Oil&Gas Sector 4 April'11 New

Equity Research
April 4, 2011 BSE Sensex: 19420
Oil&Gas and Petrochemicals

Reliance Industries
(Rs1,035 Buy) Target price Rs1,197
Play for value
ONGC
(Rs293 Buy) Target price Rs338
Cairn India
GAIL
GSPL
Petronet LNG
(Rs125 Hold) Target price Rs116
BPCL
HPCL
(Rs352 Sell) Target price Rs298
Prefer Upstream and Midstream over Downstream

Rohit Ahuja
rohit.ahuja@icicisecurities.com +91 22 6637 7274
Prolin Nandu
prolin.nandu@icicisecurities.com +91 22 6637 7386
Please refer to important disclosures at the end of this report
Equity Research

Reliance Industries
(Rs1,035 Buy) Target price Rs1,197
Play for value

The recent scenario of rising crude prices is a dj-vu for the domestic oil & gas industry, as marketing under-recoveries for oil marketing companies (OMCs) surge, while on the other hand refining margins expand. Private refining and petrochemical companies are expected to see their profitability surge as rising global demand for products trigger a margin expansion. Oil PSUs are likely to show a contrarian trend as their losses mount on surging under-recoveries. We reinitiate coverage on the oil & gas sector with a positive bias towards strong value generating companies that can withstand crude cyclicality and are able to generate stable profitability. We recommend BUY on Reliance Industries (RIL), Oil and Natural Gas Corporation (ONGC), GAIL and Gujarat state Petronet (GSPL), but advice caution on PSU OMCs. Surging under-recovery, a brewing whirlwindThe Governments inability to pass on the crude price increase is pushing oil PSUs back to pre partial deregulation days, as their under-recoveries surge to Rs770bn in FY11 and the subsidy sharing remains uncertain. The only certain factor, as per the Government, is that the upstream companies contribution will be capped at 33% which supports our positive bias for ONGC. However, we expect the OMCs to continue to underperform, as the hope for reforms fades in with rise in crude prices. even as E&P aims to steer clearfor the hydrocarbon chain in India with potential for oil & gas production to grow aggressively in the next 5-10 years. India currently offers one of the best E&P investment opportunities as it still meets >70% of its crude requirements through imports. The apparent success of the New Exploration Licensing Policy (NELP) rounds has proved that India has world-class hydrocarbon assets such as the KG Basin. But concerns persist on loss of tax benefits from discontinued gas production and disputes for approvals from the Directorate General of Hydrocarbons (DGH). However, the RIL-British Petroleum (BP) deal envisages that such issues would be eventually resolved and would not be a major hindrance for investments in the NELP blocks. Sail safe anchored on midstream value betsNatural gas pipeline companies have announced aggressive capex plans to support the incremental gas production from KG D6 and other prolific blocks in the east coast. Although there have been delays in volume ramp-up from the east coast, we believe the long-term story is still intact. We expect an incremental gas production potential of ~100mmscmd from the east coast in the next 5-10 years, which provides an excellent volume ramp-up opportunity to midstream players (GAIL and GSPL) and makes their expansion plans value generating proposition for long-term. guided by fair winds, robust GRMs & Petchem..Gross Refining Margins (GRMs), off late, have improved gradually due to improving demand from the US and Europe. We believe that complex GRMs will continue to improve as crude prices sustain at higher levels, with additional triggers from expansion in light-heavy spreads as the OPEC production increases. Petchem margins are expected to be strong as higher-than-expected incremental demand from Asia neutralises the impact of low-cost Middle East ethylene capacities. Hence, we strongly recommend RIL and GAIL (for Petchem) as ideal play on improving industry fundamentals.
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ONGC
Cairn India
GAIL
GSPL
Petronet LNG
BPCL
HPCL
(Rs352 Sell) Target price Rs298
Rohit Ahuja
Prolin Nandu
Oil&Gas sector, April 4, 2011
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TABLE OF CONTENTS
Stock views.......................................................................................................................5 Surging under-recoveries A dj-vu for oil PSUs .....................................................6 Oil PSUs are back to square one....................................................................................7 E&P, the key valuation driver .........................................................................................9 Energy demand growth in India on a long-term trajectory ..........................................9 but rising dependence on oil imports needs to be curbed.........................................10 East coast development, a major boost through D6.....................................................12 Midstream players Defensive bets............................................................................14 Acceleration in gas production requires supporting infrastructure................................14 Gas transmission infrastructure shaping up for increased supplies .............................16 Downstream gas trading margins to be under pressure...............................................18 LNG imports to surge, but pricing an issue...................................................................18 Domestic gas preferable for incremental demand ........................................................19 CGD demand potential to take 4-5 years to fructify......................................................20 GRMs and Petchem spreads to be robust ..................................................................21 GRMs to improve ..........................................................................................................21 Auto fuels to drive product demand ..............................................................................21 Light-heavy spreads to trigger complex premiums .......................................................23 Significant change in Petchem outlook .........................................................................25 Indias petrochemicals business to outperform.............................................................29 Annexure 1: Disruption in MENA props high crude price regime ............................31 Libya unrests escalate ..................................................................................................31 Support from Saudi Arabia spare capacity? .................................................................31 Algeria adds to the tension ...........................................................................................32 Developments in other MENA regions..........................................................................33 Positive impact on GRMs..............................................................................................34 Annexure 2: NELP transformed India into an attractive E&P destination ...............35 Favourable fiscal policies support strong investments .................................................37 Annexure 3: Index of Tables and Charts .....................................................................39
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COMPANIES
Reliance Industries ........................................................................................................41 ONGC ..............................................................................................................................65 Carin India.......................................................................................................................83 GAIL...............................................................................................................................103 Gujarat State Petronet .................................................................................................121 Petronet LNG ................................................................................................................137 BPCL .............................................................................................................................153 HPCL .............................................................................................................................169 Annexure 4: International financial reporting standards Impact on oil & gas sector ............................................................................................................................183 Likely impact on Indian companies uncertain........................................................... 183
Prices and Sensex as on April 1, 2011
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Stock views
Company Reliance Industries Reco Target price Buy CMP Upside Target price ONGC Buy CMP Upside Target price Cairn India Buy CMP Upside Target price GAIL Buy CMP Upside Target price GSPL Buy CMP Upside Target price Petronet LNG Hold CMP Upside Target price BPCL Hold CMP Upside Target price HPCL Sell CMP Upside 1,197 1,035 16% 338 293 15% 384 354 8% 572 464 23% 130 102 27% 116 125 (8%) 562 606 (7%) 298 352 (15%) Price to Book Price to Book, EV/Boe DCF DCF SOTP DCF, EV/Boe SOTP SOTP Valuation Methodology Comments E&P valuation concerns addressed to a major extent by the BP deal Strong refining and Petchem margins outlook Cash rich balance sheet provides multiple avenues of growth Strong reserve accretion potential Sustained RoEs despite high subsidies Attractive valuations at 7.6 x FY13E earnings Reserve accretion potential from Rajasthan Block Peak production will held leverage lower operating cost Royalty risk in the price, hence the stock offers an excellent risk-reward Dominance in gas transmission to continue, expansion to add significant value Possible triggers from Petchem expansion in high-margin environment Valuation indicate attractive risk-reward Ramp up in D6 volumes to benefit GSPL Scope of expansion in Gujarat for power and fetiliser client New pipeline if found commercially viable adds to target price Spot volume led profit expansion unsustainable Kochi terminal utilisation threatened by surging LNG prices Valuations capture the best case, hence risk-reward unfavourable Significant long-term triggers from E&P business possible Rising under-recoveries threaten short-term profitability Upsides from Bina refinery commissioning in the price High contribution from marketing business a major threat Bhatinda refinery commissioning, the only short-term positive Valuation hinges entirely on Government support, strong sell in current environment
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Surging under-recoveries A dj-vu for oil PSUs

We are getting increasingly cautious over oil PSUs, as the Governments subsidy sharing mechanism remains unclear with continuing rise in under-recoveries, leading them to be rightly undervalued vis--vis international peers by the domestic markets. And the situation is worsening day by the day, as crude continues to trade strong. Under-recoveries for oil PSUs are expected to swell past Rs100bn in FY12E and FY13E. Further, the current high inflation scenario leaves the Government with limited legroom to protect the profitability of OMCs. We see the overall policy scenario as a throwback to pre partial de-regulation days, which will continue to hamper the valuations of the OMCs. On the other hand, we are bullish on upstream PSUs such as ONGC as they stand out in terms of valuations and their ability to maintain stable profitability in a high crude price scenario. These companies have been able to maintain strong return ratios in the past 2-3 years, even during the high subsidy scenario of FY09. Though the Government has still not finalised a policy framework that caps upstream contribution of under-recoveries to one-third of the total quantum, historical data suggests that this is unlikely to undergo any major change. Chart 1: RoE comparisons of oil PSUs Upstream PSUs will maintain the RoE within 19-24%
ONGC 30 25 20 (%) 15 10 5 0 FY09 FY10 FY11E FY12E FY13E GAIL HPCL BPCL Brent (RHS) 110 100 (US$/bbl)
FY13E 31,016 635,360 221,960 271,930 1,160,266
90 80 70 60 50
Source: Company data, I-Sec Research
Table 1: Share of subsidy contribution across categories

(Rs mn) FY08 Petrol 73,320 Diesel 351,660 Kerosene 191,020 LPG 155,230 Total 77,123 Source: Infraline, I-Sec Research FY09 51,810 522,860 282,250 176,000 1,032,920 FY10 51,510 92,790 173,640 142,570 460,510 FY11E 22,059 321,047 186,671 246,067 775,845 FY12E 29,260 599,396 223,076 264,009 1,115,741
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Oil PSUs are back to square one

Inability to pass on the increase in crude prices has almost reversed the benefits of partial deregulation kick-started last year The OMCs are currently losing ~Rs4/litre in petrol, Rs10.5/litre in diesel, Rs356/cylinder in LPG and Rs21/litre in kerosene. We hereby analyse the various options that the Government can deploy in the next 1-2 years to reduce or sustain the under-recoveries of OMCs. Raising fuel prices. After de-regulation of petrol in June 10, OMCs have been raising petrol prices periodically. However, with crude flirting with US$100/bl, the OMCs are finding it hard to hike petrol prices to risk upsetting the Governments effort to contain inflation. What perhaps seemed to be the easiest step for the Government has turned the other way round. As for diesel, LPG and kerosene the current high level of food inflation leaves little, if any, scope for the Government to take any substantial price hikes. Even if the Government manages marginal hikes in diesel and LPG prices, the overall quantum of under-recoveries on these fuels would be large enough to cross FY09 levels. Subsidy sharing formula. Despite all talks about a fixed subsidy sharing formula since June 10, the Government is yet to come to anything concrete ever since crude prices have started to climb. However, in the current scenario of high crude prices, we believe, this is what the Government could to do to spice up the valuations of OMC stocks. As is evident from the pattern over the past 3-4 years, the Government can incorporate a percentage sharing formula, capping the contribution of upstream companies at 33% and OMCs at 17%, which can lead to a strong visibility in the earnings of these stocks. The Governments contribution can be in the form of cash or oil bonds, depending on the quantum. We believe that in the present situation, where crude is displaying lot of volatility, a fixed percentage sharing would be an ideal option for oil PSUs.
Chart 2: Under-recoveries Contribution from oil PSUs and the Government

Dow nstream 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY08 FY09 FY10 Year
Source: Infraline, I-Sec Research
Government
Upstream
FY11E
FY12E
FY13E
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Tweaking the tax structure. The overall contribution of the oil companies in the form of taxes, royalties and profit petroleum is far higher than the under-recoveries of OMCs (Table 2). As these under-recoveries are ultimately borne by the Government either directly (in the form of cash and oil bonds) or indirectly (subsidy contribution from upstream oil PSUs), there is no rationale for ad-hoc contribution from the upstream oil companies. In FY09, >70% of the contribution from the oil companies was in the form of excise and sales tax, a reduction in which would have been sufficient to reduce or completely provide for the under-recoveries. However, as sales tax reduction would be a hard bargain considering its a state subject, hence requires consent of the state governments the central Government could achieve the same through excise reforms. But we havent seen any initiative for change in the excise structure in this years union budget, which is a concern
Under-recoveries more or less a zerosum game for the Government
Table 2: Oil companies contribution much higher than under-recoveries

(Rs bn) Particulars Central exchequer Customs duty Cess Excise duty Royalty Corporate tax Dividend Tax on dividend Petroleum profit Others (includes service tax) Sub total State exchequer Sales tax Royalties Dividend to state govt. Octroi, duties (incl. electricity duty) Others Sub total Total contribution OMC under-recoveries Surplus Source: Industry FY05 117 49 382 22 112 76 15 4 777 FY06 92 49 472 23 109 72 13 3 833 FY07 100 69 519 28 122 80 14 35 7 938 FY08 126 69 548 31 163 76 19 42 9 1,041 FY09 63 68 541 31 120 45 11 47 9 935 FY10 46 66 625 39 179 81 19 55 10 1,118
(389) 23 0 13 7 432 1,209 201 1,008
469 32 0 22 2 525 1,358 400 958
539 36 0 19 5 600 1,538 494 1,044
564 42 0 17 11 634 1,676 771 905
633 25 0 19 5 683 1,618 1,032 586
650 33 0 19 18 721 1,839 460 1,378
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E&P, the key valuation driver

Energy demand growth in India on a long-term trajectory
India offers an aggressive long-term growth potential; hence energy consumption is expected to surge Over the past decade, India has turned out to be one of the fastest growing economies in the world, along with China. This has led to a huge demand for primary energy with Indias share of global primary energy consumption rising to 4.2% in 09 from 2.9% in 1997 (Table 3). Table 3: Global and Indian primary energy consumption
Indian consumption Oil Natural gas Total primary Nuclear Hydro Coal energy power power consumption Mn te oil eqv 260.6 272.1 280.1 295.1 296.5 307.8 316.2 343.9 362.2 378.8 409.2 433.3 468.9 Primary energy consumption Mn te oil eqv. 8,880.1 8,888.5 9,021.5 9,262.6 9,323.1 9,502.8 9,810.5 10,258.8 10,555.3 10,820.8 11,104.4 11,294.9 11,164.3 Global Indias share of global primary energy consumption % 2.93 3.06 3.10 3.19 3.18 3.24 3.22 3.35 3.43 3.50 3.69 3.84 4.19
000 Billion Mnte Mn te Mn te barrels cubic oil oil eqv. oil eqv per day meters equivalent 1997 1,828 22.3 135.9 2.3 15.9 1998 1,963 24.5 136.1 2.6 18.9 1999 2,134 25.1 135.8 2.9 18.6 2000 2,254 26.4 144.2 3.6 17.4 2001 2,284 26.4 145.2 4.3 16.3 2002 2,374 27.6 151.8 4.4 15.5 2003 2,420 29.5 156.8 4.1 15.7 2004 2,573 31.9 172.3 3.8 19 2005 2,569 35.7 184.4 4 22 2006 2,580 37.3 195.4 4 25.4 2007 2,748 40.2 212.9 4 27.7 2008 2,882 41.4 231.4 3.5 26.2 2009 2,982 42.0 245.8 3.8 24.0 Source: BP Statistical Review 10
In 10, where the global economy was expected to stutter and global demand growth to slow down, India has continued its growth trajectory with its share of global primary energy consumption going up. The Indian Government has set a sustained GDP growth target of over 9% in the near future. Historically, Indias energy growth to GDP growth ratio has stood at ~0.7 (Table 4). With GDP growth target of 9%+ in the next few years, Indias energy demand is likely to grow at ~6% (a correlation of ~0.7). This, coupled with the current global economic scenario, which has hit demand in some of the major developed countries, should see Indias share of global energy consumption rising to 5% in the next few years.
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Gross domestic product at constant (1999-00) prices 1,508,378 1,573,263 1,678,410 1,786,526 1,864,301 1,972,606 2,048,286 2,222,758 2,388,768 2,616,101 2,871,118 3,129,717 3,389,484 C.A.G.R. GDP growth rate % 4.3 6.68 6.44 4.35 5.81 3.84 8.52 7.47 9.52 9.75 9.01 8.30 6.43 Ratio 1.0 0.4 0.8 0.1 0.7 0.7 1.0 0.7 0.5 0.8 0.7 1.0 0.7
Table 4: Energy demand growth A close proxy of GDP growth

Total primary energy Growth over consumption (India) previous year Mn. tonne oil eqv % 1997 260.6 1998 272.1 4.41 1999 280.1 2.94 2000 295.1 5.36 2001 296.5 0.47 2002 307.8 3.81 2003 316.2 2.73 2004 343.9 8.76 2005 362.2 5.32 2006 378.8 4.58 2007 409.2 8.03 2008 433.3 5.89 2009 468.9 8.22 C.A.G.R. 4.62 Source: BP Statistical Review 2010 and CMIE
but rising dependence on oil imports needs to be curbed

High dependence on import has increased the necessity to raise domestic production Though the past few years have been exciting for India in terms of large discoveries, these have largely been of natural gas. And what the country is looking for is oil with the current demand at huge 3.2mbpd and rising, of which less than a third, 0.9mbpd, is met through domestic production, it is dependent on imports in a big way. The large imports also ensure that the Indian demand-supply dynamics continue to remain unfavourable in the long term. It is thus natural for Indian E&P companies to add more oil reserves, domestically or internationally, to secure long-term supplies.
Factors that justify strong investments in oil exploration

Surging oil import bill. Over a period of eight years, 00-01 to 08-09, the oil bill has grown about eight fold to US$100bn (189mmtpa) in 08-09 from US$12.9bn (74.09mmtpa) in 00-01. In addition, the Government incurred a subsidy of US$18bn on supply of petroleum products within the country. Rising energy needs. According to industry observers, to deliver a sustained growth of 8% through 31-32, India needs to: Increase its primary energy supply 3-4x from present levels Raise its electricity generation capacity/supply 5-6x the present levels to nearly 800,000MW from ~160,000MW, inclusive of all captive plants Expand coal requirement to over 2bnte/annum based on domestic quality of coal International Energy Outlook (IEO) projects that Indias oil consumption would grow by more than double to 5mnbopd by 30.
Based on above, as per investment projections, Indias energy sector would need US$120-150bn worth of investments in the next few years to meet the demand growth.
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Oil&Gas sector, April 4, 2011 Table 5: Domestic crude balance

(mbpd) Refining throughput (a) Domestic demand (b) Net exports (a-b) Domestic production (c ) Net imports (b-c) % demand Source: Industry 2007 3.0 2.5 0.5 0.7 1.8 72.0
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2010E 4.1 3.2 0.9 0.9 2.3 71.9 2012E 5.2 3.4 1.8 0.9 2.5 73.5
Table 6: Declining oil production, a concern

(mbpd) Year 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-19 2020-21 Source: Infraline Pvt./JV 0.13 0.24 0.26 0.25 0.22 0.19 0.16 0.13 0.11 0.10 0.08 0.02 ONGC 0.52 0.51 0.54 0.60 0.58 0.55 0.51 0.47 0.44 0.40 0.37 0.34 OIL 0.07 0.08 0.08 0.08 0.08 0.07 0.07 0.07 0.07 0.06 0.06 0.06 Total 0.72 0.83 0.87 0.92 0.88 0.82 0.74 0.67 0.62 0.57 0.52 0.42
Table 7: Oil import details

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 (April 10 - Dec 10) Source: Infraline Imports (mn bbls) 702.66 728.67 817.31 891.86 973.24 1167.37 845.00 Products Imports (mn mmbls) 64.71 98.52 129.45 164.65 149.00 107.47 95.05 Gross Imports (mn bbls) 767.37 827.19 946.76 1056.50 1122.24 1274.84 940.04 Product Exports (mn bbls) 133.49 171.96 246.46 298.91 282.73 373.64 268.71 Net Imports (mn bbls) 633.88 655.24 700.29 757.59 839.51 901.20 671.33
More discoveries such as Mangala and Mumbai High needed
The discovery of Mangala oil field (in Rajasthan by Cairn India) has been touted as Indias biggest after ONGCs Mumbai High discovery, back in 1981. Production from the Mangala oil field is expected to touch the peak of 240,000bpd equivalent to the current oil production from Mumbai High in the next three years. In spite of Mangala oil field pitching in full pelt, India would still need to import ~70% of its 3.2mbpd oil requirement. We therefore expect Indias E&P investments to continue to be more focused towards garnering oil producing assets either organically or inorganically. Rajasthan remains a strong hope for India in terms of further oil reserves. Also, RIL has announced some oil discoveries in the KG and the Cambay basins, which offer some of the best potentials for expansion of domestic oil production. We believe that the company may deploy its excess cashflow, primarily in acquiring E&P assets (predominantly oil) as well as accelerating the development of its oil discoveries.
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Oil&Gas sector, April 4, 2011 Table 8: Domestic oil production details

(bpd) 1. ONGC Onshore Gujarat Assam Andhra Pradesh Tamil Nadu Mumbai High Offshore Oil Condensates 2. Oil India Assam Arunachal Pradesh 3. Private/JVC Onshore Arunachal Pradesh Assam Rajasthan Gujarat Offshore Grand total (1+2+3) Onshore Offshore As on December 10, Source: Infraline
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Oil production 495,996 151,731 118,013 22,967 6,353 4,398 344,265 300,041 44,224 73,373 72,860 513 214,694 130,694 2,004 367 125,000 3,323 84,000 784,063 282,425 501,638
East coast development, a major boost through D6

Despite a series of large gas discoveries, KG Basin still offers a high undiscovered potential The Krishna Godavari (KG) Basin has been the outstanding success story of the NELP rounds (introduced in 1999). By the end of 09, a total of 35 blocks had been awarded in the basin. The success of the new policy is perhaps best measured by the increased level of drilling activity in shallow and deepwater acreage in the past 10 years. Over 80 offshore exploration and appraisal wells have been drilled, resulting in a series of gas discoveries. The likes of the Dhirubhai (D) 1 and 3, and the KG-DWN98/2 have established the KG basin as a deepwater province with giant field potential. Despite several initiatives to attract broader participation in the exploration, the acreage has largely been secured by major indigenous operators such as ONGC and RIL (which hold over 76% of total net acreage and operating 20 of 25 active licences). Over 80 exploration and appraisal wells have been drilled since the introduction of the NELP. From a peak of around 20 wells in 07, the activity has dropped by two-thirds in 09, particularly in deepwater areas. Overall, it has been a major success story. The drilling success rate (commercial plus technical) has remained consistently high with an average of 60% plus. Most of the discoveries have been gas based, some small scale fields and some super giant fields such as D6. The discovery of D6 has been the highlight of the NELP experience so far with an estimated 11tcf (P1) reserves confirmed till date. Since its discovery, RIL has gone on to discover a string of smaller gas discoveries in the KG-DWN-98/3 block, which could yield an additional 2-3tcf of incremental commercial reserves by 16. The 60mnbls oil discovery MA made in 06 was brought on-stream in 08.
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Chart 3: Acreage holdings in KG Basin blocks (dominated by ONGC and RIL)
Source: Wood Mackenzie
Chart 4: Reserve additions in the KG Basin
Chart 5: Worlds top exploration provinces (1999-2009) by number of discoveries
Egypt_Western Desert Australia_Eromanga US (GoM Deepwater)_East Gulf Coast Australia_North Carnarvon Egypt_Nile Delta Angola_Lower Congo US (GoM Deepwater)_West Gulf Coast Argentina_Neuquen Netherlands_Southern North Sea Pakistan_Indus Nigeria_Niger Delta India_Krishna - Godavari Algeria_Illizi - Ghadames India_Cambay Mexico_Salinas - Sureste Norway_Northern North Sea China_North China Oman_Rub al Khali Turkey_Thrace Indonesia_South Sumatra
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Midstream players Defensive bets

We consider the midstream natural gas space to be the best long-term defensive bet, as the business is independent of price fluctuation in the underlying commodity natural gas. Also, the existing regulations provide long-term investment viability for pipeline infrastructure. GAIL, the largest player in the space, with >9,000Kms of pipeline infrastructure would be the key beneficiary of the trend. Further, with the Petroleum and Natural gas regulatory board (PNGRB) notifying the pipeline tariffs for GAIL at higher-than-expected levels, we believe that GAIL is one of the best defensive bets in the oil & gas space. GSPLs valuations look extremely attractive considering it is at discount to GAILs. However, we believe that due to the companys aggressive growth plans, the stock offers the highest potential upside in absolute terms. Natural gas pipeline companies have announced aggressive capex plans to support the incremental production of gas from the KG D6 and other prolific blocks on the east coast. We expect incremental volume potential of ~100mmscmd from the east coast in the next 5-10 years. And the transportation of this gas would require additional pipeline infrastructure.
Acceleration in gas production requires supporting infrastructure

Strong long-term potential seen for midstream investments, as domestic blocks offer ~100mmscmd incremental production potential India has seen its domestic gas supply surge on the back of aggressive investments in exploration and production of natural gas. Production, which was almost negligible at the time of Indias independence, presently stands ~132.83mmsmcd. The main producers being ONGC, OIL, JVs of Panna-Mukta, Tapti and Ravva and RIL (which is producing gas from its KG D6 block in the east coast of Andhra Pradesh). Of the total domestic gas production of 132mmscmd, RIL is the biggest player contributing ~43% to the total production (as of July 10) with the remaining producers contributing ~57%. Apart from the KG D6, the gas is mainly produced from onshore fields in Assam, Andhra Pradesh and Gujarat with smaller quantities coming in from oil fields in Tripura, Tamil Nadu and Rajasthan. OIL is operating in Assam and Rajasthan, whereas ONGC is operating in the western offshore fields along with some other states. Gas produced by ONGC and a part of the gas produced by the JV consortiums is marketed by GAIL. Gas produced by OIL is marketed by the company itself, except in Rajasthan where GAIL is authorised to market its gas. Gas produced by Cairn Energy from Lakshmi fields in Gujarat and GSPCL from Hazira fields is sold directly by the companies at market determined prices. Table 9: Domestic gas supply scenario in FY11
ONGC and OIL *RIL KG D6 PMT/ Ravva/Ravva Satellite Long term RLNG Shell spot Other gas Total Source: Industry Volume (mmscmd) 54.3 54.0 18.7 30.0 3.5 2.7 164
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Power and fertiliser continue to drive demand

Power generation and fertiliser industries are the biggest consumers of natural gas, accounting for two-thirds of the total domestic consumption. As per the working group report on petroleum and natural gas sector for the XI Five Year Plan period, the demand for natural gas would grow to 170mmscmd in 11-12; the power and fertiliser sectors together are expected to account for 76-80% of the total natural gas consumed in the country. As per industry estimates, the demand for power is expected to grow at 30% and demand for fertiliser at 10% over the next five years. Table 10: Domestic gas demand-supply scenario
(mmscmd) Gas supply Existing sources ONGC Petronet LNG Shell Hazira Dabhol LNG Others (including OIL and Pvt JVs) New sources RIL KG D6 RIL Mahanadi basin GSPC KG basin ONGC KG basin CBM RIL others (D6 satellite, NEC 25,etc) Total supply Gas demand Power Fertiliser Sponge iron plants Refineries City gas distribution Industrial Total demand Demand-Supply Source: Industry Current 54 30 4 19 54 7 0 0 3 170 74 39 6 30 14 14 177 6.7 FY13 46 34 9 18 20 80 9 10 0 5 231 100 54 8 35 18 18 232 1.1 FY16 40 36 18 18 20 80 9 20 20 15 30 306 150 70 10 45.5 23.4 21 320 13.6 % share (FY16) 13.1 11.8 5.9 5.9 6.5 26.1 2.9 6.5 6.5 4.9 9.8
46.9 21.8 3.1 14.2 7.3 6.6
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Gas transmission infrastructure shaping up for increased supplies

Major expansion in pipeline capacities underway The present gas trunk pipeline grid is ~10,000Kms and supplies gas to 0.8mn households and 0.4mn CNG vehicles in 25 cities, mainly in the northern and western India. GAIL owns more than 67% (6,800km) of the network, followed by RIL at 14% (1,400Kms) and GSPL at 11% (1,152Kms). The remaining is owned by Assam Gas Company, OIL and Gujarat Gas Company. In Assam, the Assam Gas Company has a network of 560Kms trunk pipeline and 1,150Kms of distribution pipeline. Gujarat Gas Company owns 116Kms of transmission lines and 1,900Kms of distribution lines. GSPL has a pipeline network of 1,670Kms along Hazira-Vadodara-Ahmedabad-Kalol-Himmatnagar-Mehsana-RajkotMorbi-Vapi, which transports 38mmscmd gas, including a large volume of LNG. This is enhanced significantly by new transmission pipelines traversing the state. The network will be connected to the east-west pipeline of RIL through its 30-inch Bharuch-Jamnagar pipeline. Overall, the planned capex of pipeline networks across the country amounts to more than Rs300bn over the next 4-5 years. GAIL is in the process of doubling its transmission infrastructure to more than 16,000Kms over the next four years. Also, GSPL plans to extend its presence out of Gujarat through three major trunk pipelines (~2000 kms, Rs180 bn gross capex) -Mehsana-Bhatinda, Mallavaram-Bhilwara and Bhatinda-Srinagar. The Paradip pipeline is under the approval stage and the bids have been submitted. Reliance Gas Transmission Infrastructure (RGTIL) plans to develop more pipelines of 2,875Kms across India.
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Oil&Gas sector, April 4, 2011 Chart 6: Pipeline infrastructure in India
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Source: PNGRB
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Downstream gas trading margins to be under pressure

Gas marketing companies, traditionally, have been scouting for gas supplies due to limited availability and lack of adequate infrastructure to transport the domestically produced gas. Both these concerns are now being addressed and the segment has seen renewed fervour in terms of expansion. However, a major concern in this segment is its exposure to trading margins. Regulations in CGD business allow only three years of exclusivity for existing players. We believe that post this exclusivity period, the competition will probably be skewed in favour of large players which have an assured source of gas supply. Though this segment is expected to see robust growth over the next few years, we believe it will see pressure on margins on account of increased competition from new entrants. We therefore remain neutral to negative on the companies in this segment.
LNG imports to surge, but pricing an issue

