPL. LOG (FCFE)=11.599*LOG (COST OF EQUITY)-1.785*LOG (GROWTH RATE)-8.579 Substituting the value of the cost of equity for RPL and growth rate (average industry growth rate) 

 We obtained an FCFE for RPL as Rs.8288.11 crores Right now free-floating shares of RPL are 720 crores From this we found expected earnings per share to be Rs. 11.55

CALCULATION OF PRICE: The average P/E of the competitors are taken into consideration and the EPS thus obtained is equated to that value of 13. ONGC-17 BPCL-9 IOCL-10 CHENNAI PET-11 GAIL-18 HINDUSTAN PET-9 AVERAGE P/E =13 

 Price of RPL=13*11.55 =149.6 RPL PRICE=150 

 PRABHU.S