High prices of LNG to be a major deterrent for incremental power demand Among the various fuel alternatives, coal is expected to continue to retain its cost competitiveness vis--vis gas and is likely to remain the cheapest source of fuel in the future. However, gas is expected to continue to remain economical as compared to liquid fuels such as LPG, naphtha and fuel oil. Among the various categories of natural gas available, price of domestic gas produced by oil PSUs would be the lowest. RILs schedule to ramp up D6 gas has been delayed, but over the long term, production potential of KG basin remains robust. Though RIL gas is currently costlier than contracted LNG, the situation is expected to reverse in the near future. This is because the price of contracted LNG (by Petronet LNG) is expected to increase owing to its progressive linkage to Japanese Crude Cocktail (JCC). This is expected to make domestic gas even more competitive versus contracted-LNG during FY12 and FY13. Chart 7: Price comparison KG-D6 gas vis--vis LNG
60 50 (US$/mmbtu) 40 30 20 10 0 FY09
Source: I-Sec Research
LPG
Naphtha
Contracted LNG
Spot LNG
RIL - KG D6
PMT
APM
FY10
FY11E
FY12E
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Delay in volume ramp-up of the KG D6 gas will lead to a surge in LNG imports to India over the short term, primarily in the form of term contracts and spot volumes from regasification terminals on the west coast. The 10-20mmscmd shortfall in D6 gas (vis--vis targeted production of 80mmscmd in FY12E and FY13E) provides India an opportunity to fill this gap through LNG import. The key target for procuring LNG would be the Middle East countries, primarily Qatar, where major portion of incremental capacities are coming up. As per the table below, LNG supplies are expected to be in surplus over the next four-five years, which provides India enough leeway to capture the new LNG contracts. However, the constraint would be spare re-gasification capacities available domestically and the increasing costs of spot LNG and term contracts. Currently, Petronets Dahej and Shells Hazira are the only LNG terminals operating with the combined capacity of 13.6mmtpa (can be lower since Hazira is unable to operate at its full capacity). The Dabhol LNG terminal is expected to be commissioned in 11 with a 5mmtpa capacity, but will initially operate at around 2mmtpa. Hence, throughout 11, the available spare LNG re-gasification capacity would be around 2.5-3mmtpa, which represents a potential supply of 10-12mmscmd. Table 11: Global LNG demand-supply
(MMT) Region Asia Pacific Europe Middle East North Africa North America South America West Africa Total LNG Demand Asia Pacific Europe North America South & East Africa South America Total Surplus/(Deficit) Source: Wood Mackenzie 2010 62 3 57 23 1 12 16 174 2011 67 3 70 23 0 14 18 195 2012 67 3 73 24 0 14 19 199 2013 66 3 73 26 0 14 21 202 2014 67 3 73 27 0 14 22 206 2015 77 3 73 31 0 14 22 221 2020 85 3 73 32 0 12 22 227 2025 68 3 73 32 0 7 18 201
90 45 26 0 2 163 11
98 51 33 0 3 185 9
105 53 32 0 3 193 6
108 53 29 0 3 194 8
116 56 20 0 3 195 12
124 60 19 0 3 207 13
138 110 15 0 4 267 (41)
168 125 13 0 4 311 (110)
Domestic gas preferable for incremental demand

Domestic gas is the most cost-effective and thus most preferred alternative for power generation Power tariffs based on RIL gas will be cost competitive with respect to liquid fuels, contracted LNG and imported coal (Chart 8). Power generation through contracted LNG will turn uncompetitive from 09-10 as compared to RIL gas, given the contracted LNG-crude oil price linkage. With regard to imported coal, most of the new power projects are coming up in coastal areas and given that they have long-term contracts for sourcing coal, the cost of power generation is far less than our projections. However, the power tariff based on domestic coal will continue to remain the cheapest, followed by APM gas-based tariff. For fertiliser sector, natural gas is used both as a feedstock as well as a fuel for urea production. Due to non-availability of natural gas, expensive alternatives such as naphtha and fuel oil were used in fertiliser production. The cost of production of urea
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varies significantly with the type of feedstock and fuel used. As shown in the following chart, the cost of production is the lowest with natural gas. The Government of India has, therefore, given top priority to fertiliser sector in the allocation of KG D6 gas. Chart 8: Cost of producing urea through different fuels
800 700 600 500 (US$/te) 400 300 200 100 0 RIL.gas RIL.gas RIL.gas RIL.gas Fuel oil Fuel oil Fuel oil Naptha Naptha Naptha Naptha Fuel oil
2008-09
Source: Industry
2009-10P
2010-11P
2011-12P
Currently, there are 21 gas-based urea plants (with an aggregate capacity of 19mnte) and four other plants (with cumulative capacity of 4.0mt) based on naphtha and fuel oil. The Government has mandated all fuel oil and naphtha-based plants to switch over to natural gas. However, due to non-availability of pipeline connectivity, there will be some delay in switching over to gas-based platform at these remaining plants.
CGD demand potential to take 4-5 years to fructify

With gas availability being taken care of domestically, the clear potential for downstream business is the City Gas Distribution (CGD) business model. Though the business carries strong potential in terms of satisfying the end-user demand, which is on account of the inherent economical and environmental benefit of natural gas, the expansion in volumes is bottlenecked by the lack of infrastructure in terms of end-user pipeline connectivity. The lead time for laying CGD pipelines is longer than for crosscountry pipelines since the former requires additional local municipal approvals. Going forward, given the Governments thrust on developing cross-country as well as regional gas pipeline grids and the additional gas supply coming up in the near future (RIL gas) many major trunk pipelines are expected to be commissioned in the medium term. This is expected to boost the development of CGD throughout the country. Moreover, the Governments thrust on CGD development is reaffirmed, with CGD getting higher priority over the greenfield power plants in the gas utilisation policy framework.
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GRMs and Petchem spreads to be robust

GRMs to improve
GRMs to improve and sustain at higher levels Downstream profitability has seen a sharp improvement in the past four quarters, led by improved demand from Asian countries and stabilisation of the US and European economies. We believe that the current recovery in GRMs will sustain led by improved demand for transportation fuels and improving light-heavy spreads, We expect average complex Singapore GRMs to improve to US$7/bl levels in FY12E and to US$7.5/bl in FY13E. We also expect rising crude prices to eventually lead to increase in light-heavy spreads, which will bode well for complex refineries owned by RIL and upcoming greenfield refineries of Bharat Petroleum Corporation (BPCL), Hindustan Petroleum Corporation (HPCL) and Indian Oil Corporation (IOC).
Auto fuels to drive product demand

Global GRMs have been on a recovery path off lately, primarily led by HSD, petrol and jet kerosene cracks. We expect this segment to continue to be a long-term demand driver for these fuels. We believe that Incremental demand would continue to be driven by transportation fuels, with diesel being the most critical demand driver from the Asian and European regions. Chart 9: Global GRM trends over the year
14 12 10 Rotterdam Complex Mediterranean Complex Singapore Complex WTI Crack
(US$/bbl)
8 6 4 2 0
2005
2006
2007
2008
2009
2010
Note: Average yearly GRMs; Source: Reuters
2011
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Chart 10: Global Petroleum liquids consumption by end-use sector

150 Transportation Other
125
(quadrillion Btu)
100
75
50 2007
Source: EIA
2015
2020
2025
2030
2035
HSD (Gas oil) would be the key demand driver for refining products in the next 20 years, with its share in the petroleum demand expected to rise to >30%, while that of the gasoline slated to decline (Chart 11). The incremental push for middle distillates is clearly coming in from Asian economies such as India and China. In these countries, diesel finds a strong industrial use other than for transportation. The other strong demand driver for diesel in Asian countries is expected to be the robust growth in car sales, as consumers in this region have a preference for low-cost diesel variants as this fuel is more subsidised there. Chart 11: Product-wise demand growth
35% 30% 25% 20% 15% 10% 5% 0% 2009 2030 2015
Ethane/LPG
Jet/Kerosene
Gasoil/Diesel
Gasoline
Naphtha
Source: OPEC, World Oil Outlook, 2010
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Residual fuel
Other
Oil&Gas sector, April 4, 2011 Table 12: Robust passenger car sales growth
Cars per 1000 2007 2010 2020 North America 575 555 581 Western Europe 442 436 462 OECD Pacific 428 437 484 OECD 490 482 513 Latin America 133 138 163 Middle East & Africa 27 31 41 South Asia 10 12 26 Southeast Asia 50 57 88 China 22 30 80 OPEC 58 59 80 Developing Countries 34 39 64 Russia 207 200 296 Other trans. Economies 158 176 239 Transition economies 178 186 262 World 123 124 147 Source: OPEC, World Oil Outlook, 2010 2030 601 489 517 540 187 52 50 127 147 106 96 379 302 332 174 2007 261 238 86 585 55 22 15 32 30 22 177 29 31 60 821
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Cars million 2010 2020 259 295 238 259 88 97 585 651 60 78 27 45 20 48 38 64 41 114 24 38 209 388 28 39 35 47 62 86 856 1,126 Car growth % p.a. 2007-2030 1 0.7 0.7 0.8 2.5 5 8.7 5.1 9 4.4 5.8 2.1 2.9 2.5 2.5
2030 326 277 101 704 98 68 104 100 214 59 642 47 59 106 1,452
Light-heavy spreads to trigger complex premiums

Light-heavy crude oil spreads in the past two years have been low due to sluggish demand for light crude products (from the US and Europe as the slowdown intensified). This was followed production cut of mainly heavy crude by the OPEC and commissioning of new complex refining capacities that resulted in increased demand for heavy crude. However, the situation is starting to reverse with demand from the US improving and economic stabilisation in European countries expected to improvise the product demand scenario. However, we can expect triggers from light-heavy spreads once OPEC starts raising its production. With current crude prices at close to US$100/bl, the OPEC will eventually raise its production levels by increasing the output of heavy crude, which will consequently impact the light-heavy spreads on the higher side. An improvement in light-heavy spread back to its long-term average of US$4.2/bl in the next 4-8 quarters can be a trigger for expansion in the premium for complex refiners such as RIL. However, due to increased demand from new complex refinery additions, we do not foresee light-heavy spreads to touch its peak of US$10/bl and expect it to hover around its long-term average of US$4-5/bl. Chart 12: Arabs and Maya crude spreads
28 24 20 Light-Heavy (Arab) WTI Vs Maya Mean (Arab) Mean (WTI-Maya)
(US$/bbl)
16 12 8 4 0 (4)
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Oct-10
Source: Bloomberg
Apr-11
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Oil&Gas sector, April 4, 2011 Chart 13: OPEC spare capacity

8 7 6
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(mn bl/d)
5 4 3 2 1 0
Oct-06
Oct-07
Oct-08
Oct-09
Feb-06
Feb-07
Feb-08
Feb-09
Feb-10
Oct-10
Note: Bloomberg figures vary with IEA figures which put effective spare capacity, excl. Libya at 4.08mb/d. Source: Bloomberg, the February 11 number for spare capacity excludes Libyas spare capacity
Chart 14: Product spreads over Brent

24 20 16 Diesel Petrol Naphtha
(US$/bbl)
12 8 4 0 (4) (8)
Oct-09
Oct-10
Jul-09
Jan-10
Jul-10
Apr-10
Jan-11
Source: Bloomberg
Chart 15: Refinery utilisation rates inching up

88 85 82 USA Europe Asia
(%)
79 76 73 Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
Q2FY11
Q3FY11
Source: Reliance Q3FY11 Presentation
24
Apr-11
Feb-11
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
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Significant change in Petchem outlook

Petchem margins (especially olefins), in the past few quarters, have grown strong. A major surprise, this indicates strong demand pull despite more than 10mmtpa capacity addition in the Middle East. The incremental demand primarily comes from Asian economies, mainly China and India. Many large Petchem players expect a strong business cycle over the next 2-3 years as demand in the US and Europe revives. Limited capacities coming up in the Middle East and across the world post 11 will only help the cause. However, we have assumed margins to remain at the current levels and wait for better times. Chart 16: Demand for basic chemical & plastics Global demand for plastics
600 500 400 (MMT) 300 200 100 0 1990 1995 2000 2005 2010 2015 -7.1% (MMT) 5.2% 4.2% 5.3% 60 50 40 30 20 10 0 1990 1995 2000 2005 2010 2015 -16.2%
North American demand

4.6% 0.1% 2.0%
Western Europe demand

60 50 40 30 20 -13.9% 10 0 1990
Source: CMAI
Asian demand
1.7% 400 350 300 250 (MMT) 200 150 100 50 0 -1.6% 9.2% 7.1% 6.6%
3.2%
1.8
(MMT)
1995
2000
2005
2010
2015
1990
1995
2000
2005
2010
2015
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Ethylene capacity addition would be comfortably absorbed

An additional 13mmtpa low-cost ethylene capacity is expected to come up in the Middle East over the next four years. Over the same period, Asia is expected to come up with another 12mmtpa (led by China at 9mmtpa). However, this will be partially offset by the closure of inefficient capacities of 10mmtpa in the developed economies, especially North America and Europe (Chart 17). Hence, the net capacity addition in the next three years is expected to be ~13-15mmtpa. The global feedstock mix will tilt marginally towards ethane from 27% in 10 to 32% in by 13 resulting in pressure on naphtha-based crackers. Chart 17: Ethylene capacity addition
14.0 12.0 10.0 8.0 MMT 6.0 4.0 2.0 0.0 -2.0 -4.0 2010
Source: CMAI
North America West Europe
Middle East Northeast Asia
Southeast Asia Others
2011E
2012E
2013E
2014E
However, most of the incremental capacities coming up in the Middle East are expected to be absorbed by the demand growth in Asia. As per CMAI estimates, incremental Poly-Ethylene (PE) demand in China and India is expected to be at least 10.4mmtpa in the next two years, enough to absorb incremental capacities coming up in the Middle East assuming 80% utilisation. Chart 18: Ethylene demand trend
60 50 40 30 (MT) 20 10 0 -10 -20 -30 2000
Source: CMAI
Annual demand chg. in volumes Annual demand chg. in % (RHS)
12 10 8 6 (%) 4 2 0 -2 -4 -6
2005
2010
2015
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However, the trigger for Petchem margins is expected to come when demand growth from the US and Europe resumes in the next two years, expected to be at 4.2mmtpa. We see a possibility of re-rating of Petchem business if the margins fall in line with the forecast. Back home, RILs recent margins do justify this argument to some extent. Chart 19: Middle East PE capacity addition
9 8 7 6 (mmt) 5 4 3 2 1 0 May-08 May-09 May-10 Mar-08 Mar-09 Nov-08 Nov-09 Mar-10 Nov-10 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Sep-08 Sep-09 Sep-10 Jan-11 Delays helped keep the market tight in 2009 Current View 2008 View
Source: CMAI
Poly-Propylene to show a similar trend

CMAI indicates that the operating rates for current capacities of PP are steadily reviving, led by strong demand growth in Asia. Asia is the largest consumer of PP products, followed by the Middle East, North America and West Europe. As is the case of Ethylene, there are indications that global demand for PP will exceed expectations, which can trigger expansion in PP margins. Operating rates are critical for profitability in the petrochemicals business. Higher operating rates reflect increased demand for products, hence higher bargaining power for producers. During price negotiation, besides inventory levels, plant operating rates is an important metric that determines the relative bargaining power of producer vis-vis consumer. As depicted below, cracker operating rates globally have declined sharply over the past two years and expected to bottom out in 10 (at 80%). Post 10, it is expected to revive sharply till 14, as excess low cost capacities in the Middle East are absorbed by the market (Chart 21).
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Oil&Gas sector, April 4, 2011 Chart 20: PP demand-supply dynamics
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Source: CMAI
Chart 21: Expected consumption pattern of propylene

6,000 5,000 4,000 ('000 metric te) 3,000 2,000 1,000 0 (1,000) (2,000) (3,000) (4,000) 2004
Source: CMAI
China Asia
North America Middle East / Africa
West Europe South America
2005
2006 2007
2008
2009
2010
2011 2012
2013
2014
As the Middle East capacities are predominantly based on low-cost gas-based feedstock, they enjoy a significant advantage over crackers in other regions. The cost advantage for non-integrated crackers world over would fade on the back of supplies from the Middle East. This could also lead to possible capacity shutdowns, especially in high-cost regions such as North America and Europe.
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Oil&Gas sector, April 4, 2011 Chart 22: Ethylene production cash costs Operating costs lowest in the MiddleEast
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Source: CMAI
Chart 23: Naphtha cracks

1,650 1,500 1,350 1,200 1,050 900 750 600 450 300 150 0 Oct-05 Apr-05 Apr-06 MEG HDPE Propylene PVC PTA LLDPE Polypropylene-propylene
(US$/MT)
Oct-06
Oct-07
Oct-08
Oct-09
Apr-07
Apr-08
Apr-09
Apr-10
Oct-10
Source: Bloomberg
Indias petrochemicals business to outperform

Domestic demand for basic petrochemicals is expected to grow at a CAGR of 10-12% IN the next five years, with ethylene and propylene products constituting the major chunk. Capacity additions in India are expected to match the demand growth, led by RIL, OPAL (the JV between ONGC, GAIL, Petronet and the Gujarat government) and GAIL. The domestic operating levels have remained consistently above 90% throughout the entire down-cycle in the past two years, led by strong domestic demand. We expect the operating rates for Indian players to remain consistently above 95% as demand continues to outstrip supply.
Apr-11
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Oil&Gas sector, April 4, 2011 Chart 24: Domestic polymer demand growth
20% 16% 12% 8% 4% 0% PP PE All Polymers PVC Industry 9M FY11 (YoY)
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Chart 25: Domestic chemical demand growth
15% 12% 9% 6% 3% 0% PBR Benzene LAB BD Industry 9M FY11 grow th (YoY)
Source: RIL presentation
Source: RIL presentation
Chart 26: Overall domestic plastics and chemicals demand trend

45 40 35 30 (MMT) 25 20 15 10 5 0 1990
Source: CAMI
12.9%
9.5%
10.7%
+1.1% 2008
1995
2000
2005
2010
2015
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Annexure 1: Disruption in MENA props high crude price regime

Recent unrests in the Middle East North African (MENA) region, along with economic recovery in the developed markets, strengthen our argument for a high crude price regime and indicate an upward risk to our long-term assumption of US$100/bl Brent crude. Due to the current and potential supply disruptions in the MENA region, prices of crude may continue to remain robust at current levels of US$116/bl, or may even rise further in the medium to long term. This can aggravate the under recoveries to be borne by the oil marketing companies.
Libya unrests escalate

Due to the recent unrest in Libya, the oil production from the country has dropped by one-third from 1.6mb/d to 0.4mb/d. Libya had the production capacity of 1.8mb/d. There seems to be no immediate resolution to the aggravating dispute between the Gaddafi loyalists and the rebels even as the NATO (including the US, the UK and France) have started military action against Gaddafi. After these disputes end, it will still take some months before Libya gets back to the original levels of production, considering the bombings have affected the oil producing and exporting infrastructures. However, there are indications that things may get far worse before they improve, threatening the remaining 0.4mmbod production.
Support from Saudi Arabia spare capacity?

Saudi Arabia has 3.1mb/d spare capacity at present, which accounts for 57% of OPECs overall spare capacity (excluding Iraq and Libya). Hence, it seems the country has enough spare capacity to make up for the decline in production from Libya. Chart 27: Spare capacity
Angola, 0.41 Ecuador, 0.04 Nigeria, 0.50 Algeria, 0.14 UAE, 0.30 Qatar, 0.08 Kuwait, 0.35 Venezuela, 0.19
Iran, 0.35
Saudi Arabia, 2.80
Source: Bloomberg
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However, Saudi Arabia has never produced >9.6mb/d (maximum in July 08). Hence, their ability to make up for Libyas shortfall completely can be suspected. Also, Saudi Arabias capability to tap into its spare capacities in the short term has not been tested. Chart 28: Saudi Arabia Oil production
10.0 9.5 9.0 (mn bpd) 8.5 8.0 7.5 Oct-06 Oct-07 Oct-08 Oct-09 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Oct-10 Feb-11 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Saudi Arabia Production
Source: Bloomberg
Algeria adds to the tension

Another country in OPEC which has substantial oil production to affect the global demand supply dynamics and is currently facing internal unrest is Algeria. Algeria has current oil production of 1.25mb/d and exports ~60% of its production. The Algerian capital is witnessing clashes. In an effort to restore calm and avoid uprisings similar to those that led to the ousting of authoritarian rulers in Tunisia and Egypt earlier this year, the Algerian Government has said it will move faster in tapping funds from Algeria's rich oil and gas resources to build more houses, roads and schools. Algeria lifted a 19-year-old state of emergency last month in a concession to the opposition. Assuming that together with Libya, Algerias oil production is also curbed and Saudi Arabias tries to compensate the loss of Algerias production as well; this will leave the OPEC major with hardly any spare capacity.
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Oil&Gas sector, April 4, 2011 Chart 29: OPEC production

Ecuador Nigeria 2% 7% Algeria 4% UAE 8% Libya 5% Qatar 3% Kuw ait 8% Venezuela 8% Angola 6% Iran 11% Iraq 9%
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Saudi Arabia 29%
Source: Bloomberg
Developments in other MENA regions

Bahrain, Syria, Yemen and Morocco are the ones which are facing some uprisings at present. Although the production from these countries is not enough to change the global oil supply dynamics, these regions would just add on to the situation in Libya and Algeria. There is also a possibility that the disruption in any of the small producers might happen. Table 13: Developing crisis in other
Country Syria Production mb/d 0.40 Recent events At least six people were killed recently when Syrian security forces attacked protesters who had taken refuge in a mosque in the centre of the southern city of Daraa, Reuters reported. Yemen's parliament enacted sweeping emergency laws after President Ali Abdullah Saleh tried to curb a popular uprising demanding his resignation. The move suspends the constitution, allows media censorship, bars street protests and gives security forces 30 days of far-reaching powers. Total 1.16 Source: EIA, BBC News, Other News sources
Yemen
0.28
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Positive impact on GRMs

About 85% of Libyan oil exports go to Europe, including Italy, Germany, France and Spain. Due to Libyan unrest, the shortfall in production has to be met by Saudi Arabia by releasing spare capacity. Libya exports nine grades of crude oil. API gravities range from 26o to 43.3o, with a sulphur content as low as 0.2-0.3%. Because of the low sulphur content, the sweet crude can easily be turned into transport fuel. While the lighter, sweeter grades are generally sold to Europe, the heavier crude oils are often exported to Asian markets. Saudi oil is generally more dense and sulphurous than the Libyan crude it will replace. Europes old refineries will not be able to process the heavier Saudi crude, and fuel regulations there are less tolerant of sulphur content than elsewhere in the world. So the Middle East oil will have to be shipped to Asias newer refineries, which are designed to deal with a wide variety of grades of oil. This will help increase light-heavy spreads, thus strengthening GRMs of complex Asian refiners. Chart 30: Crude exports from Libya
France 15% Germany 10% Italy 28%
China 11%
Spain 10% Other 14% United Kingdom 4% United States 3% Greece 5%
Source: EIA
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The NELP has resulted in reducing the unexplored area from 89% to 15%.
Annexure 2: NELP transformed India into an attractive E&P destination

Over the past 11 years, exploration of hydrocarbon potential of the sedimentary basins has been carried in a big way (Chart 28), bringing down the unexplored areas to 15% from 89% in 1995-96.
Chart 31: Indias exploration history and outlook (in-place reserves)

25 Early Stage Nationalisation Dominated by National Oil companies Indian Independence Gol small fields policy Fledging liberalization Partial privatisations e.g. ONGC/OIL/IOC Onset of Liberalisation Reserves billions boe 15 Era dominated by Burmah Oil & other companies Nationalisation of Burmah Formation of State companies NELP era Open policy
Continued liberalisation Improved terms & large discoveries Emergence of Indian Private Companies (Reliance) & reinvigorated PSUs NELP Rounds Expected Accretion rate?
20
Small Fields Policy
10
ONGCs major discoveries 6 Fields e.g. Enron, Command/Caim Niko & Hardy 1847 1980 1991 1999 Recent Exploration success Reliance / GSPC / ONGC / Caim
0 1880 2009
Source: BP Statistical Review 2010 and CMIE
NELP Key highlights

Increased private sector participation 100% FDI encourages foreign investment Cost recovery up to 100% Competitive and fair bidding Seven-year income tax holiday (MAT applicable)
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Oil&Gas sector, April 4, 2011 Table 14: Blocks offered under the NELP
Blocks offered Deepwater Shallow Onland PSC signed Deepwater Shallow Onland Area awarded (sq km) Percentage of acreage awarded (%) Planned investment (US$ mn) Source: Infraline, I-Sec Research NELP I 48 12 26 10 24 7 16 1 1,94,735 7.4 1,150 NELP II 25 8 8 9 23 8 8 7 2,63,050 8.5 775 NELP III 27 9 7 11 23 9 6 8 2,04,588 6.5 1,038 NELP IV 24 12 1 11 20 9 1 10 1,92,810 6.1 1,135 NELP V 20 6 2 12 20 6 2 12 1,15,180 3.7 917
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NELP VI 55 25 6 24 52 21 6 25 3,06,200 9.7 3,317 NELP VII 57 29 9 19 41 11 7 23 1,17,000 3.6 1,700 NELP VIII 70 24 28 18 36 8 13 15 60,200 1.9 3,900
Despite one of the biggest gas discoveries at the KG D6, Indias share of global gas reserves stands at an insignificant 0.6%. Its share of global oil reserves also comes in at just 0.5%. To achieve energy security, the Government is willing to encourage more investments in the sector; we believe India is at the beginning of a huge wave of E&P investments. Table 15: India still a minnow in the global E&P stage
(bn bbls) Oil: proved reserves Australia Brunei China India Indonesia Malaysia Thailand Vietnam Other Asia Pacific Total Asia Pacific Total World of which: European Union # OECD OPEC Non-OPEC Former Soviet Union Canadian oil sands Proved reserves and oil sands Source: BP statistical review 2010 1989 3.1 1.2 16 4.3 5.1 3.7 0.2 0.1 0.9 34.7 1,006.4 7.7 116.4 763.2 175.8 67.3 NA NA 1999 4.7 1.3 15.1 5 5.2 5 0.4 1.8 1.4 39.9 1,085.6 9.0 93.3 831.9 166.4 87.2 163.3 1,248.9 2008 4.2 1.1 14.8 5.8 3.7 5.5 0.5 4.7 1.4 41.7 1,332.4 6.1 91.3 1,028.8 180.6 123.0 143.3 1,475.7 2009 4.2 1.1 14.8 5.8 4.4 5.5 0.5 4.5 1.3 42.2 1,333.1 6.3 90.8 1,029.4 180.9 122.9 143.3 1,476.4 % of total 0.3 0.1 1.1 0.4 0.3 0.4 0.0 0.3 0.1 3.2 100.0 0.5 6.8 77.2 13.6 9.2 R/P ratio 20.7 17.6 10.7 21.1 11.8 20.4 3.8 35.7 11.2 14.4 45.7 8.2 13.5 85.3 14.7 25.5
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Oil&Gas sector, April 4, 2011 Table 16: Gas reserves India versus world
Natural gas: Proved reserves Australia Bangladesh Brunei China India Indonesia Malaysia Myanmar Pakistan Papua New Guinea Thailand Vietnam Other Asia Pacific Total Asia Pacific Total World of which: European Union OECD Former Soviet Union Source: BP statistical review 2010 1989 TCM 1.0 0.7 0.3 1.0 0.7 2.6 1.6 0.3 0.7 0.2 0.2 0.3 9.5 122.4 3.4 15.6 47.1 1999 TCM 2.0 0.3 0.4 1.4 0.6 2.6 2.5 0.3 0.7 0.4 0.3 0.2 0.3 12.1 148.6 4.0 14.3 50.9 2008 TCM 3.1 0.3 0.4 2.5 1.1 3.2 2.4 0.6 0.8 0.4 0.3 0.6 0.4 16.0 185.3 2.5 16.4 57.5
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2009 TCM 3.1 0.4 0.4 2.5 1.1 3.2 2.4 0.6 0.9 0.4 0.4 0.7 0.4 16.2 187.5 2.4 16.2 58.5 % Share of total 1.64 0.19 0.19 1.31 0.59 1.70 1.27 0.30 0.48 0.24 0.2 0.36 0.19 8.66 100.00 1.29 8.6 31.2 R/P ratio 72.7 18.0 30.7 28.8 28.4 44.3 38.0 49.4 23.9 * 11.6 85.2 20.9 37.0 62.8 14.1 14.4 84.2
Favourable fiscal policies support strong investments

PSC is one of the most widely accepted forms of agreement, striking the right balance between investor and Government interests PSC, the most favoured agreement. Every E&P project is based on an agreement, wherein the operator takes the responsibility of drilling, production and other oil field services and the Government seeks to protect the public interest. Of the various types of agreement operational globally such as joint ventures, production and sharing contracts (PSC), concessions, services and hybrids, PSC is favoured in India. Table 17: Types of agreement prevailing across the world
Type of agreements Concession Joint venture Service contract Hybrid PSC Source: DGH Contractor All risk All reward Share in risk & reward No risk Mixed Exploration risk Share in reward Government Reward is a function of production & price Share in risk & reward All risk All reward Mixed Share in reward Number of countries using 59 31 2 16 40
Table 18: Indias policy vis--vis other countries

Malaysia PSC 32 10.50 75 87 15 Yes Indonesia PSC 30 3 80 91 0 Yes Philippines SA 46 7.5 70 87 0 Yes Australia R/T* 46 0 100 100 0 No New Zealand R/T 56 5 100 95 0 Yes INDIA Shallow Deep water Water PSC PSC Biddable 10 5 & 10 100 100 100 0 Yes 100 0 Yes
Type of system Contractor take (%) Royalty (%) Cost rec. limit (%) Access to gross revenue (%) Govt. Carry (%) Ring fence (%) Source: DGH
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Oil&Gas sector, April 4, 2011 Chart 32: Framework PSC fiscal terms
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Production Value
a. Royalty b. Production c. Exploration
Cost Petroleum
Profit Petroleum d. Development
Contractors share
Governments share Governments Take
Income Tax
Contractors Take
Source: DGH
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Annexure 3: Index of Tables and Charts

Tables
Table 1: Share of subsidy contribution across categories ....................................................6 Table 2: Oil companies contribution much higher than under-recoveries ...........................8 Table 3: Global and Indian primary energy consumption .....................................................9 Table 4: Energy demand growth A close proxy of GDP growth ......................................10 Table 5: Domestic crude balance .......................................................................................11 Table 6: Declining oil production, a concern.......................................................................11 Table 7: Oil import details ...................................................................................................11 Table 8: Domestic oil production details .............................................................................12 Table 9: Domestic gas supply scenario in FY11.................................................................14 Table 10: Domestic gas demand-supply scenario..............................................................15 Table 11: Global LNG demand-supply ...............................................................................19 Table 12: Robust passenger car sales growth ...................................................................23 Table 13: Developing crisis in other....................................................................................33 Table 14: Blocks offered under the NELP ..........................................................................36 Table 15: India still a minnow in the global E&P stage.......................................................36 Table 16: Gas reserves India versus world .....................................................................37 Table 17: Types of agreement prevailing across the world ................................................37 Table 18: Indias policy vis--vis other countries ................................................................37
Charts
Chart 1: RoE comparisons of oil PSUs.................................................................................6 Chart 2: Under-recoveries Contribution from oil PSUs and the Government....................7 Chart 3: Acreage holdings in KG Basin blocks (dominated by ONGC and RIL) ................13 Chart 4: Reserve additions in the KG Basin .......................................................................13 Chart 5: Worlds top exploration provinces (1999-2009) by number of discoveries ...........13 Chart 6: Pipeline infrastructure in India...............................................................................17 Chart 7: Price comparison KG-D6 gas vis--vis LNG......................................................18 Chart 8: Cost of producing urea through different fuels......................................................20 Chart 9: Global GRM trends over the year .........................................................................21 Chart 10: Global Petroleum liquids consumption by end-use sector..................................22 Chart 11: Product-wise demand growth .............................................................................22 Chart 12: Arabs and Maya crude spreads ..........................................................................23 Chart 13: OPEC spare capacity..........................................................................................24 Chart 14: Product spreads over Brent ................................................................................24 Chart 15: Refinery utilisation rates inching up ....................................................................24 Chart 16: Demand for basic chemical & plastics ................................................................25 Chart 17: Ethylene capacity addition ..................................................................................26 Chart 18: Ethylene demand trend.......................................................................................26 Chart 19: Middle East PE capacity addition........................................................................27 Chart 20: PP demand-supply dynamics .............................................................................28 Chart 21: Expected consumption pattern of propylene ......................................................28 Chart 22: Ethylene production cash costs ..........................................................................29 Chart 23: Naphtha cracks ...................................................................................................29 Chart 24: Domestic polymer demand growth .....................................................................30 Chart 25: Domestic chemical demand growth ....................................................................30 Chart 26: Overall domestic plastics and chemicals demand trend.....................................30 Chart 27: Spare capacity ....................................................................................................31 Chart 28: Saudi Arabia Oil production .............................................................................32 Chart 29: OPEC production ................................................................................................33 Chart 30: Crude exports from Libya....................................................................................34 Chart 31: Indias exploration history and outlook (in-place reserves).................................35 Chart 32: Framework PSC fiscal terms ..............................................................................38
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Equity Research
Reliance Industries
On a cyclical upturn
Reason for report: Reinitiating coverage
BUY
Rs1,035

Target price Rs1,197
Shareholding pattern
Promoters Institutional investors 29.0 28.2 MFs and UTI 2.7 2.1 FIs/ Banks 0.3 0.3 FIIs 17.9 17.5 Others 24.5 25.3 Source: www.nseindia.com Jun 10 46.5 Sep 10 46.5 Dec 10 46.5 29.2 2.4 0.3 18.3 24.3
Price chart
1,175 1,125 1,075 (Rs) 1,025 975 925 875 Nov-10 Jun-10 Jan-11 Aug-10 Mar-11 Apr-10
Reliance Industries (RIL) valuations will be led by its traditional businesses, refining and petrochemicals. Global refining margin will likely be robust (RIL US$11/bl in FY13E) as product demand from Asia surges and European and the US markets stabilise. In petchem, the demand drivers from emerging markets are expected to be strong enough to absorb incremental capacities from the Middle East. E&P will also chip in as key concerns have been addressed through the British Petroleum (BP) deal, indicating a strong bottom for its E&P valuations at US$24bn. We value RIL at Rs1,197 on sum of the parts (SOTP), which yields 15% upside from the current levels. We reinitiate coverage on RIL with a BUY and view it among one of the best value picks in the oil & gas sector. Refining GRM outlook supports our bullish view. We expect refining to contribute significantly to profitability. The recent revival in global GRMs will improve with positive demand drivers from the developed economies. RILs GRMs will likely be robust at current levels (US$11/bl in FY12E-13E), in tandem with the rise in benchmark Singapore GRMs. Improvement in light-heavy spreads and setting up of a petcoke gasification unit can provide further upside to RILs GRMs. We value refining at 7x FY13E EV/EBITDA, implying Rs458/share fair value for the segment. E&P BP deal assuages valuation concerns. The BP deal has valued RILs 23 E&P blocks (30% stake acquired) at US$24bn, indicating a bottom for its E&P valuations. The concerns on volume ramp-up in KG D6 still continue, but the deal has generated strong expectations that such issues will be resolved soon. We, however, continue to expect that D6 production will peak at 87mmscmd by endFY13E, in line with the recent comments from the Ministry of Petroleum and Natural Gas (MoPNG). We value E&P at Rs354/share, almost in line with the BP deal. Strong portfolio of exploratory blocks and BPs technical expertise can lead to significant reserve upside from most KG Basin blocks. Petrochemicals Margins to be stable. We expect RILs petchem margin to be robust at the current levels till now, margins have surpassed Street estimates. The industry now expects incremental low-cost ethylene capacities to be comfortably absorbed by the strong Asian demand, specifically from China and India. RILs predominantly domestic focus is a key advantage, which will ensure >95% petchem utilisation. RILs planned capacity expansion is expected to result in significant valuation trigger as it is expected to start during a potentially higher margin scenario. Reinitiate with BUY. Increased contribution from the high-margin oil & gas business along side gradual expansion in refining and petchem margins would drive RILs EPS over FY11-13E. Reinitiate with BUY.
Market Cap Reuters/Bloomberg Shares Outstanding (mn) 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$/'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs3,389bn/US$76bn RELI.BO/RIL IN 3,273 1,187/841 54.5 18.3 131,670 (1.9) (8.1) (5.6) 8.3 Year to Mar Revenue (Rs bn) Net Income (Rs bn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield (%) RoCE (%) RoE (%) FY10 2,037 159.0 48.0 113.9 21.6 81.1 11.3 0.7 9.2 13.2 FY11E 2,233 203.1 61.3 27.8 16.9 96.2 8.2 0.7 10.8 13.4 FY12E 2,568 248.4 75.0 22.3 13.8 111.3 7.4 0.7 11.4 13.6 FY13E 2,648 266.8 80.6 7.4 12.8 121.3 6.7 0.7 11.5 12.9
Rohit Ahuja
Prolin Nandu
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Reliance Industries, April 4, 2011
ICICI Securities
TABLE OF CONTENTS
Refining GRM outlook supports our bullish view ...................................................43 Room for further premium expansion ...........................................................................43 Refining to contribute significantly to overall valuations ...............................................45 Refining Valuation assumptions.................................................................................46 Valuations highly sensitive to GRMs.............................................................................46 E&P BP deal assuages valuation concerns .............................................................47 BP deal creates a bottom for E&P valuations...............................................................47 Volume ramp-up schedule still unclear .........................................................................48 Key issues yet to be resolved .......................................................................................49 E&P valued at US$24bn ...............................................................................................49 Key assumptions for DCF KG D6 block.....................................................................50 Strong portfolio of exploratory blocks offer high reserve accretion potential ................50 Petrochemicals Margins to be stable .......................................................................53 Strong domestic demand & integration, key differentiators ..........................................53 Contribution from petchem at Rs294/share ..................................................................54 Expansion projects, revival of off-gas based crackers Next big trigger .....................55 Valuations .......................................................................................................................56 Profitability expansion to drive valuations .....................................................................56 Reinitiate with BUY .......................................................................................................56 Rising cash reserves to be invested into core businesses ...........................................57 Key risks to our call .......................................................................................................58 Annexure 1: Consolidated financials...........................................................................59 Annexure 2: Index of Tables and Charts .....................................................................63
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Refining GRM outlook supports our bullish view

RILs GRMs will continue to be on an uptrend, driven by increased demand for middle distillates and widening lightheavy spreads Refining has to be upbeat to support our bullish view on the stock given the reduced contribution from E&P after the BP deal. RILs 62mmtpa refining capacity at Jamnagar is contributing 35% to its EBITDA, which will likely improve to >40% in FY12E-13E as GRMs scale up to US$11/bl levels. RILs GRMs are currently averaging at US$10/bl and are expected to strengthen further in Q1FY12 as the driving season begins in the US. We conservatively estimate RILs FY12E GRMs to be US$10.5/bl, considering the increased volatility in crude based on the political crisis in the Middle East and North Africa. Chart 1: GRM trend
14 12 10 (US$/bbl) 8 6 4 2 0 2005 2006 2007 2008 2009 2010 2011 Rotterdam Complex Mediterranean Complex Singapore Complex WTI Crack
Note: Average yearly GRMs, for 11 till March 31, 11 Source: Reuters
Room for further premium expansion

A key advantage that RIL enjoys due to its high complexity is its premium over benchmark Singapore GRMs. We expect the recent revival in global GRMs to sustain they are expected to improve with the global economic recovery. We expect RILs premium over Singapore GRM to stabilise at ~US$4/bl. Historically, the premium has touched US$8/bl, led by strong expansion in gas-oil spread along with the increase in Arab light-heavy spread. Hence, there is room for further premium expansion, primarily from increase in light-heavy spread, if long-term crude price sustains above US$100/bl.
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Reliance Industries, April 4, 2011 Chart 2: Light-heavy spreads Light-heavy spread expected to rise further because of the MENA region unrest
28 24 20 (US$/bbl) 16 12 8 4 0 (4) Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Light-Heavy (Arab) WTI Vs Maya
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Mean (Arab) Mean (WTI-Maya)
Oct-09
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Oct-10 Q3FY11
Source: Bloomberg
A key long-term catalyst to trigger the expansion of RILs premium over benchmark Singapore complex GRM is RILs petcoke gasification project (commissioning planned at the Jamnagar refining complex). Post the commissioning of the project (expected in three years), the Nelson complexity of the Jamnagar complex will likely increase beyond 14 (from 12.8 for the 62mntpa combined capacity), leading to higher spreads over benchmark Singapore margins. We await more clarity in the next 2-3 months, after which we will factor it in our valuations. Chart 3: RILs premium over Singapore Complex GRM RILs premium over Singapore complex can retest previous highs
15 12 (US$/bbl) 9 6 3 0 Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 RIL's GRM Singapore Complex GRM
Source: Company, Bloomberg
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Apr-11
Reliance Industries, April 4, 2011 Chart 4: OPEC spare capacity Reduction in OPEC spare capacity due to MENA unrest could add more heavy crude supplies in the market
8 7 6 (mn bl/d) 5 4 3 2 1 0 Oct-06 Oct-07 Oct-08 Oct-09 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10
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Oct-10
Note: Bloomberg figure varies with IEA figures which put effective spare capacity, excl. Libya at 4.08mb/d Source: Bloomberg, February 11 number for spare capacity excludes Libyas spare capacity
Refining to contribute significantly to overall valuations

Asian refiners trade at a premium to global refiners We have valued RILs refining business at 7x FY13E EV/EBITDA, in line with Asian and global peers. The global multiples for refining companies have been averaging at ~6.6x, but Asian peers have been averaging at 7.4x. We expect the Asian refiners to continue to command a premium due to strong local demand and higher utilisation. Although RILs refining business can command a premium over global peers considering higher profitability due to economies of scale and the fully-integrated facility at Jamnagar, we still ascribe 7x FY13E EBITDA (more than the global average, but lower than the Asian average) considering RILs focus on exports and vulnerability to the global demand-supply environment. Historically, RILs operating rate for its refinery has been at ~100%, way higher than the global average. We ascribe Rs458/share value to refining, ~38% of RILs fair value. The companys superior operational efficiency vis--vis international peers make the refining business an excellent play on the global economic recovery. Table 1: Refinery Snapshot
(Rs mn, Year ending March 31) Refining sales % growth EBITDA EBITDA (%) EBIT EBIT (%) Source: I-Sec Research FY11E 1,771,555 8.03 136,737 7.72 99,125 5.60 FY12E 2,080,222 17.42 182,291 8.76 139,679 6.71 FY13E 2,132,930 2.53 196,033 9.19 148,421 6.96
Table 2: Refinery Valuations

(Rs mn) FY13E EBITDA EV (7x EBITDA) EV (Rs/share) Source: I-Sec Research 196,033 1,372,231 458
Feb-11
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
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Reliance Industries, April 4, 2011 Table 3: Valuations for international peers Refinery
(Rs mn, Year ending March 31) EV/EBITDA (x) FY12E/ FY13E/ CY11E CY12E Valero Energy Corp 4.64 4.52 S-Oil Corp 9.58 8.79 Sunoco Inc 7.90 6.62 Cosmo Oil 6.42 5.91 Thai Oil PCL 8.00 7.52 Tesoro Corp 4.80 4.54 Frontier Oil Corp 5.29 5.85 Motor Oil Hellas Corinth Refineries SA 6.22 5.94 New Zealand Refining 6.39 5.91 Chennai Petroleum 4.64 4.52 Average 6.58 6.18 Source: Bloomberg, I-Sec Research P/BV (x) FY12E/ FY13E/ CY11E CY12E 1.05 0.95 3.22 2.74 1.72 1.59 0.68 0.64 2.13 1.93 1.13 0.97 2.41 2.14 2.26 2.00 1.05 1.84 1.98 1.86 0.95 1.64
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P/CF (x) FY12E/ FY13E/ CY11E CY12E 5.17 4.94 12.14 10.98 8.77 6.99 2.86 2.64 8.22 7.95 4.93 4.37 7.43 8.30 5.48 7.08 5.17 6.90 4.92 6.33 4.94 6.38 P/E (x) FY12E/ FY13E/ CY11E CY12E 10.51 8.90 12.84 11.75 25.50 16.98 9.09 8.10 12.42 11.77 12.27 10.73 10.83 11.85 8.14 12.70 10.51 12.70 7.54 10.86 8.90 10.94
Refining Valuation assumptions

FY12E and FY13E Singapore GRMs at US$6.5/bl and US$7/bl respectively RILs premium to Singapore GRM increased to US$4/bl for both FY12E & FY13E Overall refinery utilisation at 98% through FY12E-13E Average GRMs US$10.5/bl in FY12E and US$11/bl in FY13E
Valuations highly sensitive to GRMs

Every US$1 change in RILs GRMs impacts our fair value Rs46/share Refining valuations are highly sensitive to GRMs, which move in tandem with the global demand-supply dynamics. Lower-than-expected average GRMs can significantly impact refining valuations and hence, the stock. Our sensitivity analysis captures the impact on refining valuations (Table 4). We have factored in FY12E-13E US dollar-rupee rate of Rs46. Table 4: Sensitivity Refining value
(Rs/share) US$/Rupee 44.0 45.0 46.0 47.0 48.0 Source: I-Sec Research 10.0 389.4 400.6 411.8 422.9 434.1 10.5 411.8 423.4 435.1 446.8 458.5 GRMs (US$/bbl) 11.0 434.1 446.3 458.5 470.6 482.8 11.5 456.4 469.1 481.8 494.5 507.2 12.0 478.7 492.0 505.2 518.4 531.6
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E&P BP deal assuages valuation concerns

We value E&P at US$24bn, inline with the BP deal. The deal creates a strong bottom for E&P valuations BP bought 30% stake in RILs 23 NELP blocks for US$7.2bn, indicating a bottom to RILs E&P valuation at US$24bn. E&P concerns still exist, but the deal has generated strong expectations that such issues will be resolved soon. We, however, expect D6 production to peak at 87mmscmd by end-FY13E, in line with the recent comments by the MoPNG. We value E&P at Rs354/share, in-line the BP deal valuation. However, BPs technical expertise might aid further reserve upside from the KG Basin.
BP deal creates a bottom for E&P valuations.

BP will buy 30% in RILs 23 blocks, mostly on the East Coast this will also include the producing KG D6 block. Also, a 50:50 joint venture (JV) will be formed between the two companies for sourcing and marketing gas in India. The JV will partner in creating infrastructure for receiving, transporting and marketing natural gas in India. The partnership will combine BPs proven deepwater exploration and development capabilities with RILs project management and operations expertise. BP will pay RIL US$7.2bn and completion adjustments for the 30% interests to be acquired in the 23 production sharing contracts. Future performance payments of up to US$1.8bn could be paid based on exploration success (that will result in development of commercial discoveries). These payments and combined investment could amount to an overall commitment of US$20bn for BP over the next 10-20 years. Hence, a 30% stake at US$7.2bn values the entire stake for the 23 blocks at US$24bn. If we add the performance payment of US$1.8bn, the overall value goes up to US$30bn. The net value attributable to RIL for the transaction is ~US$23.8bn.
BP deal valuations
Assuming that the value is generated through all the 23 prospective blocks, including D6, RILs net stake in these blocks post this transaction would average at 66.7%. Grossing up the entire valuation based on cash consideration of US$7.2bn, the value attributable to RIL would be US$23.2bn. If we include the discounted value (over 10 years) of US$1.8bn cash incentives, the overall valuations stand at US$23.8bn. Table 5: BP valuation for RILs 23 blocks
(US$ bn) RIL's average stake in the blocks before the deal (%) RIL's average stake in the blocks after the deal (%) Cash payment for 30% stake by BP Gross valuation for these 24 blocks Net value for RIL Add cash Total value for RIL Performance linked cash incentive Discounted value of incentives over 10 years Net value for RIL incentives Source: I-Sec Research 97 67 7.2 24 16.0 7.2 23.2 1.8 0.6 23.8
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Reliance Industries, April 4, 2011 Table 6: Block details for transaction

Basin KG Basin Block KG-DWN-98/1 (D4) KG-DWN-98/3 (D6) KG-DWN-2001/1 (D9) KG-DWN-2003/1 (D3) KG-DWN-2004/4 (D13) KG-DWN-2004/7 (D16) MN-DWN-98/2 (MND10) MN-DWN-2003/1 (MNDV4) MN-DWN-2004/1 (MND17) MN-DWN-2004/2 (MND18) MN-DWN-2004/3 (MND19) MN-DWN-2004/4 (MND20) MN-DWN-2004/5 (MND21) NEC-OSN-97/2 (NEC25) NEC-DWN-2002/1 D9 CY-DWN-2001/2 (D5) CY-PR-DWN-2001/3 (D6) CY-PR-DWN-2001/4 (D7) PR-CY-DWN-2001/1 (PRD8) CB-ONN 2003/1 (CB10) AS-ONN-2000/1 (AS17) KK-DWN-2001/1 (D1) KK-DWN-2001/2 (D2) Exploration rounds NELP I NELP I NELP III NELP V NELP VI NELP VI NELP I NELP V NELP VI NELP VI NELP VI NELP VI NELP VI NELP I NELP IV NELP III NELP III NELP III NELP III NELP V NELP II NELP III NELP III Acreage (Sqkms) 6,700 7,645 11,605 3,280 11,904 11,856 7,195 17,050 9,885 11,813 11,316 8,822 10,454 9,461 25,565 14,325 8,600 10,590 8,255 635 6,215 27,315 31,515 272,001 RIL stake (%) 70 60 60 60 70 70 70 55 70 70 70 70 70 60 70 70 70 60 70 70 60 70 70
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BP stake (%) 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 10 Hardy (%) Niko (%) 10 10 10
Mahanadi Basin / North East Coast
15
10
Cauvery/ Palar Basin
10
Cambay Onland Upper Assam Basin Kerala Konkan Total Source: RIL, BP plc
Volume ramp-up schedule still unclear

Timeline for D-6 production ramp-up to peak is critical RILs flagship deepwater KG-D6 block in the Krishna-Godavari Basin was awarded to RIL and Niko Resources (NIKO) under NELP-1. RIL, as the operator of the block, holds 60% of the participating interest, whereas BP holds 30% and NIKO the remaining. Although the successful commissioning of this block was another proof of RILs impeccable project execution skills, the recent production decline has raised serious skepticism on block prospects. At a peak production of 87mmscmd, gas from KG D6 was to address ~50% of Indias gas demand. The timeline of achieving this peak production is unclear and the managements inability to provide any guidance adds to the uncertainty. Although the BP deal has addressed a major concern on block prospectivity, the management is still to provide clarity on gas volume ramp-up schedule.
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Key issues yet to be resolved

Pricing freedom. As per the management, RIL is awaiting clarity on pricing for incremental production from the KG Basin blocks. The company believes that incremental production from other blocks will not be viable at the price of US$4.2/mmbtu approved by the Government for the D6 block. We expect RIL to come out with clarity on most pending issues the production ramp-up at D6 or the timelines for developing NEC 25 and D6 satellite discoveries post the approval of higher gas pricing. Approval delays. RIL has been facing approval delays as regards some of its filings with the Directorate General of Hydrocarbons (DGH), given the revised capex plans for D6, notification of discoveries in some exploratory blocks and development plans of some blocks. The company has filed a formal complaint to the MoPNG. We believe the formal settlement of such issues will take time, which could add to the uncertainty over development plans. Tax benefits. The Government had rolled back the tax benefits on gas production in the FY09 Budget. The Government also changed the definition for mineral oil to exclude natural gas, due to which RIL lost on tax benefits on gas production from the D6 block. As per the industry, the NELP contracts promise tax benefits for exploration of hydrocarbons, which include both crude oil and natural gas. Hence, RIL expects some clarification in the short term before it commits further development capex towards the other blocks.
E&P valued at US$24bn

We value E&P at Rs355/share using DCF given strong cashflows from the D6 block and reserve upsides from other prospective blocks such as NEC 25, D6 Satellite, D3, D4, D9 and CBM. The KG-D6 block forms a major portion of RILs overall E&P valuation of Rs355/share, contributing ~62% to the overall value (Table 7). Other blocks can generate an overall upside of Rs135/share, assuming reserve estimates from NIKO, Hardy Oil reports (NELP blocks) and DGH estimates for the CBM blocks. Table 7: Block-wise valuations
Block D6 (KG-DWM-98/3) Possible upsides (gas) from D6 Possible upsides (oil) from D6 D6 total Potential upsides D4 NEC 25 D9 GS-O1 offshore Cauvery basin Total CBM (5 Blocks) Sohagpur east Sohagpur west Sonhat North Barmer 1 Barmer 2 CBM total Total Source: I-Sec Research RILs share (mboe) 2,548 679 52.2 3,279 247.5 717 270 43.2 315 1,278 173 153 107 299 276 1,007 5,564 Total EV EV/boe (US$ mn) (US$) 12,735 5.0 2,366 3.5 470 9.0 15,571 4.7 863 3,021 941 151 1,098 4,976 603 533 372 1,043 962 3,512 24,058 3.5 4.2 3.5 3.5 3.5 3.9 3.5 3.5 3.5 3.5 3.5 3.5 4.3 Value/ share (Rs) 177 36 7.2 220 13 34 14.5 2.3 16.9 81 9.3 8.2 5.7 16.0 14.8 54 354 Comments DCF value EV/boe multiple EV/boe multiple
EV/boe multiple DCF and EV/boe multiple EV/boe multiple EV/boe multiple EV/boe multiple
EV/boe multiple EV/boe multiple EV/boe multiple EV/boe multiple EV/boe multiple
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Key assumptions for DCF KG D6 block

Cost of equity at 13.3% Peak production of 87mmscmd from end-FY13E Gas price at US$4.2/mmbtu till FY14E and at US$5.2/mmbtu thereafter Cumulative capex at US$12bn
Strong portfolio of exploratory blocks offer high reserve accretion potential

Potential upsides from approval of FDP for NEC25 and higher reserve accretion from D4, D3 & D6 satellite blocks NEC 25. RIL is the operator of the block with 60% working interest and BP and Niko hold the remaining 30% and 10% respectively. This block covers 9,461 sqkms in the Mahanadi Basin, off the East Coast of India. The company has fulfilled its capital commitments for the block and is currently drilling under a six well programme. A development plan was previously submitted for six of the discoveries. A separate commerciality report for the successful AJ wells will be prepared when drilling is completed. RIL has 13 gas discoveries in the NEC 25 block, which have been declared commercial by the DGH. The company has submitted the development plan for six of these discoveries to the DGH, which would be disclosed on approval. As per Niko Resources, the initial estimate for production from this block was ~8.2mmscmd. However, based on the later presentation, after factoring in the incremental four discoveries, Niko now expects the production to spike 2-3x. The Niko management has sounded extremely positive on the block and expects significant reserve upside. Mahanadi D4. RIL is the operator with 55% stake, while BP and Niko hold the remaining 30% and 15% interests. The block is currently in the exploration phase, and covers more than 17,000 sqkms on the east coast. The commitment for Phase I exploration includes seismic work and drilling three exploration wells. Originally, the work was to be completed by September 09. However, the Government has approved a blanket extension of up to three years for this and other deepwater blocks, under the three-year drilling moratorium for the deepwater blocks. The seismic work has been completed and drilling has commenced from Q2FY11. D3 block Filing for commerciality expected in FY12. The D3 block was awarded to the RIL (90%) and HEPI (10%) consortium under NELP V. RIL is the operator for the block. The company has four gas discoveries in the block (Dhirubai 39, 41, 44 and 52). Four of the six commitment wells have now been drilled on the D3 exploration block. Several material undrilled prospects exist and the timing of drilling the two remaining commitment wells will be determined by the operator of the block. Although early indications are encouraging, the potential extent and commerciality of the discoveries are yet to be established. However, in the recent reserve evaluation conducted by Gaffney, cline and associates (GCA) in December 10, the gross risked resource estimates (best estimates) for this block are at 3.7tcf.
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Reliance Industries, April 4, 2011 Table 8: D3 reserve estimates

Gross prospective resources bcf Prospects Pleistocene Sand 2 (Central & Northern) Pleistocene Plicene Miocene Oligocene Low estimate 103 500 790 766 423 Best estimate 382 1279 1492 1609 1140 High estimate 944 2559 2592 2898 2344
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Gross prospective resources * GCoS(%) 305 993 1,044 1,126 273 3,743 Net to RIL (BCF) 183 595 626 675 164 2,246
RILs share (%) 60% 60% 60% 60% 60% Total (bcf)
GCoS: Geological Chance of Success Source: GCA competent Person Report, Hardy Oil
D9 block Disappointing drilling results. D9 is a deepwater block in the KG Basin covering 11,605 sqkms of area. RIL holds 60% in the block, while BP and Hardy Oil hold 30% and 10% respectively. RIL has started phase II exploration work in the block and has till date drilled two wells. Both the wells failed to deliver any significant hydrocarbon potential and were abandoned. The resource estimates on the Hardy Oil website have been significantly reduced to 4.7tcf from 10.8tcf (estimated in 09). It is unclear what strategy will RIL adopt as an operator for further drilling programme in this block, to maximise the commercial potential of the block. Table 9: D9 reserve estimates
(BCF) Gross prospective resources Prospects C1 Pliocene Northern Anticline (NW Flank B1)/U. Miocene Central Anticline (NW Flank)/U. Miocene Central Anticline (Near B3)/U. Miocene Southern Anticline (SE Flank C1) /U. Miocene Northern Anticline B1/M. Miocene Central Anticline (Near B2)/M. Miocene Southern Anticline C1 /M. Miocene Northern Anticline (near B1)/L. Miocene Central Anticline (Near B2)/L. Miocene Central Anticline (Near A2)/L. Miocene Low estimate 210 900 400 1,000 1,100 1,300 1,300 1,300 1,800 1,300 900 Best estimate 630 2,500 1,100 2,500 2,900 2,500 1,900 1,900 6,300 2,800 2,300 RIL's share High (%) GCoS (%) estimate 1,540 60 25% 5,600 60 20% 2,100 60 20% 5,300 60 20% 6,200 60 10% 4,500 60 20% 2,700 60 20% 2,600 60 15% 15,000 60 15% 5,500 60 19% 4,900 60 15% Prospective Total (bcf) Leads (bcf) Prospective + Lead (bcf) Gross prospective resources GCoS (%) 158 500 220 500 290 500 380 285 945 532 345 4,655 35.0 4,690 Net to RIL (BCF) 95 300 132 300 174 300 228 171 567 319 207 2,793 21 2,814
GCoS: Geological Chance of Success Source: GCA competent Person Report, Hardy Oil
Coal-bed methane blocks. RIL has a portfolio of five coal-bed methane (CBM) blocks awarded in the past three rounds. The company plans to begin production from the Sohagpur CBM block by end-11 and expects a peak production of 5mmscmd from these blocks over the next two-three years (Table 10). Table 10: Reserve estimates of CBM blocks
Block CBM (five blocks) Sohagpur west Sohagpur east Sonhat North Barmer 1 Barmer 2 Total Source: DGH Stake (%) 100 100 100 100 100 In place reserves (mboe) 233 308 213 598 552 1,904
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International blocks Still in the initial stages of exploration. RIL has a portfolio of 11 international blocks with 80,000 sqkms acreage distributed across Yemen (three blocks), Oman (two blocks), Kurdistan (two blocks), Colombia (two blocks), East Timor (one block) and Australia (one block). A block in Yemen is the only producing block, with oil production of 4,500bpd (Table 11). Table 11: RILs portfolio of international blocks
Block Block K Block 9 Block 18 Rovi Sarta Block 41 Block 34 Block 37 W-06-05 Borojo North Borojo South Block 39 Block 108 Block 141 Source: Company Country East Timor Yemen Oman Kurdisthan Kurdisthan Oman Yemen Yemen Australia Columbia Columbia Peru Peru Peru Location Deepwater Onland Deepwater Onland Onland Deepwater Onland Onland Shallow water Deepwater Deepwater Onland Onland Onland Acreage 2,384 2,234 21,140 516 607 23,850 7,016 6,894 5,760 4,000 4,000 8,903 12,000 5,169 Operator RIL Calvalley RIL RIL RIL RIL RIL RIL RIL RIL RIL Repsol Plus Petro RIL
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ICICI Securities
Petrochemicals Margins to be stable

We expect petrochemicals margins to be robust at the current levels, which have till now surpassed Street estimates. The industry now expects incremental low cost ethylene capacities to be absorbed comfortably by the strong Asian demand, specifically by China and India. RILs predominantly domestic focus is a key advantage, which will ensure >95% utilisation for its petchem capacity. The companys planned capacity expansion will act as a significant trigger for valuations, as the capacities will get commissioned during a favourable margin scenario.
Strong domestic demand & integration, key differentiators

RILs operating levels have remained consistently >90% throughout the entire downcycle in the past 4-5 quarters, led by strong domestic demand. Domestic demand has been resurgent, led by increased investments in infrastructure. Also, product cracks for RIL have been strong, led by integrated operations. The overall Indian polymer industry has grown 13%, led by strong 17% & 9% demand growth in PP & PE respectively (Charts 5-7). Chart 5: Domestic demand for basic chemicals and plastics Domestic plastic and chemical markets to enter into high growth
(MMT) 45 40 35 30 25 20 15 10 5 0 1990
Source: CMAI
12.9%
9.5%
10.7%
+1.1% 2008
1995
2000
2005
2010
2015
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Reliance Industries, April 4, 2011 Chart 6: Domestic polymer demand growth RIL enjoys dominance in the fast-growing polypropylene segment
20% 16% 12% 8% 4% 0% PP PE All Polymers PVC Industry 9M FY11 (YoY)
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Chart 7: Domestic chemical demand growth
15% 12% 9% 6% 3% 0% PBR Benzene LAB BD
FY13E 703,222 2.28 125,508 17.85 88,586 12.60 125,508 878,553 294
Industry 9M FY11 grow th (YoY)
Source: Company presentation
Contribution from petchem at Rs294/share

Petchem multiples can command a premium based on outperformance vis-vis peers We expect EBIT margin from petrochemicals to be stable at 14% in FY12E-13E, led by improved global outlook on polyolefin margins given the strong demand pull from the domestic and Chinese markets. Significant upside to the global margin outlook exists as the European and US markets revive, leading to more-than-expected absorption of Middle East capacities. We have valued the petrochemicals business at 7x FY13E EBITDA, in line with international peers (Table 14). We expect average multiples to expand globally over the next 2-3 years as demand recovery from the developed economies trigger a margin expansion. However, when compared with global peers (naphtha-based crackers), RIL would continue to earn superior returns on account of its fullyintegrated operations and robust domestic demand. RIL will continue to be a dominant player in the domestic petrochemicals industry and would garner >90% of the domestic market share post its planned capacity expansion. Table 12: Petrochemicals Snapshot
(Rs mn. year ending March 31) Petrochemicals sales % growth EBITDA EBITDA (%) EBIT EBIT (%) Source: I-Sec Research FY11E 599,896 8.91 120,073 20.02 85,152 14.19 FY12E 687,520 14.61 119,142 17.33 83,220 12.10
Table 13: Petrochemicals Valuations

(Rs mn) FY13E EBITDA EV (7x EBITDA) EV (Rs/share) Source: I-Sec Research
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EV/EBITDA (x) P/BV (x) P/CF (x) PE (x) FY12E/ FY13E/ FY12E/ FY13E/ FY12E/ FY13E/ FY12E/ FY13E/ CY11E CY12E CY11E CY12E CY11E CY12E CY11E CY12E 13.47 12.94 2.30 2.23 12.78 12.82 11.80 11.20 11.93 14.29 1.28 1.21 6.40 11.37 8.55 12.00 7.84 7.04 3.37 2.67 11.31 9.66 12.78 11.32 4.53 4.41 1.17 1.08 5.37 5.05 13.10 11.06 8.61 7.87 1.58 1.44 7.59 7.10 17.39 15.39 4.37 4.20 1.11 1.04 6.23 5.90 13.52 11.98 6.25 5.93 1.30 1.18 4.37 4.30 14.85 12.36 7.06 6.56 0.75 0.73 3.12 3.16 11.44 13.64 13.47 12.94 2.30 2.23 12.78 12.82 11.80 11.20 8.01 7.91 1.61 1.45 7.15 7.42 12.93 12.37
Table 14: Petrochemicals Valuations of international peers
SABIC Sinopec Shanghai Petrochemical LG Chem Asahi Kasei Toray Industries Inc Kuraray Teijin Mitsui Chemicals Honam Petrochemical Average Source: Bloomberg
Expansion projects, revival of off-gas based crackers Next big trigger

RIL had announced plans to set up an off-gas based cracker and downstream units at Jamnagar. The cracker with ~1.8mntpa ethylene capacity will probably be one of the largest crackers globally, providing economies of scale. Also, since the cracker is offgas based, we expect EBITDA margin to reach GAILs current EBITDA margin at >50%. However, the cracker is expected to start operations only after three years from the announcement date (more clarity to emerge from April FY12). RIL intends to expand its polyester capacity by 1.4mmtpa in PX, 2.3mmtpa in PTA, 0.54mmtpa in PET and by 0.36mmtpa in PFY. The overall investment in these expansion projects is ~US$12bn the projects are expected to get commissioned in FY14. We are waiting for RIL to announce precise details for the investments in these projects (probably by May 11), after which we will capture it in our valuations. The timing of the projects seems strategic and RIL expects to benefit from a potential super-cycle in petchem (expected to start in FY14).
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Valuations
Profitability expansion to drive valuations
Increased contribution from the high-margin oil & gas business along side gradual expansion in refining and petchem margins would drive RILs EPS CAGR to 24% over FY10-13E. Led by the divestment of 30% stake to BP in its 24 key E&P blocks, RILs refining business will continue to contribute the most to overall EBIT in the next 2-3 years and will likely touch a peak of 42% in FY13E as the companys GRMs expand to US$11/bl. Also, petchem capacity expansion, post FY14, will likely lead to increased contribution from the segment to overall EBIT. Therefore, the cyclical upturn in the refining and petrochemicals businesses is critical for RILs valuation expansion, while E&P would continue to provide cashflow expansion triggers for the company. Table 15: Segment-wise EBIT contribution
(Rs mn, year ending March 31) Petrochemicals % total Refining % total Oil & Gas % total Others % total Total Source: I-Sec Research FY10 85,520 43.12 58,270 29.38 54,130 27.29 430 0.22 198,350 FY11E 85,152 29.52 99,125 34.37 103,849 36.00 320 0.11 288,445 FY12E 83,220 24.86 139,679 41.72 111,497 33.30 400 0.12 334,796 FY13E 88,586 25.36 148,421 42.48 111,887 32.03 480 0.14 349,374
Reinitiate with BUY

We have valued RIL on SOTP at 1,197/share, indicating a 16% upside from the current levels. We have valued the cyclical businesses, petchem and refining, at 7x FY13E EBITDA. The KG D6 block has been valued using DCF and potential reserve upside (as per the data available) through EV/boe. RILs key cyclical businesses refining and petchem are expected to drive the companys profitability in the next 2-3 years as the developed economies stabilise and converge back to demand growth scenarios. In our view, the current stock price is not pricing in the revival in GRMs and additional triggers from the E&P assets post the RIL-BP deal. We expect global GRMs to remain robust and with ~40% of RILs EBIT accruing from refining, the companys overall profitability is expected to be robust over the next 2-3 years. Also, triggers exist in the form of faster-than-expected ramp-up in KG D6 gas production as technical and regulatory issues get addressed. RILs US$7.2bn cash compensation from BP and its technical expertise provides its E&P business with tremendous flexibility to accelerate the development of other prospective discoveries in the KG Basin. Investment in RIL will provide a unique combination of an ideal long-term play on the global economic recovery through refining and petchem and robust domestic consumption story through oil&gas production and retail businesses. Reinitiate with BUY.
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Reliance Industries, April 4, 2011 Table 16: RIL SOTP valuations

Refining Oil and gas production Petrochemicals Core business enterprise val Reliance Retail Marcellus Shale Acquisition Eagle ford shale E&P business KG D6 valuation Other blocks E&P business valuation Enterprise value Net debt (net of warrants inflow, investments made in E&P assets) Value per share (on existing business) SEZ Total value per share Source: I-Sec Research (Rs mn) 1,372,231 140,343 878,553 2,391,126 60,000 16,317 8,015 657,635 401,374 1,059,009 3,534,467 (5,195) 40,000 Per share value 458 47 294 799 20 5 3 220 134 354 1,181 (2) 1,183 13 1,197
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Comment FY13E EV/E of 7x FY13E EV/E of 7x FY13E EV/E of 7x Total investments made till date
DCF Valuation of risked reserves
Adjusted FY12 net debt Total investment made till date
Rising cash reserves to be invested into core businesses

We expect RILs >US$8bn annual cashflows to be invested in its core businesses Petchem, Refining and E&P. Concerns exist as reportedly, RIL is unable to finalise new investment avenues for its burgeoning cash reserves, especially after its failed Lyondell Basell bid and delays in E&P investments. However, the company now plans to build on its investment plan announced in Petchem and Refining. RIL intends to expand its polyester capacity by 1.4mmtpa in PX, 2.3mmtpa in PTA, 0.54mmtpa in PET and by 0.36mmtpa in PFY. The overall investment in these expansion projects is ~US$12bn the projects are expected to get commissioned in FY14. The company would implement the Petcoke regasification project (~US$1bn) at its Jamnagar refining complex, which would help raise its complexity. Also, RIL has committed US$5-7bn investments in the Shale gas businesses in the US (JVs in Marcellus and Eagle Ford shale acreages), which would contribute to its consolidated EBITDA from FY14-15. However, we believe RILs biggest investment outgo would be in developing its discoveries on the east coast. Together these discoveries have the potential to eat away at least US$20-30bn investments in the next 5-10 years, since most of these exist in high-cost deepwater basins. These investment estimates can change significantly (on the higher side) over the course of time, as the size of reserves and development plans undergo drastic changes. Table 17: RILs cashflows
(Rs bn) Operating cashflow Working capital changes Capital commitments Free cashflow Source: Company data, I-Sec Research FY09 198.3 230.2 (688.8) (260.3) FY10 200.3 (155.0) (168.1) (122.8) FY11E 291.2 (7.6) (91.9) 191.7 FY12E 330.9 (6.2) (346.2) (21.5) FY13E 368.9 (7.5) (320.0) 41.4
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Key risks to our call

If crude prices continue to rise, demand for refined products could come under downward pressure and affect RILs GRMs. Slowdown in global economic growth, either due to high crude prices or from other factors could impact RILs refining and petrochemical margins. Major changes in estimation of hydrocarbon reserves in the companies E&P blocks can have a significant impact on the valuations. Change in government levies like Royalty or taxation policies for the blocks that the company is currently producing from can have a major impact on valuations.
Chart 8: Rolling Price/EPS trend

2,000 1,600 1,200 (Rs) 800 400 0 Apr-02 Aug-02 Dec-02 Apr-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11
19x 16x 13x 10x 7x
Chart 9: Rolling EV/EBITDA trend

2,000 1,600 EV/ Share (Rs) 1,200 800 400 0 Apr-02 Aug-02 Dec-02 Apr-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11
11x 9x 7x 5x
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Annexure 1: Consolidated financials

Table 18: Profit & Loss statement
(Rs mn, year ending March 31) Gross Sales Less: Interdivisional sales Less: Excise Duty Net Sales of which Export Sales of which Domestic Sales Other Operating Income Total Operating Income Less: Raw Material Consumed Other Manufacturing Expenses Power and Fuel Personnel Expenses Selling and Distribution Expenses Other Expenses Less Amounts Capitalised Total Operating Expenses EBITDA Depreciation & Amortisation Other Income Net Other Income EBIT Less: Net Interest Recurring Pre-tax Income Add: Extraordinary Income/exp(+)/(-) Less: Taxation --Current Tax --Deferred Tax Add share of inc of Associates minority interest Net Income (Reported) Recurring Net Income Source: Company data, I-Sec Research (184) 149,687 149,687 (796) 245,031 158,976 FY09 1,823,834 265,949 45,645 1,512,240 625,823 1,198,011 1,512,240 FY10 2,428,741 311,470 79,874 2,037,397 857,775 1,570,966 2,037,397 FY11E 2,537,692 225,638 78,863 2,233,191 1,844,122 693,570 2,233,191 FY12E 2,926,890 266,883 91,709 2,568,298 2,126,386 800,504 2,568,298 FY13E 3,015,292 273,791 93,860 2,647,641 2,191,074 824,218 2,647,641
1,124,261 48,557 38,489 30,176 33,725 36,616 33,805 1,278,019 234,222 56,510 19,142 19,142 196,854 18,163 178,691 -
1,546,027 56,430 31,408 27,909 44,526 34,338 12,179 1,728,458 308,939 109,458 21,858 21,858 221,339 20,596 200,743 86,056
1,684,208 42,678 32,481 26,320 46,760 25,046 1,857,493 375,698 115,597 28,344 28,344 288,445 33,758 254,688 -
1,983,273 36,769 32,541 27,205 46,928 24,524 2,151,241 417,057 120,203 37,941 37,941 334,796 24,447 310,349 -
2,020,248 42,395 32,603 28,340 48,596 24,035 2,196,217 451,424 134,948 32,898 32,898 349,374 16,395 332,979 -
12,734 16,454
31,249 11,314
50,759 836 203,093 203,093
61,852 209 135 248,423 248,423
66,363 9 225 266,832 266,832
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Reliance Industries, April 4, 2011 Table 19: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Less: Revaluation Reserve Total Fixed Assets Total Assets FY10
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FY11E
FY12E
FY13E
227,421 201,096 48,450 110,018 476 587,461
138,908 343,933 100,829 106,472 914 691,057
464,242 385,489 113,230 108,599 3,658 1,075,217
352,171 441,433 134,822 109,606 4,162 1,042,194
199,714 450,779 139,605 110,460 4,588 905,146
345,011 12,559 31,150 388,720 198,741
381,256 7,650 36,950 425,856 265,201
425,334 16,600 35,167 477,102 598,115
497,106 19,412 33,474 549,992 492,202
506,228 19,782 31,865 557,875 347,271
25,964 38,391 64,355
24,043 107,079 131,123
39,298 107,079 146,378
61,244 107,079 168,323
86,776 107,079 193,855
1,571,824 501,382 1,070,442 738,460 122,298 1,686,604 1,949,700
2,241,253 639,340 1,601,913 170,337 94,137 1,678,113 2,074,436
2,398,713 754,937 1,643,776 89,492 94,137 1,639,131 2,383,623
2,520,378 875,140 1,645,238 292,113 94,137 1,843,214 2,503,739
2,814,816 1,010,088 1,804,728 292,113 94,137 2,002,705 2,543,831
LIABILITIES AND SHAREHOLDERS' EQUITY Borrowings Short Term Debt Long Term Debt Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital No. of Shares outstanding (mn) Face Value per share (Rs) Minority Interest Reserves & Surplus Share Premium General & Other Reserve Less: Misc. Exp. not written off Less: Revaluation Reserve Net Worth Total Liabilities & Shareholders' Equity Source: Company data, I-Sec Research
84,396 678,170 762,566 95,513
80,550 565,506 646,055 106,776
80,550 485,506 566,055 107,611
80,550 373,506 454,055 107,820
80,550 163,428 243,977 107,829
14,439 1,444 10 1,389
29,780 2,978 10 5,735
29,862 2,986 10 5,735
29,944 2,994 10 5,735
30,026 3,003 10 5,735
453,644 744,482 36 122,298 1,091,621 1,949,700
453,941 926,309 23 94,137 1,321,605 2,074,436
464,398 1,304,121 23 94,137 1,709,956 2,383,623
474,855 1,525,490 23 94,137 1,941,864 2,503,740
485,312 1,765,111 23 94,137 2,192,025 2,543,832
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Reliance Industries, April 4, 2011 Table 20: Cashflow statement

(Rs mn, year ending March 31) FY09 Cash Flow from Operating Activities Reported Net Income Add: Depreciation & Amortisation Provisions Deferred Taxes Less: Other Income Net Extra-ordinary income Operating Cash Flow before Working Capital chg (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Sale of Investments Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Issue of Share Capital during the year Proceeds from fresh borrowings Dividend paid including tax Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d) + (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 178,965 (69,654) 153,093 51,953 18,605 20,599 203,053 FY10 145,045 111,828 12,000 25,236 243,638
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FY11E 203,093 115,597 836 28,344 291,181
FY12E 248,287 120,203 209 37,941 330,757
FY13E 266,607 134,948 9 32,898 368,666
(5,892) 16,562 49,784 247 109,886 6,752 177,339 380,391
(125,523) (72,925) 27,743 (435) 45,096 2,364 (123,679) 119,958
(41,555) (12,400) (2,126) (2,744) 44,078 7,168 (7,580) 283,601
(55,945) (21,593) (1,008) (504) 71,772 1,119 (6,158) 324,599
(9,346) (4,783) (853) (427) 9,121 (1,239) (7,526) 361,140
(267,947) 4,571 (263,376) 117,015
(223,075) (16,221) (239,296) (119,338)
(76,615) (15,255) (91,870) 191,731
(324,286) (21,946) (346,232) (21,633)
(294,438) (25,532) (319,970) 41,170
20,599 20,599
(105,336) 25,235 (80,101)
201,571 29,019 230,590
39,775 39,775
35,216 35,216
286,499 374,248 (22,195) 41,351
8,613 6,174 (23,949) 129,784 -
10,539 (80,000) (26,852) (96,312) 325,334
10,539 (112,000) (26,919) (128,380) (112,072)
10,539 (210,078) (26,986) (226,525) (152,457)
42,801 221,765 178,965
221,765 152,270 (69,495)
152,270 477,604 325,334
477,604 365,532 (112,072)
365,532 213,075 (152,457)
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Reliance Industries, April 4, 2011 Table 21: Key ratios

(Year ending March 31) FY09 Per Share Data (in Rs.) EPS(Basic Recurring) Diluted Recurring EPS Recurring Cash EPS Dividend per share (DPS) Book Value per share (BV) Growth Ratios (%) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF Operating Ratio Raw Material/Sales (%) SG&A/Sales (%) Other Income / PBT (%) Effective Tax Rate (%) NWC / Total Assets (%) Inventory Turnover (days) Receivables (days) Payables (days) D/E Ratio (x) Return/Profitability Ratio (%) Recurring Net Income Margins RoCE RoNW Dividend Payout Ratio Dividend Yield EBITDA Margins Source: Company data, I-Sec Research 45.6 44.9 61.8 5.8 327.3 FY10 48.6 48.0 81.1 7.0 399.1
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FY11E 61.9 61.3 96.2 7.0 516.4
FY12E 75.6 75.0 111.3 7.0 586.4
FY13E 81.0 80.6 121.3 7.0 662.0
10.3 1.2 1.2 (2.7) 0.1
34.7 31.9 6.2 7.0 31.1
9.6 21.6 27.8 27.8 18.7
15.0 11.0 22.3 22.3 15.7
3.1 8.2 7.4 7.4 9.0
23.1 16.7 3.2 14.9 2.3 8.1
21.6 12.8 2.6 11.3 1.7 76.9
16.9 10.8 2.0 8.2 1.4 10.9
13.8 9.3 1.8 7.4 1.2 9.5
12.8 8.5 1.6 6.7 1.2 8.4
63.2 1.9 10.7 16.3 (1.5) 59.1 10.9 93.0 78.6
65.8 1.9 10.9 21.2 6.1 60.9 11.2 85.7 57.0
68.5 1.9 11.1 20.3 5.6 75.7 15.4 87.4 39.4
70.0 1.7 12.2 20.0 5.6 73.5 15.5 84.9 28.9
69.2 1.7 9.9 19.9 5.8 77.7 16.6 90.6 16.0
9.8 10.2 15.2 14.8 0.6 15.5
7.7 9.2 13.2 15.1 0.7 15.2
9.0 10.8 13.4 13.2 0.7 16.8
9.5 11.4 13.6 10.8 0.7 16.2
10.0 11.5 12.9 10.1 0.7 17.1
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Tables
Table 1: Refinery Snapshot .............................................................................................45 Table 2: Refinery Valuations............................................................................................45 Table 3: Valuations for international peers Refinery........................................................46 Table 4: Sensitivity Refining value...................................................................................46 Table 5: BP valuation for RILs 23 blocks ...........................................................................47 Table 6: Block details for transaction..................................................................................48 Table 7: Block-wise valuations............................................................................................49 Table 8: D3 reserve estimates ............................................................................................51 Table 9: D9 reserve estimates ............................................................................................51 Table 10: Reserve estimates of CBM blocks......................................................................51 Table 11: RILs portfolio of international blocks ..................................................................52 Table 12: Petrochemicals Snapshot ................................................................................54 Table 13: Petrochemicals Valuations ..............................................................................54 Table 14: Petrochemicals Valuations of international peers............................................55 Table 15: Segment-wise EBIT contribution ........................................................................56 Table 16: RIL SOTP valuations .......................................................................................57 Table 17: RILs cashflows ...................................................................................................57 Table 18: Profit & Loss statement.......................................................................................59 Table 19: Balance sheet .....................................................................................................60 Table 20: Cashflow statement ............................................................................................61 Table 21: Key ratios ............................................................................................................62
Charts
Chart 1: GRM trend.............................................................................................................43 Chart 2: Light-heavy spreads..............................................................................................44 Chart 3: RILs premium over Singapore Complex GRM.....................................................44 Chart 4: OPEC spare capacity............................................................................................45 Chart 5: Domestic demand for basic chemicals and plastics .............................................53 Chart 6: Domestic polymer demand growth .......................................................................54 Chart 7: Domestic chemical demand growth ......................................................................54 Chart 8: Rolling Price/EPS trend.........................................................................................58 Chart 9: Rolling EV/EBITDA trend ......................................................................................58
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Equity Research
ONGC
Value buy
Target price Rs338
BUY
Rs293

Oil and Natural Gas Corporation (ONGC) is Indias largest oil & gas producer with most of its production coming in from the west coast. Hinged by a cash-rich balance sheet, ONGC can comfortably explore inorganic growth opportunities outside India. The company enjoys an excellent E&P portfolio and volume and reserve growth triggers exist. The companys reserves in the KG Basin can see further upside in the short term. ONGC is an excellent defensive play, primarily due to resilient RoE despite subsidy rising to the highest ever levels of US$43/bl. We reinitiate with BUY and a target price of Rs338. Strong reserve accretion potential. The current consolidated reserve base of 9.8bboe offers strong visibility to ONGCs long-term revenues. Though in the past six years, the company has announced >115 discoveries, its large reserve accretions have been through acquisitions. We expect this to change given its discoveries in the prolific KG Basin, indicating major triggers in the next 2-3 years. Also, a strong balance sheet with US$3bn net cash provides flexibility to take the inorganic route. Volume triggers beyond FY13. We expect ONGCs sluggish project execution to change as it starts implementing major projects in the next 2-5 years. The first phase will start in Q1FY12 as ~7mmscmd additional gas production from marginal fields flow in. The next round will be from FY14 as oil production from Project Manik (offshore blocks in KG Basin) starts. Production from these fields is expected at ~15,000bl/day, rising to 100,000bl/day in three phases by FY17E-18E. Gas production from the KG-DWN-98/2 block will start by end-FY17E and is expected to be ~25mmscmd. The reserve potential of this block is being evaluated reserve upside and production triggers likely in the next 2-3 years. ONGC expects production from ONGC Videsh (OVL, the Caraboco project in Venezuela) in FY14, initially at 40,000bl/day (this will fund most of the US$19bn development costs for the block). Post the development, the production is expected to scale up to 400,000bl/day. Excellent defensive play. We expect ONGCs subsidy contribution to be at its highest at US$45/bl in FY12E-13E. Despite this, ONGC should maintain stable RoE at 22-23%, highlighting the excellent defensive nature of its profitability. The stock, therefore, is a value play, especially in a scenario of high crude prices and subsidies.
Market Cap Rs2505.5bn/US$56.2bn ONGD.BO/ONGC IN 8555.49 368/249 25.9 4.7 30,130 (9.4) 6.8 (5.6) 8.3 Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield RoCE (%) RoE (%) FY10 193,458 22.6 0.4 13.0 44.5 5.6 2.8 15.0 20.1 FY11E 259,419 30.3 34.1 9.7 48.9 4.7 3.4 18.4 23.9 FY12E 308,876 36.1 19.1 8.1 54.8 4.0 4.0 19.2 24.5 FY13E 331,305 38.7 7.3 7.6 57.4 3.6 4.2 18.3 22.7
Price chart
375 350 325 (Rs) 300 275 250 225 Aug-10 Nov-10 Mar-11 Jun-10 Apr-10 Jan-11
Reuters/Bloomberg 52-week Range (Rs) Free Float (%) FII (%)
1,017,546 1,255,153 1,353,801 1,392,136
Shares Outstanding (mn)
Rohit Ahuja
Daily Volume (US$'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%)
Prolin Nandu
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ICICI Securities
TABLE OF CONTENT
Strong reserve accretion potential ..............................................................................67 Domestic blocks Upside to reserves likely.................................................................67 Potential triggers from KG-DWN-98/2...........................................................................68 Low success rate, a concern ........................................................................................69 Volume triggers beyond FY13 ......................................................................................71 Excellent defensive play ...............................................................................................72 Subsidies have limited impact on profitability ...............................................................72 Improved profitability led by APM dismantling ..............................................................72 Cashflows support aggressive capex ...........................................................................73 Valuations .......................................................................................................................74 Value buy ......................................................................................................................74 Key risks to our call .......................................................................................................75 International comparison...............................................................................................75 Annexure 1: Financials (consolidated)........................................................................77 Annexure 2: Index of Tables and Charts .....................................................................81
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ONGC, April 4, 2011
ICICI Securities Strong reserve accretion potential

Domestic blocks Upside to reserves likely
ONGC has a portfolio of 164 blocks under various stages of exploration and development, 85 of which were awarded in the NELP rounds. In the past six years, the company has announced >120 discoveries and 45 of these are under production. The company has 12 discoveries in the prolific KG Basin, appraisals for which are underway. These discoveries can provide significant upside to ONGCs reserves in the next 2-3 years. Table 1: NELP performance
NELP discoveries I II III IV V VI VII VIII Total Source: Company data Operated 5 2 11 11 3 24 18 14 88 Phase 1 Status Phase 2 Phase 3 5 1 Comment 7 in KG-DWN-98/3 2 in MN-DWN-98/3 1 in MN-OSN-2000/2 1 in AA-ONN-2001/1 1 in CB-ONN-2002/2
3 8 2 24 16 53
1 8 3 1
13
ONGC had a lower success rate of 41%, mainly due to high number of blocks under exploration
ONGC has been able to maintain a reserve-replacement ratio (RRR) of >1 in the past five years. This has been due to investments in international blocks through OVL and more recently the acquisition of Imperial Energy. The companys current RRR at 1.74 (including the imperial acquisition), based on 3P reserve estimates though, offers some comfort on production growth visibility. However, the RRR is high due to lack of development in some major discoveries. We expect this to change due to better rig availability. ONGC would now be able to accelerate its drilling and development programme, primarily for its blocks in the east coast. In the next 1-2 years, as some of these fields start producing, the decline in overall production will be arrested and will help drive growth. ONGCs KG Basin gas discovery (block KG DWN 98/2) holds tremendous potential. Although the Director General of Hydrocarbons (DGH) has approved 3.2tcf gas reserve as the potential, industry sources expect it to be higher. ONGC has also associated oil discoveries in the other shallow water blocks in the KG basin, from which it expects to start oil production in 11. However, oil production from these discoveries will result in only a marginal increase in production and would more or less arrest the decline in its ageing fields on the west coast (Mumbai High).
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ONGC, April 4, 2011 Chart 1: Increasing reserve replacement

2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06
ICICI Securities
FY07
FY08
FY09
Source: Company data
Potential triggers from KG-DWN-98/2

The KG-DWN-98/2 block can add >6tcf recoverable reserves for ONGC and produce >25mmscmd gas by 17E The KG-DWN-98/2 block sits next to the prolific KG-D6 block of Reliance Industries off the east coast. ONGC has 65% interest in KG-DWN-98/2, Cairn India 10%, Petrobras 15% and Statoil 10%. Petrobras and Statoil have, however, decided to exit the block. ONGC has so far drilled a total of 13 exploratory wells in the 7,294 sqKms block that is divided into northern and southern appraisal areas. As per industry sources, the nine gas discoveries in the northern discovery area (NDA) of this block may hold >3.2tcf of recoverable gas reserves and can yield much more than estimated 25-30mmscmd (post FY17). ONGC has submitted a proposal for declaring these gas discoveries commercially viable. Post approval of commerciality, ONGC would submit a detailed field development plan (FDP) for the discoveries in the northern appraisal areas. The initial estimate for capex is >US$5bn, primarily for production from the Padmawati, Kanakadurga, Annapurna, N-1, D/KT, U, A, W and E gas finds in the NDA. As the discoveries are not independently viable, the firm plans to combine these with finds in the neighboring acreage and develop them as a cluster. An investment requirement of US$4bn is estimated to develop ultra-deep sea UD-1 discovery in the southern part of the KG-DWN-98/2 block. UD-1 is to be developed separately from the NDA. Together with NDA fields, ONGCs total spend would be ~US$10bn. However, DGH is yet to approve the commerciality of UD-1, which is expected to hold >1.9tcf of recoverable gas reserves. The NDA consists of Padmawati, Kanakadurga, Annapurna, N-1, D/KT, U, A, W and E gas finds in water depths ranging from 594 meters to 1,283 metres. The Southern Discovery Area consisting of UD-1 discovery in Ultra deepwater has a depth of 2,841 metres.
68
FY10
ONGC, April 4, 2011
ICICI Securities
Low success rate, a concern
ONGCs average success rate over the past seven years has been at ~41%, lower than its PSU peer Oil India (OIL) at 57%, as more blocks come under ONGCs exploration programme, making it difficult to manage rig procurements on time, especially for offshore shallow and deep water blocks. Therefore, ONGC has struggled to meet its minimum work programme (MWP) commitments for many blocks, resulting in cost over-runs and relinquishment of prospective blocks. The company has drilled 780 wells in the past seven years, 10x more than OIL and higher than any other domestic private company. Table 2: Status of wells drilled
(number of wells) Year Wells drilled 2002-03 150 2003-04 124 2004-05 109 2005-06 106 2006-07 87 2007-08 98 2008-09 106 Total 780 Source: Infraline Hydrocarbon-bearing wells 66 51 43 45 32 50 32 319 % of Hydrocarbon-bearing wells 44.0 41.1 39.4 42.5 36.8 51.0 30.2 40.9
Recently, ONGC addressed rig availability concerns by hiring three deepwater rigs for the long term. The current scenario of high spare capacity in jack-ups offers ONGC a good opportunity to accelerate its drilling programme. ONGC had acquired UK-based Imperial Energy with assets in Western Siberia, Russia, in FY09. Imperial was acquired at US$1.9bn (Rs42/share for ONGC shareholders), at an EV/boe of US$2.06. Given the risks associated with reserve development in Russia and the unfriendly Russian tax regime, the lower multiple for the acquisition is well justified. Current production of Imperial Energy is at 18,000bopd and will likely rise to >45,000bopd in the next 3-5 years. Chart 2: Reserve accretion trend (3P)
90 80 70 60 (mn te) 50 40 30 20 10 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Company data
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ONGC, April 4, 2011 Table 3: Reserve break-up (excluding KG Basin blocks)

(mmboe) ONGC's earlier estimate 1P 2P 3P 916.9 995.5 1,393.2 1,618.3 1,896.3 2,101.8 2,535.2 2,891.8 3,495.0 Audited estimates 1P 2P 3P 983.7 1,757.0 1,975.4 1,426.7 1,706.3 2,117.6 2,410.4 3,463.3 4,093.1
ICICI Securities
Mumbai High Other 63 fields Total Domestic gas (mmtpa) Mumbai High Other 63 fields Total Total Oil Equivalent Uncertified reserves Domestic JV Total
Absolute change 1P 2P 3P 66.8 761.5 582.2 (191.6) (190.1) 15.8 (124.8) 571.5 598.1
1P 7.3 (11.8) (4.9)
% chg 2P 76.5 (10.0) 19.8
3P 41.8 0.8 17.1
356.8 1,817.3 2,174.1 4,709.3 667.5 273.6 5,650.4
436.9 2,541.8 2,978.7 5,870.5 1,181.2 305.5 7,357.2
542.2 3,044.9 3,587.1 7,082.1 1,468.3 321.2 8,871.6
311.8 1,767.8 2,079.6 4,490.0 667.5 273.6 5,431.1
500.2 2,545.9 3,046.1 6,509.3 1,181.2 305.5 7,996.0
589.3 3,098.5 3,687.8 7,780.9 1,468.3 321.2 9,570.3
(45.0) (49.5) (94.5) (219.3) (219.3)
63.3 4.1 67.4 638.8 638.8
47.1 53.6 100.7 698.8 698.8
(12.6) (2.7) (4.3) (4.7) (3.9)
14.5 0.2 2.3 10.9 8.7
8.7 1.8 2.8 9.9 7.9
OVL Fields audited 1,311.4 2,557.6 2,847.5 Not audited 14.6 404.9 418.8 Total OVL 1,326.1 2,962.5 3,266.3 Consolidated total 6,976.5 10,319.7 12,137.9 Source: Company data; recent reserves audit
1,246.1 2,492.3 2,760.2 14.6 404.9 418.8 1,260.8 2,897.2 3,179.0 6,691.8 10,893.2 12,749.4
(65.3) (65.3) (284.6)
(65.3) (65.3) 573.5
(87.3) (87.3) 611.5
(5.0) (4.9) (4.1)
(2.6) (2.2) 5.6
(3.1) (2.7) 5.0
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ONGC, April 4, 2011
ICICI Securities Volume triggers beyond FY13
Volume growth is expected to be within 1-2% till FY13E.
We expect ONGCs volume growth to be 1-2% in FY12E-13E as production from new fields in Brazil, Russia and KG Basin primarily neutralise the production decline from existing fields. Volume expansion for ONGC would kick-in from FY14. ONGC expects production from OVL (the Caraboco project in Venezuela) to be at 40,000bl/day initially (which will fund most of the development costs of US$19bn for the block). Post the development project, the production is expected to scale up to 400,000bl/day. Table 4: Sales volume assumptions
(MMT) Crude oil Natural Gas (BCM) LPG Natural Gasoline / Naphtha Crude oil (US$/bl) Net realisation post subsidies (US$/bl) Source: Company data, I-Sec Research FY09 22.879 20.533 1.029 1.544 88.5 45.8 FY10 22.330 20.598 1.108 1.598 69.9 54.5 FY11E 22.553 20.712 1.130 1.630 86.8 56.8 FY12E 22.779 21.033 1.153 1.663 100 62.2 FY13E 23.234 21.454 1.176 1.696 100 62.3
Table 5: Sales profile

(Rs mn) FY09 Crude oil 407,837 Natural Gas 80,355 LPG 22,752 Natural gasoline / Naphtha 48,406 Ethane / propane 9,890 Superior kerosene oil 16,702 Others 1,526 MS/HSD 72,972 Total 660,439 Source: Company data, I-Sec Research FY10 460,471 73,797 21,924 47,137 10,249 3,256 463 183 617,480 FY11E 436,766 150,532 36,426 58,385 12,446 4,033 233 698,821 FY12E 466,609 151,722 42,104 68,101 14,232 4,704 272 747,745 FY13E 470,254 154,757 42,946 69,463 14,232 4,798 278 756,728
Table 6: Estimated production plan

2009-10 (actual) 2012E-13E (likely) 2015E-16E (envisaged) Additions from Source: Company data Crude oil production (MMT) 24.86 >28 Cluster 7, WO Series, B-193, D-1 Additional, B-22 Natural gas production (mmscmd) 63 72 100 Cluster 7, WO Series, B Series, North Tapti, B-193, B-22
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ONGC, April 4, 2011
ICICI Securities Excellent defensive play

Subsidies have limited impact on profitability
RoEs to be robust at 23% levels
A key positive for PSU upstream companies is that their returns continue to be strong despite varying levels of under-recoveries. In FY09, when the subsidy contribution was the highest for ONGC at US$36/bl, its RoE was still stable at 20% (Table 7). Going forward, in FY12E-13E, we expect ONGCs subsidy contribution to be at its highest, at US$43/bl. Despite this, we expect ONGC to maintain stable RoE of 2223%, highlighting the excellent defensive nature of ONGCs profitability. The stock, therefore, is a value play, especially in a scenario of high crude price and subsidies. Profitability is expected to improve as oil production from OVL (insulated from subsidies) improves in the next 3-4 years. Gas production from the companys KG blocks would also help expand the companys RoEs. Table 7: Key ratios and subsidies
Y/E March ONGC's share (Rsmn) ONGC's share (US$mn) Sales (mn bl) US$/bl RoCE (%) RoE (%) Net realisation post subsidy (US$/bl) Source: Company data, I-Sec Research FY09 319,996 7,054 165.0 42.8 17.1 22.8 45.8 FY10 143,681 3,030 161.0 18.8 15.0 20.1 54.5 FY11E 258,615 5,580 162.6 34.3 18.4 23.9 56.8 FY12E 323,565 7,034 164.2 42.8 19.2 24.5 62.2 FY13E 328,742 7,147 167.5 42.7 18.3 22.7 62.3
Improved profitability led by APM dismantling

Profitability to improve to US$17/bl from FY12E owing to a revision in APM gas price ONGCs profitability has always been capped by the subsidy burden (Table 8). The company has consistently generated net post tax realisation within US$9-15/bl, independent of crude price movement. In a rising crude environment, ONGCs profitability is affected by an increase in subsidies, capping its net realisation. However, on the back of revision in APM gas prices to US$4.2/mmbtu, we expect the companys net realisations to rise to US$17/bl. However, going forward, we expect ONGCs profitability to improve sharply due to the gas price hike being captured fully into the numbers. We expect net realisation to improve to US$16-17/bl consistently. The implementation of the Kirit Parikh recommendations can further boost profitability and lead to a re-rating for ONGC. Table 8: ONGC P&L structure (standalone)
(US$/boe) Revenues Net crude realisation (US$/bl) Gas realisation (Rs/scm) Crude oil subsidies (US$/bl) Costs EBITDA PBT PAT Source: Company data, I-Sec Research FY09 44.26 45.76 3.9 42.77 23 21.41 16.62 10.77 FY10 40.37 54.53 3.6 18.82 16 23.87 16.83 11.28 FY11E 46.52 56.82 7.3 34.32 18 28.74 21.98 14.73 FY12E 50.44 62.17 7.2 42.83 19 31.94 25.39 17.01 FY13E 50.53 62.34 7.2 42.66 18 32.04 26.09 17.48
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ICICI Securities
Cashflows support aggressive capex
ONGCs consolidated balance sheet enjoys a steady cashflow visibility and zero leverage. With an estimated cash balance of >US$9.2bn in FY13E, the company is well placed to capitalise on organic and inorganic expansion opportunities. The regulatory delays associated with being a PSU company are the only major hindrance for ONGC for tracing a path of aggressive growth. Table 9: Cashflow overview
(Rs mn) Operating cashflow Working capital changes Capital commitments Free cashflow Source: Company data, I-Sec Research FY10 378,882 18,956 (347,883) 30,999 FY11E 427,091 (36,874) (386,114) 40,977 FY12E 510,810 6,250 (342,035) 168,775 FY13E 529,155 2,369 (301,266) 227,889
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ONGC, April 4, 2011
ICICI Securities Valuations

Value buy
ONGC value pick based on stable profitability despite surging subsidies
Our fair value for ONGC implies a multiple of 5.9x FY13E cash earnings, after capturing in Rs323bn subsidies based on the average Brent crude price of US$100/bl in FY12E-13E. Our fair value is derived based on a 5x FY13E cash earnings, at a 30% discount to global peers and then adding value of its investments and reserve upsides. We believe that a discount to international peers is justified based on the uncertainty associated with the subsidy sharing mechanism and companys inability to undertake aggressive inorganic growth opportunities. Our fair value still offers a 24% upside, which indicates the CMP capture the worst case for the company, and hence we believe the stock is an excellent value pick. We prefer using a cash-flow multiple, considering ONGCs matured production portfolio and steady capex in the next 5-10 years. The cashflow method provides an ideal comparison parameter with international peers, nullifying the impact of variable depreciation and depletion structures and tax structure. Also, given the lack of clarity on production profile and PSC for many of the companys domestic and international blocks, valuing the company using DCF becomes difficult. Table 10: Valuations
(Rs mn) Consolidated Cash earnings Equity value (@ 5x) Core value (Rs/share) Probable reserves Value of holdings Total Reserves - 2P (mmboe) Implied EV/boe Source: I-Sec Research 491,130 2,455,650 287 24 27 338 10,320 6.1
ONGC will likely enjoy a potential reserve upside of Rs24/share or 2.2bboe over its current reserve base of 10.2bboe. We have valued these reserves at US$2/boe, assuming a sharp discount to our implied multiple of US$6.1/boe. Table 11: Probable reserves valuations
Probable reserves (mmboe) Valuation multiple (US$/boe) Probable reserves value (US$ mn) Probable reserves value (Rs mn) Probable reserves value (Rs/share) Source: I-Sec Research 2,255 2.0 4,511 202,988 24
ONGCs implied EV/boe multiple of 6.1x at our fair value indicates a sharp discount to global average of 17x, reflecting the negative impact from uncertain subsidy sharing. This discount can reduce if the Government can formulate a subsidy sharing mechanism that can yield strong visibility to ONGCs cashflows.
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ONGC, April 4, 2011
ICICI Securities
Sharp variation in Brent prices, which can influence Governments policy, and skew it towards or against upstream players as far as the subsidy calculations are concerned
80 285 90 312 100 338 110 363 120 386
Table 12: Valuation sensitivity to crude

Crude (US$/bl) Value (Rs/share) Source: I-Sec Research
Implementation of any major reforms like a subsidy sharing formula or diesel deregulation can be a major upside risk Major changes in estimation of hydrocarbon reserves in the companies E&P blocks can have a significant impact on the valuations. Change in government levies like Cess or Royalty for the blocks that the company is currently producing from can have a major impact on valuations Especially for the Rajasthan block operated by Cairn (ONGC 30% stake). We have not factored any valuation upside in case the royalty is made cost recoverable this would be a positive for ONGC
International comparison
Table 13: Global E&P Valuation comparison
E&P companies Rosneft Oil Co CNOOC Ltd EnCana Corp Canadian Natural Resources Ltd Woodside Petroleum Ltd Apache Corp Anadarko Petroleum Corp Devon Energy Corp EOG Resources Inc Chesapeake Energy Corp Southwestern Energy Co PTT Exploration & Production PCL Murphy Oil Corp Oil India Ltd Cairn India Ltd Average Source: Bloomberg P/CF (US$) FY12/CY11 5.69 7.60 6.39 8.12 13.93 5.44 6.71 7.09 7.45 5.12 9.42 7.13 5.47 8.09 7.00 7.38 FY13/CY12 6.01 7.20 5.72 6.56 9.71 4.95 5.67 5.89 5.79 4.68 7.41 5.97 5.00 7.05 6.15 6.25
Table 14: Global E&P Reserve/boe

Pure E&P Rosneft Oil Co EnCana Corp Apache Corp Anadarko Petroleum Corp Devon Energy Corp EOG Resources Inc Talisman Energy Inc Chesapeake Energy Corp Southwestern Energy Co Nexen Inc Average Source: Bloomberg EV (US$ mn) 111,407 32,391 59,344 50,741 41,950 36,180 27,886 37,647 16,021 17,292 P2 reserves (mmboe) 13,970 2,309 2,953 2,422 2,874 1,949 1,149 2,849 823 919 US$ EV/boe 7.97 14.03 20.09 20.95 14.60 18.56 24.26 13.21 19.47 18.83 17.20
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ONGC, April 4, 2011 Table 15: Global integrated Reserve/boe

Integrated PetroChina Co Ltd Exxon Mobil Corp Petroleo Brasileiro SA BP PLC Chevron Corp Total SA Gazprom OAO ENI SpA Statoil ASA ConocoPhillips Occidental Petroleum Corp BG Group PLC Lukoil OAO Suncor Energy Inc Husky Energy Inc TNK-BP Holding Hess Corp Average Source: Bloomberg EV (US$ mn) 364,621 430,194 285,875 156,639 213,772 163,825 230,203 138,928 102,522 127,884 87,468 91,831 69,459 81,418 31,016 46,813 32,869
ICICI Securities
P2 reserves (mmboe) 21,803 24,809 12,093 25,188 10,545 10,695 221,700 6,502 2,124 8,310 3,363 2,893 13,029 3,897 1,046 8,557 1,537 US$ EV/boe 16.72 17.34 23.64 6.22 20.27 15.32 1.04 21.37 48.27 15.39 26.01 31.74 5.33 20.89 29.64 5.47 21.39 19.18
Chart 3: Rolling price/EPS trend

600 500 400 (Rs) 300 8x 200 100 0 Apr-02 Aug-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11
14x 12x 10x
6x

500 400 EV/ Share (Rs) 300 4x 200 100 0 Apr-02 Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11
6x 5x
3x 2x
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ONGC, April 4, 2011
ICICI Securities Annexure 1: Financials (consolidated)

Table 16: Profit and loss statement
(Rs mn, year ending March 31) Gross Sales Less: Excise Duty Net Sales Total Operating Income Less: Raw Materials Consumed (incld stock adj) Royalty and Cess Other Manufacturing Expenses Power and Fuel Personnel Expenses Other Expenses Total Operating Expenses EBITDA (margin %) EBITDA Recouped costs Add: Other Income EBIT Less: Gross Interest Recurring Pre-tax Income Add: Extra Ordinary income/ (expense) Add: Prior period adjustments Less: Taxation Current Tax Deferred Tax Less: Minority interest Add: Earnings from Associate Companies Net Income Consolidated Recurring Net Income Source: Company data, I-Sec Research FY09 1,094,129 48,246 1,045,884 1,045,884 FY10 1,061,688 44,143 1,017,546 1,017,546 FY11E 1,313,898 58,746 1,255,153 1,255,153 FY12E 1,412,651 58,851 1,353,801 1,353,801 FY13E 1,450,881 58,745 1,392,136 1,392,136
289,746 167,335 58,932 1,469 11,619 99,883 628,985 39.9 416,899 154,304 50,721 313,316 2,385 310,931 763 4,464 111,056 3,501 3,747 99 197,953 192,726
253,390 158,131 64,511 1,347 14,071 82,601 574,050 43.6 443,496 187,188 52,728 309,035 5,022 304,013 401 176 95,757 11,558 3,319 78 194,035 193,458
360,577 180,312 81,714 2,041 16,576 78,590 719,811 42.7 535,342 158,706 27,649 404,284 15,467 388,817 110,648 17,310 1,518 78 259,419 259,419
360,876 202,324 83,609 2,221 17,037 80,412 746,480 44.9 607,321 159,830 31,026 478,517 15,455 463,062 133,058 19,874 1,331 78 308,876 308,876
361,191 210,705 86,230 2,268 17,626 81,794 759,814 45.4 632,322 159,825 38,867 511,365 14,175 497,190 144,032 20,647 1,284 78 331,305 331,305
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ONGC, April 4, 2011 Table 17: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Goodwill (On consolidation) Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Less: Revaluation Reserve Total Fixed Assets Total Assets LIABILITIES AND SHAREHOLDER'S EQUITY Borrowings Short Term Debt Long Term Debt Total Borrowings Deferred Tax Liability (net) Liability for abandonment Minority Interest Share Capital Paid up Equity Share Capital Reserves & Surpluses Share Premium General & Other Reserve Less: Misc. Exp. not written off Net Worth Total Liabilities & Shareholder's Equity Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
225,956 65,424 71,814 132,644 11,309 507,146
223,842 82,400 71,424 120,567 7,431 505,664
220,142 74,563 85,923 120,567 7,431 508,627
299,967 75,019 93,682 120,567 7,431 596,666
437,544 76,277 96,950 120,567 7,431 738,769
117,772 82,460 82,158 282,390 224,757
140,882 85,937 75,158 301,977 203,687
112,404 83,205 76,158 271,766 236,861
117,742 91,704 77,158 286,603 310,063
119,112 96,509 78,158 293,779 444,990
17,083 17,720 34,803 114,039
17,083 34,510 51,593 95,385
17,083 34,510 51,593 95,385
17,083 34,510 51,593 95,385
17,083 34,510 51,593 95,385
1,697,482 1,059,546 637,936 247,580 885,517 1,259,116
1,933,001 1,177,574 755,427 256,164 1,011,591 1,362,257
2,147,706 1,267,161 880,545 299,354 1,179,899 1,563,739
2,386,796 1,390,414 996,382 308,344 1,304,726 1,761,768
2,605,256 1,529,166 1,076,090 301,865 1,377,955 1,969,924
56,466 9,125 65,591 92,231 171,451 14,114
21,604 41,065 62,669 102,912 174,590 16,432
21,554 66,065 87,620 115,783 174,868 16,706
21,554 56,065 77,620 130,722 177,817 17,808
21,554 41,065 62,620 146,380 177,387 18,872
21,389
21,389
42,778
42,778
42,778
312 900,534 6,506 915,729 1,259,116
312 992,365 8,413 1,005,653 1,362,257
312 1,134,086 8,413 1,168,763 1,563,738
312 1,323,123 8,413 1,357,800 1,761,768
312 1,529,987 8,413 1,564,664 1,969,924
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ONGC, April 4, 2011 Table 18: Cashflow statement

(Rs mn, year ending March 31) FY09 a) Cash Flow from Operating Activities Consolidated Net Income Add: Depreciation & Amortisation Deferred Tax Less: Other Income Net Extra-ordinary income Operating Cash Flow before Working Capital chg (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from fresh borrowings Dividend paid including tax Others Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 201,700 191,431 4,855 50,721 763 346,502 FY10 197,354 205,019 10,681 52,728 401 359,926
ICICI Securities
FY11E 260,937 217,805 12,871 27,649 463,964
FY12E 310,208 217,209 14,939 31,026 511,330
FY13E 332,590 228,036 15,658 38,867 537,416
7,561 (1,344) (61,964) (657) 19,438 27,826 (9,141) 337,361
(16,976) 390 12,077 3,878 23,110 (3,523) 18,956 378,882
7,837 (14,500) (28,478) (1,732) (36,874) 427,091
(456) (7,759) 5,338 9,499 6,623 517,953
(1,258) (3,268) 1,370 5,805 2,650 540,066
(376,045) (331,093) (386,114) (342,035) (301,266) 10,018 (16,790) (366,027) (347,883) (386,114) (342,035) (301,266) (28,666) 30,999 40,977 175,917 238,800
50,721 50,721
52,728 52,728
27,649 27,649
31,026 31,026
38,867 38,867
56,147 (80,076) (23,492) (47,421) 763 (24,603)
(2,922) 24,950 (10,000) (15,000) (82,198) (100,894) (117,110) (122,742) (1,120) 3,618 (8) (2,349) (86,240) (72,326) (127,118) (140,091) 401 (2,113) (3,700) 79,825 137,577
250,558 225,956 (24,603)
225,956 223,842 (2,113)
223,842 220,142 (3,700)
220,142 299,967 79,825
299,967 437,544 137,577
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ONGC, April 4, 2011 Table 19: Key ratios

(Year ending March 31) FY09 Per Share Data (in Rs.) Diluted Recurring Earning per share (DEPS) Diluted Earnings per share Recurring Cash Earnings per Share (CEPS) Free Cash flow per share (FCPS - post capex) Book Value (BV) Adjusted Book Value (ABV) Dividend per Share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value Price to Adjusted Book Value EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Operating Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Other Income / Pre-tax Income Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT Debt Servicing Capacity Ratio (DSCR) Current Ratio Cash and cash equivalents / Total Assets Turnover Ratios Inventory Turnover Ratio (x) Assets Turnover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research 22.5 23.1 40.6 84.5 107.0 107.0 8.0 FY10 22.6 22.7 44.5 80.8 117.5 117.5 8.2
ICICI Securities
FY11E 30.3 30.3 48.9 99.4 136.6 136.6 10.1
FY12E 36.1 36.1 54.8 99.7 158.7 158.7 11.7
FY13E 38.7 38.7 57.4 98.0 182.9 182.9 12.3
13.0 7.2 2.7 2.7 6.0 0.5 7.5 (87.7) 2.7
13.0 6.6 2.5 2.5 5.6 0.5 6.6 81.1 2.8
9.7 6.0 2.1 2.1 4.7 0.4 5.9 61.3 3.4
8.1 5.3 1.8 1.8 4.0 0.4 4.9 14.3 4.0
7.6 5.1 1.6 1.6 3.6 0.4 4.7 10.5 4.2
(7.9) (0.3) 8.1 (2.1) (7.9)
0.4 9.7 (2.7) 6.4 0.4
34.1 9.8 23.4 20.7 34.1
19.1 12.1 7.9 13.4 19.1
7.3 4.8 2.8 4.1 7.3
39.9 30.0 28.4 17.6 16.3 36.8
43.6 30.4 28.4 18.1 17.3 35.3
42.7 32.2 30.3 20.2 7.1 32.9
44.9 35.3 33.4 22.3 6.7 33.0
45.4 36.7 34.7 23.2 7.8 33.1
17.1 17.9 22.8 34.6
15.0 14.9 20.1 36.4
18.4 20.3 23.9 33.2
19.2 21.3 24.5 32.4
18.3 21.0 22.7 31.7
17.2 (0.1) 13,137 19,569 110.5 17.9
16.5 (1.5) 6,154 9,846 119.0 16.4
17.4 1.1 2,614 3,607 132.3 14.1
15.3 0.6 3,096 4,097 154.5 17.0
13.4 0.4 3,608 4,702 196.0 22.2
5.2 1.0 81 24 136
4.5 0.8 77 25 186
5.9 0.9 64 22 128
6.2 0.8 74 23 116
6.2 0.8 99 24 120
80
ONGC, April 4, 2011
ICICI Securities Annexure 2: Index of Tables and Charts

Tables
Table 1: NELP performance ...............................................................................................67 Table 2: Status of wells drilled ............................................................................................69 Table 3: Reserve break-up (excluding KG Basin blocks) ...................................................70 Table 4: Sales volume assumptions ...................................................................................71 Table 5: Sales profile ..........................................................................................................71 Table 6: Estimated production plan ....................................................................................71 Table 7: Key ratios and subsidies.......................................................................................72 Table 8: ONGC P&L structure (standalone) ....................................................................72 Table 9: Cashflow overview ................................................................................................73 Table 10: Valuations ...........................................................................................................74 Table 11: Probable reserves valuations .............................................................................74 Table 12: Valuation sensitivity to crude ..............................................................................75 Table 13: Global E&P Valuation comparison...................................................................75 Table 14: Global E&P Reserve/boe.................................................................................75 Table 15: Global integrated Reserve/boe ........................................................................76 Table 16: Profit and loss statement ....................................................................................77 Table 17: Balance sheet .....................................................................................................78 Table 18: Cashflow statement ............................................................................................79 Table 19: Key ratios ............................................................................................................80
Charts
Chart 1: Increasing reserve replacement............................................................................68 Chart 2: Reserve accretion trend (3P) ................................................................................69 Chart 3: Rolling price/EPS trend .........................................................................................76 Chart 4: Rolling EV/EBITDA trend ......................................................................................76
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ONGC, April 4, 2011
ICICI Securities
82
Equity Research
Cairn India
Risk-reward favourable
Target price Rs384
BUY
Rs354

Cairn India is a rare, pure oil production play in India and should be viewed more as a reserve growth story given the high potential of its Rajasthan assets. The stock recently underperformed the Sensex in spite of a 30% crude price hike due to a dispute with ONGC on royalty sharing post the announcement of the CairnVedanta deal. Notwithstanding, the current market price offers good risk-reward and more or less discounts the royalty risk. The stock is currently trading at 4.8x FY13E EPS and 3.1x FY13E EBITDA. We value Cairn on sum of the parts (SOTP) to arrive at Rs384 target price, implying a 16% upside from the current levels. Reinitiate with BUY. Key risks are lower-than-expected crude price, delay in the production ramp-up schedule. Rajasthan Royal gains for Cairn. Rajasthan assets have witnessed reserve accretion & upgrades in the past three years. Cairn had announced a 51% upgrade in its overall reserve estimates in Rajasthan. Cairn raised its gross peak production estimates 37% to 240,000bpd. With just ~20-30% of the Rajasthan block being explored and as four discoveries are at the appraisal stage, further reserve upgrade is likely. Thus, Cairn is a strong long-term bet Vedantas bid can be considered as a testimony to our view. Rajasthan blocks to yield high profitability. Cairns Rajasthan operation offers higher net realisation versus peers as it is an onshore block and given the economies of scale. The completion of the pipeline infrastructure offers Cairn a unique connectivity advantage (to service PSUs and private refiners). We expect a sharp jump in profitability as Rajasthan gross production ramps up to 150,000bopd (plan yet to be approved) by July 11 and later to 210,000bopd by June 13E, while the recently upgraded peak production will likely kick in post 13. Cess litigation can be a trigger. Cairn has challenged the Government on cess payment for Rajasthan production. As per Cairn, it is not liable to pay cess, but it pays ~Rs2,500/te in protest. We factor in continued cess payment of Rs2,500/te. Hence, if the court ruling favours Cairn, Rs23/share upside exists to our target price. Reinitiate with BUY. We value Cairn on SOTP assets are separately valued to yield a target price of Rs384/share. Also, Rajasthan assets have been evaluated on DCF. For reserve upsides through additional recovery from 3P reserve estimates in Rajasthan, we assume a value of 10x EV/boe (similar to that derived from DCF), due to lack of clarity on the production profile.
Market Cap Reuters/Bloomberg Shares Outstanding (mn) 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs673bn/US$15.1bn CAIL.BO/CAIR IN 1901.77 368/266 37.7 10.8 18,328 5.5 14.2 (5.6) 8.3 Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield RoCE (%) RoE (%) FY10 22,627 12,734 6.7 35.3 52.7 7.5 68.2 0.0 3.4 3.8 FY11E 96,366 54,414 28.7 327.3 12.3 31.3 9.2 3.5 14.5 15.5 FY12E 207,767 127,270 67.1 133.9 5.3 73.9 3.7 8.1 30.2 32.0 FY13E 219,330 139,590 73.6 9.7 4.8 80.7 3.1 8.9 29.4 30.1
Price chart
380 360 340 (Rs) 320 300 280 260 Aug-10 Nov-10 Mar-11 Jun-10 Apr-10 Jan-11
Rohit Ahuja
Prolin Nandu
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Cairn India, April 4, 2011
ICICI Securities
TABLE OF CONTENT
Rajasthan Royal gains for Cairn ...............................................................................85 Rajasthan blocks Strong execution track record .......................................................85 Crude sales from Rajasthan supported by pipeline advantage ....................................86 Vedanta deal Outcome uncertain..............................................................................88 Vedanta Group Lower gearing makes the acquisition viable.....................................89 Rajasthan blocks to yield high profitability ................................................................91 Cairn enjoys one of the lowest lifting costs ...................................................................91 Strong cashflows...........................................................................................................92 Improved profitability .....................................................................................................93 Valuations .......................................................................................................................94 Implied valuation gap offers opportunity .......................................................................94 Reinitiate with BUY .......................................................................................................94 EV/boe comparison indicates undemanding valuations ...............................................95 Key risks to our call .......................................................................................................96 Annexure 1: Financials (consolidated)........................................................................97 Annexure 2: Index of Tables and Charts ...................................................................101
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ICICI Securities
Rajasthan Royal gains for Cairn

Rajasthan blocks Strong execution track record
Timely execution of Mangala project, ready to pump 150,000bpd Cairns Rajasthan asset has witnessed reserve accretion and upgrade in the past three years. Cairn had announced 51% upgrade in its reserve estimates in Rajasthan in FY10. The company had consequently increased its gross peak production estimates 37% to 240,000bpd, primarily led by 150,000bpd upside from Mangala and additional production of 30,000bpd from Barmer Hill and other discoveries. Cairn has successfully achieved its earlier targeted peak production of 125,000bpd and is awaiting approval from the Directorate General of Hydrocarbons (DGH) to expand its peak production to 150,000bpd. We estimate peak production from Mangala-Bhagyam-Aishwarya (MBA) to be 210,000bpd by end-11E. However, Cairn has not clarified the timelines for 240,000bpd peak production due to ongoing appraisal studies for the Barmer discoveries. We estimate peak production to kick in by end-14. Table 1: Reserve estimate upgrade in the past three years (3P)
Blocks
Mangala Bhagyam Aishwarya Total Saraswati & Raageswari Oil - STOIIP Total 20 additional discoveries, including Barmer Hill Oil STOIIP GAS STOIIP Total 35+ prospects resources Total Government is yet to approve; Source: Company data
Gross Initial Reserve in Place mboe 2010 2008 % chg 1,293 1,206 7.2 468 557 (16.0) 293 281 4.3 2,054 2,044 0.5 78 2,132 2,044 4.3
1,603 270 4,005 2,500 6,505
1,443 298 3,785 3,785
11.1 (9.4) 5.8

71.9
Table 2: Reserve estimate upgrade in the past three years (2P) Cairn has revised 2P reserves for its Rajasthan block by 51% in 2010, thereby making a case for future upgrades
Blocks 2P+2C Mangala Bhagyam Aishwarya Saraswati & Raageswari Oil Total MBA EOR Barmer Hill + Other Risked prospective resources Total * Government is yet to approve; Source: Company data Gross Reserve, Resources & Potential (mboe) 2010* 2008 % chg 477 418 14.1 151 140 7.9 66 56 17.9 8 50.0 12 706 622 13.5
308 140 250

1,404
308 0 0
930
51.0
Table 3: Gross production details

Bpd Earlier Updated*
Mangala 125,000 150,000 Bhagyam 40,000 40,000 Aishwarya 10,000 20,000 Others 30,000 Total 175,000 240,000 *Government is yet to appove this incremental production; Source: Company data
Net to Cairn (70% stake) 105,000 28,000 14,000 21,000 168,000
% chg
20.0 0.0 100.0

37.1
85
Cairn India, April 4, 2011 Chart 1: Estimated production profile

180 160 ('000 bbls/d of oil equivalent) 140 120 100 80 60 40 20 0 2010 2012 2014 2016 2018 2020 RJ-ON-90/1
ICICI Securities
CB/OS-2
Ravva
2022
2024
Source: Vedanta presentation
Crude sales from Rajasthan supported by pipeline advantage

The completion of the pipeline will help Cairn deliver crude at a low cost and have supporting infrastructure to enable production ramp-up Cairns 590Kms pipeline from Mangala to Salaya, implemented at a cost of US$800mn, offers the company a unique advantage of selling its crude production from Rajasthan this is crucial as it provides marketing access to Indias refining infrastructure. Considering the waxy nature of Rajasthan crude (pour point at 40oC), it requires a heated pipeline infrastructure, which would ensure efficient low-cost delivery to the refineries. The expected operating cost for the pipeline is ~US$1.5/bl. The commissioning of the pipeline infrastructure is a major relief for Cairn, both in terms of cost and the ability to ramp up production. The Government has allowed Cairn to recover the cost of the pipeline expenditure for the block. This gives it an edge in terms of marketing crude (without transportation charges). Complex refiners, especially Reliance Industries (RIL) and Essar Oil would prefer buying this crude instead of importing, considering the US$1-1.5/bl GRM advantage (as Cairn will exclude this cost from crude sale price).
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Cairn India, April 4, 2011 Chart 2: Mangala Salaya pipeline

~590km heated pipeline from MPT to Salaya complete; sales commenced
ICICI Securities
Mangala
Radhanpur
Kandla
Viramgam
Jamnagar/Salaya Bhogat
Koyali
Tankers to coastal refineries Pipeline route Existing pipelines Refinery

Source: Company
Table 4: Diversified portfolio of E&P blocks

Blocks Basin
RJ-ONN-2003/1 RJ-ON-90/1 CB-OS-2 Ravva GS-OSN-2003/1 MB-DWN-2009/1 KK-DWN-2004/1 KG-DWN-98/2 KG-ONN-2003/1 KG-OSN-2009/1 PR-OSN-2004/1 SL 2007-01-001
Rajasthan Rajasthan Cambay Gujarat Mahanadi Kerala - Konkan Krishna Godavari Krishna Godavari Krishna Godavari Palar Basin -
Participating Interest (%) 30 70 40 22.5
49 40 100 10 49 100 35 100
Net Production Operator (bpd) ENI India 87,500 Cairn India 5,392 Cairn India 9,161 Cairn India Oil & Natural Gas Corp. (ONGC) -
Status / Plan
1-3 exploratory wells Two exploration wells Appraisal & exploration plans Well GSA-1 plugged & abandoned 300 sqKms of 3D acquisition is being planned. Two appraisal wells 10 Five prospects identified - Two wells drilled 3D 800Kms Two completed in Q1CY10; drilling in 11 The 3D seismic data has been processed. Drilling to commence soon
ONGC ONGC Cairn Cairn Cairn
Source: Company, I-Sec Research
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ICICI Securities
Vedanta deal Outcome uncertain

Vedanta deal matches our value of US$16 bn for Cairn Cairn Energy plc would sell its 40-51% stake in Cairn India to Vedanta Group plc at Rs405/share, which comprises Rs355/share valuation for Cairn India and Rs50/share non-compete fee. However, the open offer by Sesa Goa would be at Rs355/share, at ~Rs50/share discount for minority shareholders. The overall valuation for the deal is US$16bn (US$11.8/boe based on our estimate of 1.35bboe overall recoverable reserves), at an average price of Rs387/share. Our valuation for Cairn yields a similar value. Hence, Vedanta intends to acquire Cairn at an implied crude price of US$100/bl as per our calculations. Cairn plc plans to pass on a major portion of the US$6.5-8.5bn cash to its shareholders in the UK, widely comprised of institutional investors. The company would use a minor component of the cash for exploration in Greenland.
Table 5: Cairn-Vedanta deal valuation

Cairn Energy's current holding in Cairn India (%) Stake sale (%) Amount considered (US$ bn) Cairn Energy's holding in Cairn India after dilution (%) Price per share ( Rs for buy out from Cairn plc) Open offer by Sesa Goa@Rs355/share Total stake post open offer (%) Total consideration (US$ bn) Implied Valuation (US$ bn) Implied Valuation (Rs/share) Source: I-Sec Research Case I 62.4 51.0 8.4 11 405 2.9 71.0 11.3 16.0 387 Case II 62.4 40.0 6.6 22 405 2.9 60.0 9.5 15.9 385
What does the deal change?

Cairn Indias exploration activities in India will change perceptibly. Cairn has a strong proven record in India, indicated through robust recovery at its Ravva oil field and timely execution of its Rajasthan development project. Although both the Cairn plc and Vedanta managements have assured that the Cairn India team will be intact, some changes in the long term are likely (future development and exploration activities). ONGCs royalty payment arrangement in Rajasthan for 100% production is a key concern for the company, especially the expanding scale of production. The Government has been trying hard to coax Vedanta-Cairn towards a compromise on the royalty arrangement. As per the production sharing contract, it is clear that ONGC will have to pay royalty. However, it is unclear if the royalty expenditure will be considered as cost recoverable. The Cairn India management has assured that there will be no compromise on the royalty arrangement, and hence, this concern may persist even after the deal is approved by the Government. However, the current stock price is capturing in the impact of royalty; so Cairn offers good risk-reward.
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ICICI Securities
Vedanta Group Lower gearing makes the acquisition viable

Vedantas balance sheet indicates high comfort levels to complete the deal The Vedanta Group is a diversified FTSE-100 natural resources group, with primary operations in India. As on March 31, 10, Vedanta was Indias largest non-ferrous metals and mining company based on revenues, with its business primarily located in India and other assets and operations in Zambia and Australia. The Group is engaged in zinc, copper, aluminium and iron ore businesses and is developing a commercial power generation business. Vedantas subsidiaries, Sterlite Industries (India), Hindustan Zinc & Sesa Goa are listed on the BSE and the NSE in India. Chart 3: Vedanta Group Holding structure
Vedanta Resources plc (Listed on LSE)
79.4%
70.5%
54.6%
94.5%
55.7%
Konkola Copper Mines plc (Copper Business)
Vedanta Aluminium Limited (Aluminium Business)
29.5%
Sterlite Industries (India) Limited (Listed on BSE, NSE and NYSE Copper Business)
3.1%
The Madras Aluminium Company Limited (Aluminium Business)
Sesa Goa Limited (Listed on BSE and NSE Iron Business)
51.0%
64.9%
100%
100%
Bharat Aluminium Company Limited (Aluminium Business)
Hindustan Zinc Limited (Listed on BSE and NSE Zinc Business)
Sterlite Energy Limited (Power Business)
Copper Mines of Tasmania Pty. Ltd. (Copper Business)
2NOV201016450883
Source: Company
The Vedanta Group has access to debt facility of up to US$6.5bn to fund its 40-51% stake buyout in Cairn India. The open offer by Sesa Goa for a further 20% stake can be funded through Sesa Goas US$3bn cash reserves (56% subsidiary of Vedanta). If Sesa Goas open offer is not fully subscribed, the company can purchase shares from Vedanta plc to reach 20%. As per estimates from the Vedanta Group, the companys consolidated net gearing post the deal would be below 25% in FY11E, indicating balance sheet strength. Table 6: Indicative financials for Vedanta post deal
(US $ mm) Net Debt/EDITDA (x) Vedanta FY 2010 947 2,296 0.4 Pro forma FY 2010 11,030 2,459 4.5 1,2 <2 Pro forma FY 2011E 1,2 <1 Pro forma FY 2012E Note: 1 Pro-forma for Vedanta Group and Cairn India, 2- Vedanta estimates Source: Vedanta Presentation Net Debt EBITDA Net Gearing (%) 8 37 <25 <20
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Cairn India, April 4, 2011 Table 7: P&L highlights

(US$ mn) H1FY11 Revenues 4,582 Operating profits 990 Operating profit margin (%) 21.61 EBITDA 1349 EBITDA margin (%) 29.43 Net profits 337 Net profit margin (%) 7.36 EBITDA/Interest Exp (x) 5.43 Note: Half yearly returns are annualised Source: Company, Bloomberg FY10 7,931 1,473 18.57 2036 25.67 602 7.59 3.78
ICICI Securities
Table 8: Balance sheet highlights
(US$ mn)
Total assets Total debt Cash plus investment Net debt Total shareholders equity Net debt to equity (x) RoE (%) RoCE (%)
H1FY11 25,815 8,983 7,342 1,641 12,459 0.13 16.12 13.31
FY10 24,060 8,174 7,239 935 11,440 0.08 15.40 10.45
Chart 4: Revenue break-up

Energy and Gold 4% Copper 29%
Aluminium 14%
Iron Ore 15%
Copper-Zambia 19%
Source: Company, Bloomberg
Zinc 19%
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ICICI Securities
Rajasthan blocks to yield high profitability

Cost advantage in terms of low lifting cost of US$5/bl, well below the world average of US$10-14/bl, due to onshore production
Cairn enjoys one of the lowest lifting costs

Cairns lifting cost is the lowest among global peers owing to production commencement from Rajasthan. We expect its lifting cost to be US$4.4/bl from FY12E, well below the global average of US$10/bl (for similar sized companies) in 11. Cairn enjoys cost advantage owing to bulk production from onshore Rajasthan blocks, as lifting costs onshore are much lower than offshore costs. Chart 5: International lifting costs
16.0 14.0 12.0 (US$/bbl) 10.0 8.0 6.0 4.0 2.0 0.0 2003
Source: Industry
World average at US$6.1/bbl
Horizon Companies Overseas Integrated Oils 2004 2005
Global Integrated Oils Small U.S. E&Ps 2006 2007 2008 2009
Cost advantage will translate into higher EBIT levels at US$60/bl in FY13 viz-a-via global average of US$1215/bl
Based on low cost structure, we estimate Cairn to enjoy among the highest EBIT realisations at US$60/bl in FY12E, well above the global average of US$25-30/bl. As the company expands its production in the next 2-3 years, the cost structure will improve. This will provide Cairn with a sustainable cost advantage over peers, which is crucial, especially during a low crude price scenario. This cost advantage will ensure that the company would enjoy higher P/CF multiple compared with peers, once the peak production threshold is crossed. We, therefore, consider Cairn to be an excellent long term bet.
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Cairn India, April 4, 2011 Chart 6: International E&P cost structure

1,000,000 800,000 (US$MM) 600,000 400,000 200,000 0
ICICI Securities
50 40 (US$/boe) (US$/boe) (US$/boe) (US$/boe) 30 20 10 0
2003
2004
2005
2006
2007
2008
2009
Lifting Costs
Exploration Expenses Pre-tax Profit
DD&A (Incl. Writedowns/ Impairment) Net Income/boe Revenue/boe
Other Expenses/ (Income)

Source: Industry
Table 9: Cairns cost structure at Rajasthan

(US$/bl) Income statement Net realisation Total expenditure EBIDTA EBIT Source: I-Sec Research FY11E 87 15.9 66.9 63.5 FY12E 82.7 14.8 72.2 67.6 FY13E 87 14.5 64.6 59.9
Strong cashflows
Strong cashflow generation of US$2.5bn likely from FY13, giving financial muscle for aggressive exploration activities We expect Cairn to generate steady cashflow of US$2.5bn from FY13E. High incremental cashflows provide Cairn a strong bandwidth to aggressively explore in prospective basins. As is true for any exploration company, cash generation ultimately decides the risk-taking abilities as regards exploring frontier basins and generating maximum returns. Post FY11, Cairn would aggressively expand its exploration activities to diversify its reserves portfolio outside Rajasthan. Table 10: Expected cashflows
(Rs mn) Operating cashflow Working capital changes Capital commitments Free cashflow Source: I-Sec Research FY09 6,632 4,460 (33,543) (23,908) FY10 2,562 (8,956) (49,169) (55,564) FY11E 57,159 (1,394) (25,832) 29,933 FY12E 151,337 (7,126) (22,395) 121,816 FY13E 145,243 (2,705) (12,680) 129,858
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ICICI Securities
Improved profitability
Improved profitability in the next two years is likely, followed by a drop from FY13 as profit petroleum kicks in As Cairns production expands, its profitability will likely improve in the next two years. However, once the profit petroleum component kicks in from FY13, it will drop. Post FY13, we expect Cairns profitability to be stable and to be contingent on the successful implementation of extended oil recovery (EOR) and expansion of peak production through additional contribution from other potential prospects. Hence, Cairns key strategy would be to continue to develop incremental discoveries in Rajasthan, which would require continuous infusion of capex. Table 11: Key ratios
(%)
RoCE RoIC RoE Source: I-Sec Research
FY09 2.8 121.7 3.0
FY10 3.4 24.8 3.8
FY11E 14.3 68.0 15.2
FY12E 33.2 185.3 35.3
FY13E 28.6 364.8 29.2
Table 12: Key assumptions

Brent (US$/bl) Cess (Rs/te) Gross MBA production (bpd) Net overall production (mmboe) Source: I-Sec Research
FY11E 84 2500 79,000 31 FY12E 100 2500 195,000 57 FY13E 100 2500 210,000 59
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ICICI Securities
Valuations
We value Cairn on SOTP to capture its cashflows from the Rajasthan block and reserve upsides. Risk-reward is favourable at the current levels and Cairn is a superb long-term pick. We reinitiate coverage with BUY at Rs384/share target price.
Implied valuation gap offers opportunity

Based on our calculation, current crude prices capture long-term average crude at US$80/bl levels, below the current crude price and our long-term average Brent assumption of US$100/bl. Cairn offers an upside based on the current reserve and production estimates. In our view, the stock price will reflect its then prevailing gross realisation on achieving peak production from Rajasthan fields in FY14. Based on our assumption of Brent crude at US$100/bl for FY12E-13E, we expect the stock to be valued in line with its gross realisation of US$100/bl (Brent), rather than at the current discounted value of US$80/bl. We value the companys core assets on DCF, assuming a peak production of 240,000bopd in FY14E and EOR implementation ensuring that the production is constant in the next 10 years.
Reinitiate with BUY

We value Cairn on SOTP assets are separately valued to yield a target price of Rs384/share. Rajasthan assets have been evaluated on DCF. For reserve upsides through additional recovery from 3P reserve estimates in Rajasthan, we assume a value of 10x EV/boe (similar to that derived from DCF), due to lack of clarity on the production profile.
Key assumptions
WACC at 13% EOR implementation from FY13; peak production with EOR for 10 years Long-term average brent at US$100/bl
Table 11: Valuations

(Rs mn) Valuation of Cairns E&P Assets - MBA, Ravva, Cambay FCFE based valuations Present value of future cashflows Number of shares Value per share (Rs /share) Exploration upside per share Exploration upside(Rs mn) Total EV Total reserves considered for valuation EV/boe (US$/bl) Overall value (Rs/share) Source: I-Sec Research
546,581 1,897 288 23 44,059 727,446 1,350 11.7 384
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ICICI Securities
At our target price of Rs386/share, Cairn will trade at an EV/boe of ~12x, lower than the global average of 17x
EV/boe comparison indicates undemanding valuations

Based on a global comparison, Cairn seems attractive on this parameter. Though the average EV/boe has risen in tandem with crude price, Cairns current EV/boe of 10.5x is at a discount to global peers. At our SOTP of Rs384, Cairn will trade at 11.7x EV/boe, still at a discount to 17x, the average for international peers. However, a discount to global peers is justified given that the peak production is still two years away. Post-13, there is a possibility that Cairn may get re-rated to trade at a premium to the international average (most likely if the concerns on royalty and cess are taken care of), based on the successful implementation of its EOR programme and precise production profile estimates from its other Barmer discoveries. This indicates a strong long-term potential offered by the stock. Table 12: EV/boe comparison
Pure E&P Rosneft Oil Co EnCana Corp Apache Corp Anadarko Petroleum Corp Devon Energy Corp EOG Resources Inc Talisman Energy Inc Chesapeake Energy Corp Southwestern Energy Co Nexen Inc Average Source: Bloomberg, I-Sec Research EV (US$ mn) 111,407 32,391 59,344 50,741 41,950 36,180 27,886 37,647 16,021 17,292 P2 reserves (mmboe) 13,970 2,309 2,953 2,422 2,874 1,949 1,149 2,849 823 919 USD EV/boe 7.97 14.03 20.09 20.95 14.60 18.56 24.26 13.21 19.47 18.83 17.2
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ICICI Securities

Crude price movement, a major risk
Reserve upgrades have led to Cairns stock price outperforming versus crude price movement Crude price movement has a direct correlation to Cairns cash flows. The stock price has always reacted to crude price movement. However, the long-term impact has been muted due to reserve upgrades by Cairn. Therefore, going forward, the correlation with crude price movement may further sharply reduce in case there are further reserve upgrades. Table 13: Crude price sensitivity
(Rs/US$) 44 45 46 47 48 Source: I-Sec Research
80 306 312 315 321 324
Crude Price (US$/bbl) 90 100 336 373 343 381 350 384 357 391 364 393
110 398 406 415 423 431
120 433 434 443 452 461
Chart 7: Cairn versus Brent crude

400 350 300 250
(Rs)
Brent (RHS)
Cairn
160 140 120

(us$/bbl)
100 80 60 40 20 0
May-07 Dec-07 Dec-08 Dec-09 Aug-07 Aug-08 Aug-09 Aug-10 Nov-10 Apr-08 Apr-09 Apr-10 Mar-11 Jan-07
200 150 100 50 0
Source: Bloomberg
Cess litigation Favourable ruling can trigger upsides

Cairn has challenged the Government on cess payment for Rajasthan production. As per Cairn, it is not liable to pay cess, but it pays ~Rs2,900/te in protest. We factor in continued cess payment of Rs2,500/mt. Hence, if the court ruling favours Cairn, Rs23/share upside exists to our target price.
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ICICI Securities
Annexure 1: Financials (consolidated)

(Rs mn, year ending March 31) Net Sales Total Operating Income Less: Government's share of profit petroleum Production costs FY09 25,156 25,156 FY10 22,627 22,627 FY11E 96,366 96,366 FY12E 207,767 207,767 FY13E 219,330 219,330
10,829 1,190 1,145 2,166 222 940

16,493 8,663
6,397 1,131 1,102 3,031 (366) 1,390

12,684 9,943
5,855 6,036 700 2,980 7,598

23,170 73,196
5,447 10,605 661 6,485 17,634

40,833 166,935
3,954 11,141 526 6,763 18,775

41,159 178,171
Staff costs Administrative expenses Decrease in inventories Royalty & Cess

Total Operating Expenses EBITDA
Depreciation & Amortisation Add: Other Income

EBIT
2,698 5,945
11,910
1,485 4,077
12,534
4,921 733
69,008
12,822 1,997
156,110
13,460 4,862
169,573
Less: Gross Interest

Recurring Pre-tax Income Unsuccessful exploration costs Extra Ordinary income / (expense)
64
11,846 1,179 (198)
148
12,386 2,085
2,641
66,367 221 -
1,961
154,149 202 -
680
168,893 171 -
Less: Taxation Current Tax Deferred Tax

Net Income (Reported) EBIT*(1-t) Consolidated Recurring Net Income Source: Company data, I-Sec Research
1,811 623
8,035 9,462 9,411
2,216 (2,564)
10,649 12,886 12,734
11,964 (11)
54,193 56,579 54,414
26,904 (25)
127,069 128,889 127,270
29,330 (28)
139,420 140,153 139,590
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Cairn India, April 4, 2011 Table 15: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Other liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Total Investments Deferred Tax Asset Fixed Assets Gross Block Less Accumulated Depreciation Net Block FY10
ICICI Securities
FY11E
FY12E
FY13E
65,271 1,683 1,516 3,505 704

72,679
9,294 2,909 3,067 8,318 145

23,734
11,652 8,560 7,920 8,318 145

36,595
45,412 8,081 17,077 8,318 145

79,031
93,492 8,081 18,027 8,318 145

128,063
8,648 1,400 1,747 4,337

16,132 56,548
8,652 22 1,194 4,937

14,806 8,928
17,693 93 1,194 4,937

23,918 12,678
21,474 201 1,194 4,937

27,806 51,225
17,369 212 1,194 4,937

23,712 104,351
1,713
1,713 84
17,124
17,124 166
17,124
17,124 478
17,124
17,124 766
17,124
17,124 1,010
1,435 802 633 16,812 13,799 3,014 62,027

65,674 253,193 377,211
2,228 958 1,270 20,170 15,175 4,995 91,635

97,899 253,193 377,310
3,228 1,140 2,088 44,477 19,915 24,562 92,160

118,810 253,193 402,282
3,978 1,385 2,593 65,578 32,491 33,086 92,703

128,382 253,193 450,691
4,478 1,672 2,805 77,195 45,664 31,531 93,266

127,602 253,193 503,280
Producing properties Less: Depletion Net producing properties Exploratory & Development assets
Total Fixed Assets Goodwill Total Assets LIABILITIES AND SHAREHOLDERS EQUITY Borrowings Long Term Debt Total Borrowings
43,564 43,564 5,624 18,967 1,897 10
34,007 34,007 4,619 18,967 1,897 10
32,007 32,007 4,609 18,967 1,897 10
17,007 17,007 4,583 18,967 1,897 10
4,555 18,967 1,897 10
Deferred Tax Liability Paid up Equity Share Capital No. of Shares outstanding (mn) Face Value per share (Rs)
Reserves & Surplus Share Premium General & Other Reserve Net Worth Total Liabilities & Shareholders Equity Source: Company data, I-Sec Research
309,057 328,023
377,211
309,057 10,657 338,680

377,307
309,057 37,643 365,667

402,283
309,057 101,077 429,100

450,691
309,057 170,701 498,725

503,280
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Cairn India, April 4, 2011 Table 16: Cashflow statement

(Rs mn, year ending March 31) FY09 a) Cash Flow from Operating Activities Profit/Loss before taxation Add: Depreciation & Amortisation Provisions Deferred Tax FY10
ICICI Securities
FY11E
FY12E
FY13E
11,846 2,698 623 5,945 1,967

6,632
10,649 1,533 (2,564)
54,193 4,921 (11)
127,069 12,822 (25)
139,420 13,460 (28)
Less: Other Income Net Extra-ordinary income Other Adjustments Op Cash Flow before Working Capital change (a)
Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Other Adjustments Working Capital Inflow / (Outflow) (b) Current Tax/FBT paid(net of refunds) Net Cash flow from Operating Activities (a) + (b) as a % of Operating Cash Flow Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Consideration paid for acquisition of undertaking Exploration & Development Capex Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Other Income Other Adjustments Net Cash flow from Investing Activities (d)
4,077 2,979
2,562
733 315
58,055
1,997 288
137,580
4,862 244
147,746
(467) (168) 1,362 (570) 5,060 2,042 (2,801) 4,460 (1,458) 9,634
(1,227) (1,551) (4,813) 560 5 (1,930)

(8,956) (6,395)
(5,651) (4,853) 9,041 71

(1,392) 56,663
480 (9,156) 3,781 108

(4,788) 132,792
(1) (950) (4,105) 11

(5,045) 142,701
(342) 5,416 (38,617) (33,543)

(23,908)
(33,758) (15,411)
(25,832) -
(22,395) -
(12,680) -
(49,169) (55,564)
(25,832) 30,831
(22,395) 110,398
(12,680) 130,021
5,945 (3,533) 2,412 33,208 40,440 73,648 (198) 51,953
4,077
4,077
733
733
1,997
1,997
4,862
4,862
Issue of Share Capital during the year Proceeds from fresh borrowings Dividend paid including tax Others Net Cash flow from Financing Activities (e)
Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research
(9,557) 5,068 (4,489)

(55,976)
(2,000) (27,207)
(29,207) 2,357
(15,000) (63,635)
(78,635) 33,760
(17,007) (69,795)
(86,802) 48,081
13,318 65,271 51,953
65,271 9,295 (55,976)
9,294 11,652 2,357
11,652 45,412 33,760
45,412 93,492 48,081
99
Cairn India, April 4, 2011 Table 17: Key ratios

(Year ending March 31) FY09 Per Share Data (in Rs.) Diluted Recurring Earning per share (DEPS) Diluted Earnings per share Recurring Cash Earnings per share (CEPS) Free Cashflow per share (FCPS-post capex) Reported Book Value (BV) Adjusted Book Value (ABV) ** Dividend per share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value Price to Adjusted Book Value Price to Sales Ratio EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Operating Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Net Worth (RoNW) Dividend Payout Ratio Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
5.0 4.2 6.4 (12.6) 162.9 162.9 0.0
6.7 5.6 7.5 (29.3) 168.6 168.6 0.0
28.7 28.6 31.3 16.3 182.8 182.8 12.3
67.1 67.0 73.9 58.2 216.2 216.2 28.7
73.6 73.5 80.7 68.6 252.9 252.9 31.4
71.3 83.5 2.2 2.2 26.7 74.7 54.3 67.2 (27.1) 0.0
52.7 63.0 2.1 2.1 29.6 68.2 54.1 (106.1) (12.2) 0.0
12.3 12.4 1.9 1.9 7.0 9.2 9.8 11.9 21.9 3.5
5.3 5.3 1.6 1.6 3.2 3.7 4.0 4.7 5.7 8.1
4.8 4.8 1.4 1.4 3.1 3.1 3.3 3.9 4.3 8.9
242.8 119.6 108.1 30.0 265.6
69.1 46.8 31.6 43.5 69.1
327.3 317.3 450.6 636.2 327.3
133.9 136.1 126.2 128.1 133.9
9.7 9.2 8.6 6.7 9.7
34.4 47.3 47.1 31.9 20.6
43.9 55.4 54.7 47.1 (2.8)
76.0 71.6 68.9 56.2 18.0
80.3 75.1 74.2 61.2 17.4
81.2 77.3 77.0 63.6 17.3
2.8 3.0 0.0
3.4 3.8 0.0
14.5 15.5 50.0
30.2 32.0 50.0
29.4 30.1 50.0
100
ICICI Securities

Tables
Table 1: Reserve estimate upgrade in the past three years (3P) .......................................85 Table 2: Reserve estimate upgrade in the past three years (2P) .......................................85 Table 3: Gross production details .......................................................................................85 Table 4: Diversified portfolio of E&P blocks........................................................................87 Table 5: Cairn-Vedanta deal valuation ...............................................................................88 Table 6: Indicative financials for Vedanta post deal ...........................................................89 Table 7: P&L highlights .......................................................................................................90 Table 8: Balance sheet highlights.......................................................................................90 Table 9: Cairns cost structure at Rajasthan.......................................................................92 Table 10: Expected cashflows ............................................................................................92 Table 11: Valuations ...........................................................................................................94 Table 12: EV/boe comparison.............................................................................................95 Table 13: Crude price sensitivity.........................................................................................96 Table 14: Profit and loss statement ....................................................................................97 Table 15: Balance sheet .....................................................................................................98 Table 16: Cashflow statement ............................................................................................99 Table 17: Key ratios ..........................................................................................................100
Charts
Chart 1: Estimated production profile .................................................................................86 Chart 2: Mangala Salaya pipeline....................................................................................87 Chart 3: Vedanta Group Holding structure ......................................................................89 Chart 4: Revenue break-up.................................................................................................90 Chart 5: International lifting costs .......................................................................................91 Chart 6: International E&P cost structure ...........................................................................92 Chart 7: Cairn versus Brent crude ......................................................................................96
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ICICI Securities
102
Equity Research
GAIL
An ideal defensive play
Target price Rs572
BUY
Rs464

GAIL is an excellent defensive bet in the oil&gas sector underpinned by two key catalysts. In the natural gas transmission space, GAIL is embarking on an aggressive expansion spree to double its network to >16,000Kms in the next 3-4 years. Already, it owns Indias largest pipeline infrastructure and transmits 70% of the natural gas production. Hinged by secure, long-term earnings visibility and dominance in the high-margin pipelines space, GAIL is in a safe spot in transmission. Also, petchem valuations can double in the next 4-5 years as the capacities ramp-up and ethylene margin improves. However, niggling concerns exist in the form of delayed volume-ramp-up and rising subsidy. Nonetheless, we recommend GAIL as an ideal play in the domestic gas sector. Reinitiate with BUY and sum-of-the-parts (SOTP) target price of Rs572/share. Transmission GAILs supremacy to continue. GAIL is set to double its transmission network to >16,000Kms in the next 3-4 years at Rs200bn capex to absorb the incremental 60-100mmscmd gas supply. Also, the high-margin pipelines business is a cash cow for GAIL and forms 49% of its valuations. GAILs transmission business offers a good defensive play given the high cashflow visibility and as transmission is independent of inherent commodity (gas) price movement. New tariff regulations have been a positive for GAIL. We value transmission at Rs286/share based on DCF. Petchem Hidden ace. Petchem valuations, in the next 4-5 years, can double as GAILs Pata gas cracker expands to 0.8mntpa this can boost long-term valuations multifold led by economies of scale and improved ethylene margin globally. Also, GAILs petchem profitability will always be higher than the industry average as it is gas-based. GAILs petchem operating margin should be +55% in the next 2-3 years versus the global average of ~25%. We value petchem at Rs144/share on EV/E. Key risks. In our view, LPG will be a drag due to rise in subsidy. We estimate subsidy to rise to Rs25bn annually in the next two years as the net under-recoveries for oil marketing companies (OMCs) likely cross Rs100bn in FY12E-13E on the rise in crude price. Transmission is also exposed to the risk of delayed volume ramp-up. Reinitiate with BUY. We value GAIL on SOTP at Rs572/share. At the current market price, GAIL is attractively valued at 9x FY13E CEPS. Reinitiate with BUY.
Market Cap Reuters/Bloomberg 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs588bn/US$13.2bn GAIL.BO/GAIL IN 1268.5 538/401 42.1 13.0 14,500 (10.0) 11.1 (5.6) 8.3 Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield RoCE (%) RoE (%) FY10 282,212 31,395 24.8 4.5 18.7 29.2 8.1 1.6 17.2 19.9 FY11E 346,108 38,778 30.6 23.5 15.2 35.5 7.0 1.5 17.3 21.3 FY12E 371,559 48,160 38.0 24.2 12.2 45.6 6.0 1.8 16.6 22.4 FY13E 389,408 48,943 38.6 1.6 12.0 50.8 6.2 1.8 13.2 19.5
Price chart
550 510 (Rs) 470 430 390 Oct-10 Aug-10 Dec-10 Mar-11 Jun-10 Apr-10 Jan-11
Rohit Ahuja
Prolin Nandu
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GAIL, April 4, 2011
ICICI Securities
TABLE OF CONTENT
Transmission GAILs supremacy to continue .......................................................105 Expansion spree to spur valuations ............................................................................105 Gas volumes to swell, led by on-track expansion.......................................................105 Pipelines Long-term earnings visibility provides an upper hand..............................106 Pipelines A cash cow ...............................................................................................106 New tariff regulations, a positive .................................................................................108 Petchem An ace up GAILs sleeve ..........................................................................109 Petchem margin to continue to be robust ...................................................................109 Higher subsidies to pressurise LPG..........................................................................110 CGD provides volume scalability in the long term...................................................110 E&P development long drawn ....................................................................................111 Valuations GAIL, an ideal defensive bet.................................................................112 Improved profitability from debt raising .......................................................................112 Key risks to our call .....................................................................................................113 Financials Transmission, the backbone.................................................................114 Annexure 1: Financials (consolidated)......................................................................116 Annexure 2: Index of Tables and Charts ...................................................................120
104
GAIL, April 4, 2011
ICICI Securities Transmission GAILs supremacy to continue

Expansion spree to spur valuations
GAIL owns Indias largest pipeline infrastructure, spanning more than 7,200Kms it transmits 70% of the countrys natural gas production. The company is on a major expansion spree to ensnare a large chunk of incremental gas volumes expected from the east coast of India. We expect GAIL to continue with its dominance in the gas transmission segment and recommend it as one of the best defensive bets in the oil & gas space. Our SOTP value is at Rs572/share. We reinitiate coverage with a BUY.
Gas volumes to swell, led by on-track expansion

GAILs transmission capacity to double in next 3-4 years and the use of leverage for the projects will be RoE-accretive The expected surge in gas supply from the east coast would beef up transmission volumes in the next four years. Also, GAIL will double its gas transmission network to >16,000Kms in the next 3-4 years from 7,200Kms at present. GAIL has recently placed the order for the 610Kms Dadri-Bawana-Nangal pipeline and has invited expression of interests for the Jagdishpur-Haldia and Kochi-Mangalore- Bangalore pipelines. The company is also ramping up the existing capacity of its GREP pipeline grid to 78mmscmd from 56mmscmd in Q1FY12. Based on the above, we expect overall gas transmission volumes to increase to 160mmscmd by 13E-14E from 120mmscmd at present. GAIL plans to raise an additional debt of Rs4.5bn in FY11E and Rs7bn in FY12E to fund the pipeline capex. This is a deviation from the policy of low debt as earlier, the tariffs were RoE based. Current regulations, which compute tariff on an RoCE basis, provide incentive to fund the pipeline capex at a higher debt-to-equity. This can sharply improve RoEs in the next 3-4 years once the new pipelines start contributing to revenues. Table 1: Pipeline infrastructure Overall snapshot
NG Trans Pipeline (km) NG Trans Capacity (MMS CMD) Source: Company, I-Sec Research FY10 ~7,200 ~150 FY14E ~160,00 ~300
Table 2: Pipeline capex Status

Pipeline projects DVPL Pipelines Phase II Incl. Compressor At Jhabua & Vijaipur Vijaipur Dadri Pipelines (Incl. Compressor At Kailaras & Chainsa) Dadri Bawana Nangal Pipeline Chainsaj - Hajjar - Hissar Pipeline Approved cost (Rs mn) 58,370 49,270 Capacity (mmscmd) 24 to 78 20 to 80 Length (Kms) Completion schedule (status) 610 June 11 (one compressor at Jabhua and Vijaipur commissioned) 499 June 11 (VijaipurDadri Pipeline commissioned in January 10, compressor stations remaining) 594 August 11 (commissioned up to Bawana in March 10) 349 April 11 (commissioned up to Sultanpur in March 10 and Neemrana in September 10) * 2,050 On hold 1,414 Phase I March 12 Phase II December 12 1,126 Phase I March 12 Phase II December 12 6,642
23,580 13,150
31 35
Jagdishpur Haldia Pipeline Dhabol - Bangalore Pipeline Kochi - Koottanad - Mangalore / Bangalore Total Source: Company Presentation
75,960 49,940 32,630 302,900
32 16 16
105
GAIL, April 4, 2011
ICICI Securities
Pipelines Long-term earnings visibility provides an upper hand
GAILs transmission business offers good long-term earnings visibility, given the high entry barriers and the nascent stage of the domestic gas industry. GAILs 7,200Kms pipeline network connects most power and fertiliser units across the western and northern corridors in India. Due to limited gas availability and infrastructure constraints, customers once tied up would retain the supplier. This yields a first-mover advantage for GAIL and a sustained, long-term revenue source. Also, post the recently announced pipeline expansion plan, GAIL would operate across the 16,000Kms national pipeline grid, connecting all the major demand centres. Thus, most of the gas (produced domestically or imported) will have to use GAILs pipeline infrastructure.
Pipelines A cash cow

High-margin pipeline business contributes 49% to overall valuations Pipelines is a high-margin business as it yields more than 85% operating margins, and is independent of any movements in the natural gas price as revenues are based on regulated tariffs. GAIL enjoys domestic dominance in the space and most of its valuations come from pipelines GAILs pipeline business contributes 49% to overall valuations. Hence, this business makes GAIL one of the most defensive bets in the oil & gas space. Cashflows from the new pipelines will likely contribute significantly to GAILs EV (Rs207/share). Pipeline volumes are expected to increase ~40% to ~160mmscmd in the next 2-3 years from 120mmscmd at present, led by increased supply from the east coast and Rs200bn overall capex. On the back of Reliance Industries (RIL) KGD6 volumes, GAILs existing pipelines are already operating at ~75% utilisation (HVJ/DVPL operating at ~100%). We prefer to value GAILs pipeline business on DCF given long-term cash flow visibility and a regulated tariff regime. We have capped volume estimates for LPG pipelines at the current levels as waning LPG demand domestically does not justify any need to augment LPG pipeline capacity. Based on DCF, LPG transmission should form Rs10/share of GAILs overall EV. Table 3: Transmission Valuations
Pipelines Existing pipelines LPG transmission New pipelines (includes GREP expansion) Total EV of transmission business (A) Source: I-Sec Research EV (Rs mn) 87,098 13,045 263,229 363,372 % of total EV 11.8 1.8 35.6 49.1 Rs/share 68.6 10.3 207.4 286.3
106
GAIL, April 4, 2011 Table 4: Domestic demand-supply situation

Gas supply Existing sources ONGC Petronet LNG Shell Hazira Dabhol LNG Others (including OIL and Pvt JVs) New sources RIL KG D6 RIL Mahanadi basin GSPC KG basin ONGC KG basin CBM RIL others (D6 satellite, NEC 25, etc) Total supply Gas demand Power Fertiliser Sponge iron plants Refineries City gas distribution Industrial Total demand Demand-Supply Source: Industry Current 54 30 4 19 54 7 0 0 3 170 74 39 6 30 14 14 177 6.7 FY13 46 34 9 18 20 80 9 10 0 5 231 100 54 8 35 18 18 232 1.1
ICICI Securities
FY16 40 36 18 18 20 80 9 20 20 15 30 306 150 70 10 45.5 23.4 21 320 13.6 % share (FY16) 13.1 11.8 5.9 5.9 6.5 26.1 2.9 6.5 6.5 4.9 9.8
46.9 21.8 3.1 14.2 7.3 6.6
Chart 1: Pipelines GAILs expansion plans
TAPI P/L FROM PAKISTAN
IPI PL FROM PAKISTAN
CHAINSA JHAJJAR HISAR P/L

Hisar
NANGAL
BHATINDA DELHI
DADRI BAWANA NANGAL P/L GREP II

BAREILLY
Jhajjarr GURGAUN
JAISALMER
MATHANIA
AGRA
AURAIYA
KANPUR
LUCKNOW JAGDISHPUR
DISPUR PATNA
DVPL PH-II
BARMER GWALIOR
PHOOLPUR
KOTA
UJJAIN RAJKOT
AHMEDABAD
JHANSI VIJAYPUR BHOPAL
VARANASI
GAYA
AGARTALA
BOKARO
JABALPUR BHILAI
DAHEJ I & II 10 mmtpa*
BHARUCH BARODA SURAT
KOLKATA CUTTACK
DAMRA BHUBANESHWAR
HALDIAJAGDHISPUR P/L
HAZIRA 3.6 mmtpa DABHOL 5 mmtpa DABHOL-BANGALORE P/L
MUMBAI
PUNE
RAJAMUNDRY
KRISHNAPATNAM KAKINADA
SOLAPUR
KOLHAPUR GOA
HYDERABAD
VIJAYAWADA NELLORE
BANGALORE
MALLAVARAM BHILWARA P/L
Transmission Pipelines
Existing Gas pipelines LPG Pipeline GAILs Planned Pipeline RILs East West Pipeline LNG Terminal
MANGALORE
CHENNAI
EWPL
KOCHI-KANJIKKOD-BANGALOREMANGALORE P/L
KANJIKKOD
COIMBATORE
TIRUCHCHIRAPALLI
KOCHI 5 mmtpa
TUTICORIN
107
GAIL, April 4, 2011
ICICI Securities
New tariff regulations, a positive
Tariffs based on PNGRB notifications for the existing pipelines have surprised on the upside
The Petroleum and Natural Gas Regulatory Board (PNGRB) had notified Rs33.4/mmbtu average pipeline tariff for GAILs GREP/DVPL grid pipeline post expansion, which had come as a positive surprise compared to an earlier expectation of Rs30/mmbtu. This has indicated that regulations in general can offer a positive surprise compared to our calculations, due to lack availability of precise operating cost structure for individual pipelines. The tariff revision will be applicable post completion of the GREP expansion, scheduled by June 11. The PNGRB tariff notification is a positive for GAILs existing and upcoming GREP pipeline grid, as its a critical asset for GAIL transmitting ~80% of the companys current volumes. However, there is no clarity on the tariffs for new pipelines which will get commissioned in the next 2-3 years. Hence, we have factored in tariffs from them at the levels fixed for the DVPL-GREP upgradation, i.e., at ~Rs53.6/mmbtu. These regulations provide long-term visibility to GAILs cashflow, which leaves gas supply as the only concern that can hamper the companys valuation upside. However, with the recent optimism built in post the RIL-BP deal on the KG Basin gas volume ramp-up, this risk will gradually subside over the next 1-2 years. Table 5: Tariff recommendations as per PNGRB
(Rs/mmbtu) Particulars As per proposal of GAIL (levelised) Moderation/reduction by Board Inflation change to 4.5% against 5% Unaccounted gas not allowed Number of operating days changed to 355 days Volumes (divisor) considered as per regulation Corporate FBT disallowed O&M capex reduced to 70% Others Total moderation/reduction by Board Levelised tariff after moderations by the Board Existing levelised tariff Source: Company Presentation DUPL/DRPL 40.2 (0.6) (2.9) (1.0) (10.7) (0.0) (0.1) (0.3) (15.7) 24.5 26.1 Existing HVJGREP-DVPL 35.4 (0.5) (1.2) (2.8) (6.4) 0.9 (9.9) 25.5 25.5 0 53.65 53.65 DVPL-GREP upgradation
108
GAIL, April 4, 2011
ICICI Securities Petchem An ace up GAILs sleeve

Petchem margin to continue to be robust
GAIL enjoys a strong cost advantage as it has a pure gasbased cracker
GAIL operates a gas cracker at Pata, Uttar Pradesh, which can produce 450,000tpa of ethylene. GAILs Board has recently approved plans to double the ethylene capacity at Pata to 800,000tpa in the next 3-4 years. Initially, the company plans to increase the capacity to 510,000tpa by the next year. We, however, exclude the expansion from our estimates as GAIL has not disclosed details on capex and timelines. Petchem valuations, in the next 4-5 years, can double as the Pata gas cracker expansion gets completed and the ethylene margin scenario improves; hence, Petchem can boost valuations multifold in the long term. Average ethylene product (hdPE/lldPE) realisations have risen along with the crude prices (though with a lag), led by global economic recovery. Going forward, we expect the impact of excess ethylene capacity additions globally (predominantly in the Middle East) to be muted as demand growth from the emerging markets should be strong enough to absorb global ethylene capacity addition (up to 26mmtpa additions expected). Also, GAILs Petchem profitability will always be higher than the industry average as it is purely gas-based. We expect GAILs Petchem operating margin to be +55% in the next 2-3 years versus the global average of ~25%. Table 6: Ethylene capacities
Year 2010 2011 2012 2013 2014 Total Source: CMAI Capacity (MMT) 137 142 143 147 151 YoY chg 12.5 4.8 0.8 4.8 4.0 26.8 Demand (MMT) 115 119 123 130 136 YoY chg 4 4 7 6 21 Required Utilisation (%) 83.9 84.0 86.3 88.2 89.9
With gas being a primary feedstock for GAILs Petchem business and given the estimated robustness in hdPE/lldPE prices, we expect Petchem margin to be continue to expand from current levels of 55%. Accordingly, we estimate GAILs Petchem EBITDA to expand to Rs26bn levels by FY13E. We value the business at 7x FY13E EBITDA (at a marginal discount to global peers), which yields a fair value of Rs144/share. Table 7: Petchem Overview
(Rs mn, year ending March 31) Revenue Revenue Growth (%) EBITDA EBITDA Margin (%) EBIT EBIT Margin (%) Source: I-Sec Research FY10 29,907 9.9 15,537 52.0 13,988 46.8 FY11E 37,927 26.8 21,519 56.7 19,969 52.7 FY12E 40,297 6.2 23,698 58.8 22,148 55.0 FY13E 42,668 5.9 26,039 61.0 24,488 57.4
Table 8: Petchem Valuations

FY13E EBITDA (Rs mn) EV (7x EBITDA) (Rs mn) EV (Rs/share) Source: I-Sec Research 26,039 182,270 144
109
GAIL, April 4, 2011
ICICI Securities Higher subsidies to pressurise LPG
High subsidies continue to pressurise LPG valuations
GAILs LPG and liquid hydrocarbon business has run into tough terrain in the past few years, mostly due to the Governments ad hoc subsidy-sharing policy. GAIL operates a 1.3mmtpa gas-based LPG extraction unit, which is sold to PSU OMCs. However, because GAIL produces LPG, the Government has involved it in upstream subsidy sharing. The companys LPG business has been continuously impacted by subsidies, fluctuating between profits and losses in the past 4-5 years. Considering that the OMCs net under-recoveries will likely breach the Rs100bn mark in FY12E-13E in wake of the sharp crude price spike, we expect GAILs subsidy to rise to Rs25bn annually in the next two years. Going forward, we expect the LPG margin to decline, led by increased costs. We have valued the business at 6x FY13E EBITDA, which yields a fair value of Rs63/share. Table 9: LPG Overview
(Rs mn, year ending March 31) Revenue Revenue growth (%) EBITDA EBITDA margin (%) EBIT EBIT margin (%) Source: I-Sec Research FY10 28,791 -3.16 7,435 25.82 6,589 22.88 FY11E 26,561 -7.75 6,033 22.71 5,170 19.46 FY12E 33,678 26.79 13,075 38.82 12,194 36.21 FY13E 33,903 0.67 13,300 39.23 12,402 36.58
Table 10: LPG Valuations

FY13E EBITDA (Rs mn) EV (6x EBITDA) (Rs mn) EV (Rs/share) Source: I-Sec Research 13,300 79,801 63
CGD provides volume scalability in the long term

The CGD segment of GAIL completes its presence in entire value chain GAIL, to encompass the entire gas value chain (from production to marketing), has forayed into city gas distribution (CGD) by floating a state-wise, dedicated SPV with OMCs to supply gas to households, commercial users and the transport sector. And given that its maiden venture through Indraprastha Gas (IGL) has been a success, the company has floated eight SPVs in respective states to tap in the potential of natural gas as a key alternative to conventional fuels such as petrol, diesel and LPG. The company plans to create ~40 more SPVs across India as a part of the Government of Indias Blue Sky initiative to promote clean fuels. GAIL has ventured into other countries in this business by investing strategically (Rs1,500mn) in gas distribution companies (two companies in Egypt and one in China). We have valued GAILs various investments in CGD business at Rs17/share.
110
GAIL, April 4, 2011
ICICI Securities E&P development long drawn
We have valued E&P business Rs4.5/share, but has potential to add Rs16/share if we include the CBM blocks
GAIL, in consortium with exploration majors such as ONGC/GSPC, has diversified into the high-risk exploration business and has succeeded in some blocks. The company currently holds 10-80% participating interest in 30 exploration blocks (in different phases of exploration). These blocks are located in basins such as Mahanadi, Bengal, Gujarat-Saurashtra, Mumbai, Cambay, Assam-Arakan and Cauvery. The development in such businesses takes time and hence, is long drawn in nature. As is true with any E&P business, a significant discovery in any block can completely change the E&P valuations, which can exponentially raise fair value. We have factored in just GAILs net interest in Cambay and Myanmar blocks to ascribe Rs4.5/share (net) fair value to E&P. We have not factored in the CBM blocks as exact development plans have not been disclosed yet. However, inclusive of the CBM blocks, the overall value for E&P shoots up to Rs16/share. Cambay block. GSPC and GAIL have struck oil in the Cambay basin (Block CBONN-2000/1 recoverable reserve of 3.5mmbbl) and are currently in the production stage. The production is planned for 10 years and we have valued the block at Rs420mn (Rs0.10/share) CBM blocks. The GAIL consortium has been awarded three CBM blocks in the third round of CBM bidding in India recently (at Chhattisgarh and Jharkhand). GAIL's share in the above blocks is within 35-45% (net share of reserves at 127Bcm). We have valued the blocks at an EV/boe of 2x and a recovery of 35%, implying Rs11/share gross value. Myanmar blocks. GAIL has 10% stake in two blocks in Myanmar (Block A1 & A3), with an estimated in-place reserves of ~20Tcf (as per the Myanmar Government). At a 10% recovery factor and an EV/boe of 3x, its value stands at Rs9.1/share (gross value). Table 11: E&P valuations
Block Stake (%) 50 7.5 35 35 45 Reserves (mboe) 3.5 1,800 990 342 756 2,081 GAILs share (mboe) 0.4 55.35 121 42 111 286 Total discounted EV (Rsmn) 165 10,406 10,915 3,771 10,002 14,115 (6,472) 20,049 EV/boe (US$) 8.0 3.0 2.0 2.0 2.0 4.0 Value/share (Rs) 0.1 9.1 4.9 1.7 4.5 11.1 15.8
CB - ONN - 2000/1 Myanmar Block A1,A3 CBM (3 Blocks)
CBM total Write-offs Total Source: I-Sec Research
111
GAIL, April 4, 2011
ICICI Securities Valuations GAIL, an ideal defensive bet
Strong long-term defensive play
We reinitiate coverage on GAIL with a BUY rating At the current market price of Rs464, GAIL is trading at 12x FY13E earnings. Based on cash earnings, the company is attractively valued at ~9x FY13E CEPS. We have used SOTP, which yields Rs572/share value for GAIL we have valued each business separately, incorporating the value of GAILs investments in companies such as ONGC, Petronet LNG etc. At our 12-month target price of Rs572, GAIL would be trading at a comfortable 11.3x FY13E cash earnings. Even in a scenario of changing dynamics (surge in gas supply from the east coast), GAIL will continue to dominate domestic gas transmission and hence, is an ideal defensive play in the domestic oil & gas space. Reinitiate coverage with a BUY. Table 12: SOTP valuations
(Rs mn) Particulars Natural gas transmission (Existing pipelines) LPG transmission New pipelines (includes GREP expansion) Total EV of transmission business (A) Natural gas trading (B) LPG production business (C) Petrochemicals business (D) Total EV (D) 2.4% stake in ONGC 12.5% stake in Petronet LNG 22.5% stake in Indraprastha Gas Total portfolio stake (E) 8.45% stake in Myanmar A-1 block 50% stake in Cambay offshore block Possible write-offs in the next three years E&P value (F) Stakes in city gas distribution projects (India and abroad) (G) Firm value Less: Net debt (FY12E) Equity value Source: I-Sec Research Enterprise value 87,098 13,045 263,229 363,372 49,967 79,801 182,270 675,409 30,703 7,456 7,862 46,021 11,486 920 (6,462) 5,944 21,660 749,034 22,575 726,459 Rs/share 68.6 10.3 207.4 286.3 39.4 62.9 143.6 532.2 24.2 5.9 6.2 36.3 9.1 0.7 4.7 17.1 590.3 17.8 572.0 Method DCF DCF DCF 7x FY13E EBITDA 6x FY13E EBITDA 7x FY13E EBITDA 20% discount to market price 20% discount to market price 20% discount to market price EV/boe EV/boe
Improved profitability from debt raising

Debt equity would still be comfortable at 82% in FY13E after pipeline capex GAILs current low leverage at 32% strongly boosts its overall capex plans of Rs250bn in the next 4-5 years. The company plans to raise its debt to Rs200bn over the next two years through a combination of ECBs and borrowings from domestic banks to fund its pipeline capex. This would raise GAILs debt-to-equity to 82% in FY13E, which is comfortable and would fund the overall Rs250bn capex (including E&P and petrochemicals spend). The company can also dilute its holding in ONGC worth Rs76bn (Rs60/share) to fund its capex. Table 13: Overall capex projections
Projected capex Pipeline E&P Petrochemicals Others Total Source: Company, I-Sec Research FY11 38,500 4,600 2,300 13,180 58,580 FY12 37,500 7,670 3,830 27,390 76,390 FY13 37,500 7,670 3,830 27,390 76,390
112
GAIL, April 4, 2011
ICICI Securities
Traditionally, GAIL has avoided the debt route as earlier, the tariffs were annual RoEbased. On the other hand, the current tariff regulations, based on RoCE, incentivise high debt funding for incremental pipeline capex. GAIL has, therefore, rightly opted for an aggressive debt raising plan, based on which we expect its RoEs to improve markedly from the current 22% once the new pipelines start generating revenues post FY13. GAIL might witness a re-rating (as future cashflows indicate higher incremental returns) and a possible P/BV expansion (FY13E P/BV of 2.2x). Chart 2: Planned borrowings through FY11-13
100
75 (Rs bn)
50
25
0 FY11
FY12
FY13
Table 14: Return ratios

RoCE RoNW Source: I-Sec Research FY07 15.66 19.25 FY08 17.81 21.20 FY09 18.63 21.64 FY10 17.25 19.89 FY11E 17.30 21.27 FY12E 16.56 22.45 FY13E 13.18 19.53

Execution risks such as delays or cost escalation in pipeline expansion could affect the IRR upside from the project. Global ethylene margin contraction could mar GAILs petchem margins. Inability of the Government to pass on the increase in LPG price to the customer could affect GAIL in the form of higher subsidy burden. Delay in ramp-up D6 production could lower transmission volumes, thereby affecting the total tariff.
113
GAIL, April 4, 2011
ICICI Securities Financials Transmission, the backbone
GAILs revenues and profitability will led by gas transmission
GAILs revenue growth would be primarily led by gas transmission volumes as the other businesses seem lacklustre at present. We expect the company to cross 150mmscmd volumes in FY13E, led by expansion in RILs KG D6 production to ~87mmscmd and incremental production from ONGC fields. Table 15: Revenue profile
(Rs mn, year ending March 31) Gas transmission volumes (mmscmd) Tariffs (Rs/('000 scm) Gas transmission % Tot % grth LPG transmission % Tot % grth Petchem % Tot % grth LPG & LHC % Tot % grth Gas trading % Tot % grth Others (GAIL Telecom, E&P) % Tot Total % grth Source: I-Sec Research FY10 106.70 813.55 31,684 11.7 27.6 4,472 1.7 17.6 29,122 10.8 2.2 28,330 10.5 -4.5 188,029 69.5 2.7 533 0.2 282,170 4.4 FY11E 115.28 803.49 33,809 12.5 6.7 4,472 1.7 0.0 37,927 14.0 30.2 26,561 9.8 -6.2 242,368 89.6 28.9 972 0.4 346,108 22.7 FY12E 139.30 927.63 47,165 17.4 39.5 4,472 1.7 0.0 40,297 14.9 6.2 33,678 12.5 26.8 244,766 90.5 1.0 1181 0.4 371,559 7.4 FY13E 159.00 1,019.06 59,141 21.9 25.4 4,472 1.7 0.0 42,668 15.8 5.9 33,903 12.5 0.7 248,013 91.7 1.3 1211 0.4 389,408 4.8
Also, as gas transmission is a high-margin business, we expect GAILs EBITDA to grow faster to ~US$2bn by FY13E. Other businesses will continue to be a drag. Table 16: EBITDA contribution from businesses
(Rs mn, year ending March 31) Gas transmission % Tot % sales Gas Trading % Tot % sales LPG transmission % Tot % sales Petchem % Tot % sales LPG & LHC % Tot % sales Others (GAIL telecom, E&P write-offs, etc) % Tot Total % grth Source: I-Sec Research FY10 23,792 54.58 75.09 4,038 8.65 2.15 3,422 7.85 76.53 14,667 33.64 50.36 7,435 17.06 26.24 (6,666) (15.29) 46,688 7.10 FY11E 25,610 58.75 75.75 7,089 11.56 2.92 3,477 7.98 77.75 21,519 49.36 56.74 6,033 13.84 22.71 (2,414) (5.54) 61,569 31.33 FY12E 36,097 82.80 76.53 7,091 8.74 2.90 3,477 7.98 77.75 23,698 54.36 58.81 13,075 29.99 38.82 (2,283) (5.24) 81,456 32.36 FY13E 46,406 49.33 78.47 7,138 7.59 2.88 3,477 3.70 77.75 26,039 27.68 61.03 13,300 14.14 39.23 (2,280) (2.42) 94,500 15.93
114
GAIL, April 4, 2011
EV/ Share (Rs) (Rs) 100 100 0 200 300 400 500 600 700 800 200 0 400 500 600 700 800 900
(Rs) 300 400 500 600 700
100 Apr-02 Apr-02 Oct-02 Apr-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Apr-10 7x 2x Sep-10 Mar-11 1x 3x 11x 13x 9x 4x Sep-10 Mar-11 Sep-02 Feb-03 Jul-03 Dec-03 May-04 Oct-04 Mar-05 Aug-05 Jan-06 Jun-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09
200
300
Apr-05
Chart 3: Rolling price/EPS trend
Chart 4: Rolling price/book trend
Jul-05
Nov-05
Mar-06
Jul-06
Nov-06
Mar-07
Jul-07
Nov-07
Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
5x
Nov-10
12x 10x 8x
16x 14x
ICICI Securities
Mar-11
115
GAIL, April 4, 2011
ICICI Securities Annexure 1: Financials (consolidated)

(Rs mn, year ending March 31) Gross Sales Less: Excise Duty Net Sales of which Export Sales of which Domestic Sales Telecom revenues Other Operating Income E&P revenues Total Operating Income Less: Raw Material Consumed Power and Fuel Personnel Expenses Selling and Distribution Expenses Other Expenses E&P business expenses Total Operating Expenses EBITDA Depreciation & Amortisation Other Income EBIT Less: Gross Interest Recurring Pre-tax Income Add: Extraordinary Income Less: Extraordinary Expenses Less: Taxation --Current Tax --Deferred Tax Net Income (Reported) Recurring Net Income Source: Company data, I-Sec Research FY09 245,729 5,163 240,566 240,566 243 31,405 272,214 FY10 253,302 3,794 249,508 249,508 124 32,248 332 282,212 FY11E 312,493 1,188 311,305 311,305 311 33,831 661 346,108 FY12E 337,530 1,288 336,243 336,243 341 34,136 840 371,559 FY13E 355,097 1,343 353,755 353,755 371 34,443 840 389,408
203,442 8,695 5,767 6,212 855 3,651 228,621 43,593 5,599 7,966 45,960 870 45,090 (2,013)
208,336 9,104 6,212 6,955 1,417 3,500 235,523 46,688 5,618 5,411 46,481 700 45,781 4
260,950 9,319 6,678 3,130 1,331 3,131 284,539 61,569 6,199 3,471 58,841 1,133 57,709 -
263,713 10,727 7,685 3,397 1,398 3,183 290,103 81,456 9,710 3,186 74,933 4,122 70,811 -
267,286 12,044 8,640 2,288 1,468 3,183 294,909 94,500 15,475 3,272 82,297 10,099 72,198 -
14,977 62 28,037 30,050
13,750 636 31,398 31,395
18,850 81 38,778 38,778
22,552 100 48,160 48,160
23,153 102 48,943 48,943
116
GAIL, April 4, 2011 Table 18: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Goodwill Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Exploratory wells in progress Less: Revaluation Reserve Total Fixed Assets Total Assets FY10
ICICI Securities
FY11E
FY12E
FY13E
34,562 6,014 15,033 31,117 546 87,272
41,718 6,317 12,950 33,240 83 94,308
22,107 8,452 15,545 35,508 87 81,700
26,310 8,477 15,792 37,931 91 88,601
23,902 8,863 16,559 40,520 96 89,939
19,725 22,054 4,675 46,455 40,818
20,318 34,165 6,479 60,962 33,346
25,449 34,165 6,479 66,093 15,606
25,718 34,165 6,479 66,363 22,238
26,067 34,165 6,479 66,711 23,228
17,217 156 17,373
20,634 96 20,730
30,134 96 30,230
41,002 96 41,098
42,002 96 42,098
176,040 85,537 90,503 20,825 3,438 114,767 172,957
210,377 91,066 119,311 19,570 3,735 142,616 196,692
227,522 97,242 130,280 77,047 7,310 214,638 260,474
364,489 106,926 257,563 23,180 10,885 291,628 354,965
524,650 122,376 402,274 9,365 14,460 426,099 491,425
LIABILITIES AND SHAREHOLDERS' EQUITY Borrowings Short Term Debt Long Term Debt Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital No. of Shares outstanding (mn) Face Value per share (Rs) Reserves & Surplus Share Premium General & Other Reserve Net Worth Total Liabilities & Shareholders' Equity Source: Company data, I-Sec Research
1,001 11,000 12,001 13,259
14,804 14,804 13,896
49,804 49,804 13,977
108,501 108,501 14,077
208,383 208,383 14,178
12,685 1,268 10
12,685 1,268 10
12,685 1,268 10
12,685 1,268 10
12,685 1,268 10
3 135,009 147,696 172,957
3 155,305 167,992 196,692
3 184,006 196,693 260,474
3 219,699 232,387 354,965
3 256,176 268,864 491,425
117
GAIL, April 4, 2011 Table 19: Cashflow statement

(Rs mn, year ending March 31) FY09 Cash Flow from Operating Activities Reported Net Income Add: Depreciation & Amortisation Deferred Taxes Less: Other Income Net Extra-ordinary income Op. Cash Flow before Working Capital change (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from fresh borrowings Dividend paid including tax Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 28,037 5,291 62 7,966 (2,013) 27,437 FY10 31,398 5,529 636 5,411 4 32,149
ICICI Securities
FY11E 38,778 6,176 81 3,471 41,564
FY12E 48,160 9,684 100 3,186 54,757
FY13E 48,943 15,450 102 3,272 61,222
(316) (4,298) (8,245) 22 1,747 3,599 (7,490) 19,947
(303) 2,083 (2,123) 464 593 13,915 14,628 46,777
(2,135) (2,595) (2,268) (4) 5,131 (1,871) 39,693
(25) (246) (2,423) (4) 269 (2,429) 52,328
(386) (768) (2,588) (5) 348 (3,398) 57,824
(22,558) (2,464) (25,022) (5,075)
(33,379) (3,358) (36,736) 10,041
(78,198) (9,500) (87,698) (48,005)
(86,675) (149,921) (10,868) (1,000) (97,543) (150,921) (45,214) (93,097)
7,966 7,966
5,411 5,411
3,471 3,471
3,186 3,186
3,272 3,272
(657) (10,388) (11,046) (2,013) (10,167)
2,803 (11,102) (8,300) 4 7,156
35,000 (10,077) 24,923 (19,611)
58,697 (12,466) 46,231 4,203
99,882 (12,466) 87,416 (2,408)
44,730 34,562 (10,168)
34,562 41,718 7,156
41,718 22,107 (19,611)
22,107 26,310 4,203
26,310 23,902 (2,408)
118
GAIL, April 4, 2011 Table 20: Key ratios

(Year ending March 31) FY09 Per Share Data (in Rs.) EPS(Basic Recurring) Diluted Recurring EPS Recurring Cash EPS Dividend per share (DPS) Book Value per share (BV) Growth Ratios (%) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF Operating Ratio Raw Material/Sales (%) Other Income / PBT (%) Effective Tax Rate (%) NWC / Total Assets (%) Inventory Turnover (days) Receivables (days) Payables (days) D/E Ratio (x) Return/Profitability Ratio (%) Recurring Net Income Margins RoCE RoNW Dividend Payout Ratio Dividend Yield EBITDA Margins Source: Company data, I-Sec Research 23.7 23.7 28.1 7.0 116.4 FY10 24.8 24.8 29.2 7.5 132.4
ICICI Securities
FY11E 30.6 30.6 35.5 6.8 155.1
FY12E 38.0 38.0 45.6 8.4 183.2
FY13E 38.6 38.6 50.8 8.4 212.0
32.4 10.8 16.2 16.2 12.9
3.7 7.1 4.5 4.5 3.8
22.6 31.9 23.5 23.5 21.5
7.4 32.3 24.2 24.2 28.7
4.8 16.0 1.6 1.6 11.3
19.6 16.5 4.0 8.8 1.4 29.0
18.7 15.9 3.5 8.1 1.3 12.3
15.2 13.1 3.0 7.0 1.3 15.9
12.2 10.2 2.5 6.0 1.3 13.1
12.0 9.1 2.2 6.2 1.5 13.6
84.6 17.7 33.4 3.6 36.2 19.1 33.8 17.1
83.5 11.8 31.4 (4.3) 35.3 20.2 35.1 17.1
83.8 6.0 32.8 (2.5) 36.6 16.6 32.0 32.4
78.4 4.5 32.0 (1.1) 32.4 16.9 35.4 52.7
75.6 4.5 32.2 (0.1) 32.2 16.6 35.4 82.8
10.7 18.6 21.6 31.7 1.5 16.0
10.9 17.2 19.9 30.3 1.6 16.5
11.1 17.3 21.3 22.2 1.5 17.8
12.9 16.6 22.4 22.1 1.8 21.9
12.5 13.2 19.5 21.8 1.8 24.3
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GAIL, April 4, 2011
ICICI Securities Annexure 2: Index of Tables and Charts

Tables
Table 1: Pipeline infrastructure Overall snapshot ..........................................................105 Table 2: Pipeline capex Status ......................................................................................105 Table 3: Transmission Valuations..................................................................................106 Table 4: Domestic demand-supply situation.....................................................................107 Table 5: Tariff recommendations as per PNGRB .............................................................108 Table 6: Ethylene capacities .............................................................................................109 Table 7: Petchem Overview...........................................................................................109 Table 8: Petchem Valuations .........................................................................................109 Table 9: LPG Overview..................................................................................................110 Table 10: LPG Valuations ..............................................................................................110 Table 11: E&P valuations..................................................................................................111 Table 12: SOTP valuations ...............................................................................................112 Table 13: Overall capex projections .................................................................................112 Table 14: Return ratios .....................................................................................................113 Table 15: Revenue profile.................................................................................................114 Table 16: EBITDA contribution from businesses ..............................................................114 Table 17: Profit and loss statement ..................................................................................116 Table 18: Balance sheet ...................................................................................................117 Table 19: Cashflow statement ..........................................................................................118 Table 20: Key ratios ..........................................................................................................119
Charts
Chart 1: Pipelines GAILs expansion plans....................................................................107 Chart 2: Planned borrowings through FY11-13 ................................................................113 Chart 3: Rolling price/EPS trend .......................................................................................115 Chart 4: Rolling price/book trend ......................................................................................115 Chart 5: Rolling EV/EBITDA trend ....................................................................................115
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Equity Research
Gujarat State Petronet

Moving into higher growth orbit
Target price Rs130
BUY
Rs102

Gujarat State Petronet (GSPL) is the largest transmission network operator in Gujarat, connecting all the major demand centres in the state through its 1,700Kms long pipeline infrastructure. GSPLs transmission volumes have surged to 38mmscmd in the past two years, led by KG-D6 supply and LNG from Petronet LNG (PLNG). GSPL is mulling expanding aggressively beyond Gujarat it has won three bids for inter-state trunk pipelines, spanning 4,000Kms. The growth thrust makes GSPL an aggressive long-term play, offering a possible Rs44/share upside if the pipelines are found to be commercially viable we have excluded this in our valuations. We reinitiate coverage on GSPL with a BUY. We value GSPL on DCF, which yields a target price of Rs130/share. The stock offers excellent risk-reward in the long term. Reinitiate with a BUY. Gujarat, still a golden opportunity. GSPL has benefited from Reliance Industrys (RIL) gas production from the KG-D6 basin its transmission volumes have risen to 38mmscmd in the past two years. We expect GSPL to transmit >50mmscmd volumes in the next three years as gas supplies ramp up from RIL and ONGC. The company now intends to move beyond Gujarat. With ~27mmscmd incremental demand to come up from gas-based power plants in Gujarat, the state offers ample volume growth opportunity for GSPL. Expanding horizons. GSPL has bid for four new cross-country pipelines in a JV with oil marketing companies (OMCs, GSPL has 52% stake), which would expand its reach beyond Gujarat. The company has won three bids, but the official licences have not been awarded by the PNGRB due to a stay by the Supreme Court on PNGRBs authority to award licences. The three pipelines would span 4,000Kms in India at a capex of Rs180bn in the next 3-4 years. In our view, these pipelines can add up to Rs44/share upside to GSPLs target price if they are found to be commercially viable we have not captured this in our target price. Key concerns Tariffs and volume ramp-up. Some key concerns are the longpending authorisation from the Petroleum and Natural Gas Regulatory Board (PNGRB) for GSPLs Gujarat pipelines and the approval of tariffs. We expect these to be addressed by Q2FY12 as GSPL files for its tariff notification by March end. As was the case for GAIL, it is unlikely that GSPLs current tariffs would decline post the notification (also assured by the management). Reinitiate with a BUY. At our target price of Rs130/share, GSPL would trade at a comfortable 8.2x FY13E cash earnings. Reinitiate with a BUY.
Market Cap Reuters/Bloomberg 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$/'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs57.3bn/US$1.3bn GSPT.BO/GUJS IN 562.58 128/82 62.3 11.3 1,870 (13.5) 12.4 (5.6) 8.3 Year to Mar Revenue (Rs bn) Net Income (Rs bn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield (%) RoCE (%) RoE (%) FY10 9,920 4110 7.3 232.4 13.9 11.5 7.3 1.0 17.4 29.6 FY11E 11,049 5646 10.0 37.4 10.1 12.3 7.1 1.0 18.4 31.1 FY12E 12,319 6287 11.2 11.4 9.1 13.9 5.9 1.0 16.8 26.8 FY13E 12,859 6901 12.7 13.9 8.0 15.9 5.1 1.0 16.6 23.5
Price chart
130 120 110 (Rs) 100 90 80 Nov-10 Aug-10 Mar-11 Jun-10 Apr-10 Jan-11
Rohit Ahuja
Prolin Nandu
121
Gujarat State Petronet, April 4, 2011
ICICI Securities
TABLE OF CONTENT
Gujarat, still a golden opportunity .............................................................................123 Volume rise in Gujarat to be led by domestic gas supplies ........................................123 Expanding horizons.....................................................................................................126 Upsides from new pipelines back-ended ....................................................................126 Financial overview .......................................................................................................129 Volume growth on track ..............................................................................................129 Debt raising to sustain RoEs.......................................................................................129 Valuations attractive....................................................................................................130 Reinitiate with a BUY ..................................................................................................130 DCF Key assumptions .............................................................................................130 Key risks to our call .....................................................................................................130 Annexure 1: Financials (standalone) .........................................................................132 Annexure 2: Index of Tables and Charts ...................................................................136
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ICICI Securities
Gujarat, still a golden opportunity

Volume rise in Gujarat to be led by domestic gas supplies
GSPL has significant presence in Gujarat the gas hub of India and a major recipient of east coast gas Gujarat is one of the largest natural gas demand centres in India and GSPL has been pivotal in developing the gas market in the state. The company has until recently primarily focused on connecting prominent demand centres in the state. The power sector is a major gas demand driver in Gujarat; hence, we expect incremental gas volume growth for GSPL to be sensitive to pricing. This makes the increase in low-cost domestic gas supply critical to propel volume growth in Gujarat gas supply will rise mostly due to the ramp-up in RILs KG D6 volumes. High cost LNG will have a limited role to play in terms of satiating future power demand. Post the RIL-British Petroleum deal, the ramp-up schedule for the KG D6 field is perking up and can surprise on the upside by achieving peak production sooner than expected.
Table 1: Upcoming gas-based power plants in Gujarat

Company GSPC Location Hazira, Pipavav Sujen, Dahej Dhuvarna Capacity (MW) 1050 Gas utilisation (mmscmd) 5.3 Comments Hazira plant of 350MW to come up in April FY12 Pipavav plant of 350MW to come up in June FY12 Another 350MW expansion at Pipavav to come up in Q3FY12 UNOSUGEN project(brownfield) of 382.5MW at Sugen, for which EPC contract has been awarded DGEN project at Dahej SEZ (1,200MW) likely by FY14E L&T has been awarded the EPC contract for the project Two projects by DMIC (1,000MW & 1,300MW) likely to come in 13-14
Torrent
1583
7.9
Gujarat State Electricity Corporation Delhi-Mumbai Industrial Corridor (DMIC) Source: Industry
375 2300
1.9 11.5 26.5
Total
5308
Major volume growth in Gujarat will come from Power and Fertilizer companies, priority sectors in terms of gas allocation
GSPL has benefited from RILs D6 gas production its transmission volumes have risen to 38mmscmd in the past two years. The companys 1,700Kms long infrastructure in Gujarat connects all the major gas demand centres to the supply sources. Also, connectivity to the LNG terminals of Shell and Petronet LNG and the HVJ pipeline in the West and with the Reliance Gas Transmission Infrastructure (RGTIL) pipeline in the east coast offers GSPL a unique advantage of giving its customers the option to source gas from all the major sources. Chart 2: Supply source in Gujarat
80 70 60 Petronet RIL D6 PMT Others
Chart 1: Gas demand source in Gujarat

120 100 80 Pow er Plant Fertilizer Others Captive Pow er Plant SME
(mmscmd)
50 (mmscmd) 40 30 20
60 40 20 0 FY11 FY12 FY13 FY14
10 0 FY11 FY12 FY13 FY14
Note: Others include refinery, petchem plant, steel plants etc; Source: Infraline, Industry
123
Gujarat State Petronet, April 4, 2011 Chart 3: GSPLs network in Gujarat
ICICI Securities
Source: Company
D6 production ramp-up will push GSPL volumes towards 50mmscmd
Optimism of growth in domestic supply has re-emerged based on the recent RIL-BP deal for the KG basin blocks. Consequently, we see a possible expansion in GSPLs volumes based on the following phases: Phase I D6 volume ramp up to 65-67mmscmd from 51mmscmd. This would add 4-5mmscmd to GSPLs volumes, which would be mainly supplied to power projects in Gujarat. Thus, overall volumes would rise to 42-43mmscmd from 38mmscmd. Phase II D6 volumes to ramp up to 87mmscmd by end FY13E from 67mmscmd. This would add ~6-7mmscmd to GSPLs volumes and overall volumes would move up to 50mmscmd in FY14E. Additional infrastructure is required to ramp up beyond 50mmscmd.
However, we have factored in delay in ramp-up of gas production from KG D6 and believe that expansion to 87mmscmd would happen only by end FY13. Volume growth for GSPL would be primarily driven by LNG in FY12. Addition from RIL kicks in only from FY13 as per our estimates.
124
Gujarat State Petronet, April 4, 2011 Table 2: Domestic demand-supply

(mmscmd) Gas supply Existing sources ONGC Petronet LNG Shell Hazira Dabhol LNG Others (including OIL and Pvt JVs) New sources RIL KG D6 RIL Mahanadi basin GSPC KG basin ONGC KG basin CBM RIL others (D6 satellite, NEC 25, etc) Total supply Gas demand Power Fertiliser Sponge iron plants Refineries City gas distribution Industrial Total demand Demand-supply Source: Industry Current 54 30 4 19 54 7 0 0 3 170 74 39 6 30 14 14 177 6.7 FY13E 46 34 9 18 20 80 9 10 0 5 231 100 54 8 35 18 18 232 1.1
ICICI Securities
FY16E 40 36 18 18 20 80 9 20 20 15 30 306 150 70 10 45.5 23.4 21 320 13.6 % share (FY16E) 13.1 11.8 5.9 5.9 6.5 26.1 2.9 6.5 6.5 4.9 9.8
46.9 21.8 3.1 14.2 7.3 6.6
Chart 4: Gas, most competitive versus other alternate fuels

800 700 600 500 (US$/te) 400 300 200 100 0 RIL.gas RIL.gas RIL.gas RIL.gas Fuel oil Fuel oil Fuel oil Naptha Naptha Naptha Naptha Fuel oil
2008-09
Source: Industry
2009-10P
2010-11P
2011-12P
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ICICI Securities
Expanding horizons
Upsides from new pipelines back-ended
New pipeline bids, if commercially viable, offer an upside of Rs44/share to our target price In a regulated tariff scenario, the only way to expand valuations is to continuously incur capex. GSPL has won three bids of the four cross-country pipeline bids, which would expand its reach beyond Gujarat. Mallavram-Vijaipur-Bhilwara (1,585Kms) Rs60-70bn capex & 30mmscmd capacity. GSPL has won the bid for the Mallavram-Vijaipur-Bhilwara pipeline, in consortium with OMCs, Indian Oil Corporation (IOC), Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation (BPCL). GSPL will own 52%, while IOC, HPCL and BPCL will 24%, 12% & 12% respectively. GSPL is planning to supply gas from the east coast to tap in the demand potential in Central India and East Rajasthan. The overall demand potential from this region is expected to be ~20mmscmd. However, this pipeline will compete with RGTIL and GAILs pipeline infrastructure. Hence, the key to success is excess supply from the east coast in the next 4-5 years. Mehsana-Bhatinda (1,670Kms) Rs65-80bn capex & 30mmscmd capacity. GSPL has won the bid for the Mehsana-Bhatinda pipeline together with OMCs. GSPL would own 52%, while IOC, HPCL and BPCL would own 24%, 12% and 12% respectively. GSPL wants to tap in gas demand centres in Bhatinda (from the upcoming HPCLMittal 9mmtpa Bhatinda refinery) and other demand centres en route to Rajasthan. The company sees a demand of 10mmscmd in Bhatinda, with other areas in Rajasthan potentially generating 10-20mmscmd demand. Bhatinda-Srinagar (740Kms) Rs30-40bn capex & 30mmscmd capacity. GSPL has won the bid for the pipeline in consortium with OMCs. GSPL would own 52%, while IOC, HPCL and BPCL would 24%, 12% and 12% respectively. The infrastructure for the pipeline would be difficult to implement and operate given its passage through the strife-ridden Jammu & Kashmir state. GSPL sees a demand potential of ~10mmscmd in Jammu and Srinagar. However, we are guarded in valuing the capex of the pipeline even if GSPL wins the bid as the route is prone to terrorism. Surat-Paradip (1,680Kms) Rs70-80bn capex & 30mmscmd capacity. The PNGRB has set March 28, 11 as the deadline for submitting the bids, the outcome of which will be declared by end-April or May 11. This pipeline runs parallel to RGTILs Kakinada-Bharuch pipeline, which is surprising. However, with >50-100mmscmd incremental gas production expected from the east coast in the next 5-10 years, GSPL probably envisages lack of pipeline capacity by RGTIL and other pipelines connecting the east coast. The company sees a potential demand of 20mmscmd in Paradip (from the upcoming 15mmtpa Paradip refinery and the proposed petrochemical complex).
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ICICI Securities
GSPL has won three bids for the new pipelines, but the official licences have not been issued by the PNGRB due to a stay by the Supreme Court on PNGRBs authority to award licences. The three pipelines span 4,000Kms in India and entail a capex of Rs180bn in the next 3-4 years. We believe the pipelines can add up to Rs44/share upside to GSPLs target price if they are found to be commercially viable. Table 3: Valuations for new pipelines
(Rs mn) New pipeline capex (gross) New pipeline capex (net to GSPL) Debt (70%) Equity Book value/Share (x) Discounted book value (four years) Project IRR (RoCE) P/BV valuation (@implied RoE of 17%, 1.4x) (x) Source: I-Sec Research 180,000 93,600 65,520 28,080 50 32 12% 44
Clarity is required on the biddable tariff component for the new pipelines before we factor it in our target price. Commercial viability of new pipelines assessable only after bid details are disclosed RoCE. GSPL has won three pipeline bids, but there is no clarity on financial parameters, the most prominent being the RoCE at which the bids were made. Since RoCE is a biddable component, any variation can significantly impact the expected valuation upside from these pipelines. Volume ramp-up schedule. For the new pipeline bids, this portion is biddable. While for existing pipelines or those authorised by the PNGRB, the utilisation moves in the following sequence annually 60%, 70%, 80%, 90% and 100%, for bidding, this can be flexible with the fastest sequence to 100% winning the bid. Assuming a 30mmscmd capacity, a company which has bid 80% in the first year will have to start with an average volume of 24mmscmd in the first year. Assuming lack of clarity on any firm gas supplies post 15, offering a high utilisation can be a major risk and can hamper the companys actual project IRR. Capex. A lower capex assumed would translate into competitive tariffs, on which the outcome of the financial bid will be based. A major risk to this assumption is cost overrun due to delays or run-up in raw material costs.
127
Gujarat State Petronet, April 4, 2011 Chart 5: Proposed pipeline bids by GSPL
ICICI Securities
DELHI
Source: Company
128
ICICI Securities
Financial overview
Volume growth on track
We expect GSPLs revenue growth to depend on its volume ramp-up in Gujarat. The companys gas transmission volumes will likely touch 50mmscmd in FY13E as RILs production from KG-D6 ramps up along with incremental volumes from the Petronet LNG terminal. Based on the volume rise, we expect average transmission tariffs for GSPL to decline to Rs0.7/scm in FY13E from Rs0.8/scm at present. However, post FY13, GSPLs revenue growth would depend on the commissioning of the recently bid cross-country pipelines and the ramp-up in domestic gas production. We have assumed nil contribution from GSPL to the Gujarat Socio Economic Development Scheme (GSEDS), the tax scheme implemented by the Gujarat Government PBT would have been eroded 30% if contribution was made to GSEDS (the Gujarat Government has made no clarifications on GSEDS). Also, as per industry sources, the Gujarat Government has informally withdrawn the order owing to the impact on the future IPOs proposed by the state entities, most prominent being the proposed issue of Gujarat State Petroleum Corporation (GSPC). Table 4: Key financials and assumptions
(Rs mn, year ending March 31) Volumes (mmscmd) Average tariffs (Rs/scm) Average tariffs (Rs/mmscmd) Revenues YoY growth (%) EBITDA YoY growth (%) EBITDA margin PAT (adjusted) YoY growth (%) PAT margin Source: I-Sec Research FY10 32.59 848.47 0.85 9,920 103.48 9,297 118.79 93.73 4,110 232.62 41.44 FY11E 37.39 809.72 0.81 11,049 11.39 10,391 11.77 94.05 5,617 36.66 50.84 FY12E 42.15 823.22 0.82 12,319 11.49 11,613 11.75 94.27 6,249 11.25 50.73 FY13E 50.39 718.82 0.72 12,859 4.39 12,023 3.53 93.50 6,897 10.37 53.63
Debt raising to sustain RoEs

Debt-to-equity of 0.3x in FY13E gives GSPL financial flexibility to fund capex for new pipelines We expect GSPLs leverage to decline to 0.3x levels in FY13E, which will provide good financial bandwidth to GSPL while funding its share of the capex for the three new cross-country pipelines (overall Rs180bn). The company is expected to fund these pipelines in a debt-to-equity ratio of 70:30. As the regulated tariffs are independent of the funding structure, we believe GSPL would be able to maintain its current RoE over the long-term. Table 5: Key ratios
(Year ending March 31) RoCE (%) RoNW (%) D/E ratio (x) Source: I-Sec Research FY10 7.68 29.62 0.90 FY11E 17.38 31.01 0.81 FY12E 19.11 26.71 0.51 FY13E 18.18 23.53 0.29
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ICICI Securities
Valuations attractive
Reinitiate with a BUY
We recommend GSPL as one of the most aggressive plays in the oil & gas sector At the current market price of Rs102, GSPL is attractively valued at FY13E P/E of 8x. Based on cash earnings too, the company is appealing at 6.4x FY13E CEPS. We value the company on DCF, which yields Rs130/share target price. At this target price, GSPL would trade at a comfortable 8.2x FY13E cash earnings. As the dynamics of the domestic midstream gas industry is changing with regulations and as significant supplies commence from the east coast, we believe GSPL is one of the most aggressive growth plays in this space. Reinitiate with a BUY. Table 6: DCF valuations
(Rs mn) PV of FCF to FY24E Terminal value PV of terminal value EV Less: Net debt Value for shareholders Number of shares (mn) GSPL Value for extant business (Rs/share) Source: I-Sec Research 56,763 112,909 27,490 84,253 11,407 72,846 562.1 130
Table 7: Sensitivity of DCF value

(Rs/share) Terminal growth (%) 1 2 3 4 5 Source: I-Sec Research 10.50 118 132 148 169 199 11 112 124 138 157 181 WACC (%) 11.48 106 117 130 146 167 12 101 110 121 136 154 12.50 96 104 114 127 143
DCF Key assumptions

Average volumes at 53mmscmd beyond FY13E Average tariffs to decline to Rs0.7/scm from FY13E WACC at 11.5% and terminal growth at 3% Capex assumed only for infrastructure which is being implemented at present No capex or revenue contribution factored in from the recently bid pipelines

Delay in ramp-up D6 production could lower transmission volumes, thereby affecting the total tariff. Delay in resolution of the litigation on formally announcing the winners of the three trunk pipeline bids can escalate project cost. Cost escalation in GSPLs trunk pipeline network could affect the IRR of the project.
130
Gujarat State Petronet, April 4, 2011 Chart 6: Rolling Price/EPS trend

200 175 150 125 (Rs) 100 75 50 25 0
ICICI Securities
16x 14x 12x 10x 8x
May-10
Oct-10 4x 3x 2x 1x Oct-10 10x 8x 6x 4x 2x Oct-10
Nov-07
Chart 7: Rolling PBV trend

200 175 150 125 (Rs) 100 75 50 25 0 May-10 Feb-09 Jul-09 Nov-07 Aug-06 Dec-09 Sep-08 Mar-11 Mar-11 Jan-07 Jun-07 Apr-06 Apr-08

250 200 Ev/ Share (Rs) 150 100 50 0 Feb-09 Jul-09 May-10 Nov-07 Aug-06 Dec-09 Jan-07 Jun-07 Sep-08 Apr-06 Apr-08
Aug-06
Dec-09
Sep-08
Mar-11
Feb-09
Jan-07
Jun-07
Apr-06
Apr-08
Jul-09
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ICICI Securities
Annexure 1: Financials (standalone)

(Rs mn, year ending March 31) Total Operating Income Less: Employee cost Gas transportation cost Connectivity charges Admin & other expense Total Operating Expenses EBITDA EBIDTA Margin (%) Depreciation & Amortisation Other Income EBIT Less: Gross Interest Recurring Pre-tax Income Add: Extraordinary Income Less: Extraordinary Expenses Less: Taxation CSR tax --Current Tax --Deferred Tax Net Income (Reported) Recurring Net Income Source: Company data, I-Sec Research FY09 4,875 FY10 9,920 FY11E 11,049 FY12E 12,319 FY13E 12,859
109 36 91 390 626 4,249 87.2 1,705 243 2,788 870 1,918 2
99 4 519 622 9,297 93.7 2,365 247 7,180 938 6,241 27
122 3 533 658 10,391 94.0 1,258 189 9,322 1,257 8,064 -
153 3 551 706 11,613 94.3 1,558 361 10,415 1,447 8,969 -
176 2 659 836 12,023 93.5 1,730 581 10,874 1,210 9,665 -
537 145 1,234 1,236
1,870 261 4,137 4,110
2,081 338 5,646 5,646
2,306 376 6,287 6,287
2,359 405 6,901 6,901
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Gujarat State Petronet, April 4, 2011 Table 9: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Operational Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Tax Dividend Others Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Total Investments Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Less: Revaluation Reserve Total Fixed Assets Total Assets LIABILITIES AND SHAREHOLDERS' EQUITY Borrowings Short Term Debt Long Term Debt Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital No. of Shares outstanding (mn) Face Value per share (Rs) Reserves & Surplus Share Premium General & Other Reserve Less: Misc. Exp. not written off Net Worth Total Liabilities & Shareholders' Equity Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
975 926 544 3018 3,018 153 5,615
1,742 1,327 753 3600 3,600 129 7,549
2,037 1,493 929 4571 4,571 129 9,158
5,989 1,664 1,036 3408 3,408 129 12,226
8,536 1,737 1,082 1796 1,796 129 13,280
3,700 42 1,590
4,765 83 3,486 2,794 656 36 8,334 (785)
4,905 87 3,486
3,781 92 3,486
2,890 96 3,486
5,331 284
8,478 681
7,358 4,868
6,472 6,809
356 356
666 666
666 666
666 666
666 666
24,212 6,526 17,686 6,446 24,132 24,772
33,255 8,887 24,368 5,387 29,755 29,635
43,014 10,146 32,869 6,993 39,862 41,209
51,438 11,704 39,734 430 40,164 45,698
53,383 13,434 39,949 514 40,463 47,938
430 11,079 11,509 1,144
30 12,565 12,595 1,405
18,839 18,839 1,743
17,324 17,324 2,119
12,916 12,916 2,523
5,621 562 10 4,009 2,521 33 12,119 24,772
5,624 562 10 4,011 6,003 3 15,635 29,636
5,624 562 10 4,011 10,991 20,626 41,209
5,624 562 10 4,011 16,620 26,255 45,698
5,624 562 10 4,011 22,863 32,498 47,938
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Gujarat State Petronet, April 4, 2011 Table 10: Cashflow statement

(Rs mn, year ending March 31) FY09 Cash Flow from Operating Activities Reported Net Income Add: Depreciation & Amortisation Provisions Taxes Less: Other Income Net Extra-ordinary income Op Cash Flow before Working Capital change (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow before Capital commitments Purchase of Fixed Assets Purchase of Investments Consideration paid for acquisition of undertaking Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from equity issue Proceeds from fresh borrowings Dividend paid including tax Other items Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d) + (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 1,234 1,706 145 243 (2) 2,844 FY10 4,137 2,362 261 247 27 6,486
ICICI Securities
FY11E 5,646 1,258 338 189 7,053
FY12E 6,287 1,558 376 361 7,860
FY13E 6,901 1,730 405 581 8,454
(529) (127) (1,138) 81 (394) 619 (1,488) 1,356
(401) (209) (581) 24 1,065 1,937 1,836 8,322
(166) (177) (971) 139 4 (1,170) 5,883
(172) (107) 1,162 (1,124) 4 (236) 7,624
(73) (45) 1,612 (891) 5 607 9,061
(4,579) (0) (4,579) (3,223)
(7,984) (310) (8,294) 28
(11,366) (11,366) (5,483)
(1,860) (1,860) 5,764
(2,029) (2,029) 7,032
243 243
247 247
189 189
361 361
581 581
2 1,849 (493) 31 1,388 (2) (1,594)
5 1,086 (658) 32 465 27 767
6,244 (658) 3 5,589 295
(1,515) (658) 0 (2,173) 3,952
(4,408) (658) (0) (5,066) 2,547
2,569 975 (1,595)
975 1,742 767
1,742 2,037 295
2,037 5,989 3,952
5,989 8,536 2,547
134
Gujarat State Petronet, April 4, 2011 Table 11: Key ratios

(Year ending March 31) FY09 Per Share Data (Rs) Diluted Rec. Earning per share (DEPS) Diluted Earnings per share Recurring Cash Earnings per share (CEPS) Free Cashflow per share (FCPS-post capex) Reported Book Value (BV) Adjusted Book Value (ABV) Dividend per share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring EPS Price to Book Value Price to Adjusted Book Value Price to Sales Ratio EV / EBITDA EV / Total Operating Income EV / Op Free Cash Flow (Pre-Capex) EV / Net Operating FCF (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins SGA Expenses / Sales Other Income / Pre-tax Income Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Normalised RoCE (as per PNGRB) Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Long Term Debt / Total Debt Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT (x) Debt Servicing Capacity Ratio (DSCR) (x) Current Ratio (x) Cash and cash equivalents / Total Assets Turnover Ratios Assets Turnover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research 2.2 2.2 5.2 (5.7) 21.6 28.6 0.7 FY10 7.3 7.3 11.5 0.0 27.8 37.4 1.0
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FY11E 10.0 10.0 12.3 (9.7) 36.7 46.4 1.0
FY12E 11.2 11.2 13.9 10.2 46.7 56.5 1.0
FY13E 12.7 12.7 15.9 13.0 59.9 70.3 1.0
46.3 19.5 4.7 3.6 11.74 15.9 13.9 50.0 (21.0) 0.7
13.9 8.8 3.7 2.7 5.77 7.3 6.9 8.2 2,454.6 1.0
10.1 8.3 2.8 2.2 5.18 7.1 6.7 12.6 (13.5) 1.0
9.1 7.3 2.2 1.8 4.65 5.9 5.6 9.0 11.9 1.0
8.0 6.4 1.7 1.4 4.45 5.1 4.8 6.8 8.8 1.0
21.1 10.8 16.7 16.6 21.1
232.4 120.1 103.5 118.8 232.6
37.4 6.6 11.4 11.8 37.4
11.4 13.6 11.5 11.8 11.4
13.9 14.1 4.4 3.5 9.8
87.2 57.2 39.3 25.3 8.0 12.7 35.6
93.7 72.4 62.9 41.4 5.2 4.0 34.1
94.0 84.4 73.0 51.1 4.8 2.3 30.0
94.3 84.5 72.8 51.0 4.5 4.0 29.9
93.5 84.6 75.2 53.7 5.1 6.0 28.6
7.7 7.6 10.5 34.2 9.3
17.4 17.7 29.6 13.6 20.4
18.4 19.1 31.1 10.0 23.8
16.8 17.9 26.8 8.9 20.4
16.6 18.6 23.5 8.2 19.1
104.4 87.6 (2.8) 3.2 4.0 1.0 3.9
89.5 89.7 (8.5) 7.7 7.6 0.9 5.9
99.8 91.5 (3.3) 7.4 6.2 1.1 4.9
74.1 89.1 (2.5) 7.2 6.1 1.7 13.1
47.5 83.7 (3.6) 9.0 7.8 2.1 17.8
0.2 (107.4) 35.9 145.9
0.4 (59.2) 23.8 77.9
0.3 (64.1) 27.8 79.9
0.3 (36.7) 29.1 64.3
0.3 (40.4) 30.1 47.3
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Tables
Table 1: Upcoming gas-based power plants in Gujarat....................................................123 Table 2: Domestic demand-supply ...................................................................................125 Table 3: Valuations for new pipelines ...............................................................................127 Table 4: Key financials and assumptions .........................................................................129 Table 5: Key ratios ............................................................................................................129 Table 6: DCF valuations ...................................................................................................130 Table 7: Sensitivity of DCF value......................................................................................130 Table 8: Profit & Loss statement.......................................................................................132 Table 9: Balance sheet .....................................................................................................133 Table 10: Cashflow statement ..........................................................................................134 Table 11: Key ratios ..........................................................................................................135
Charts
Chart 1: Gas demand source in Gujarat ...........................................................................123 Chart 2: Supply source in Gujarat.....................................................................................123 Chart 3: GSPLs network in Gujarat..................................................................................124 Chart 4: Gas, most competitive versus other alternate fuels............................................125 Chart 5: Proposed pipeline bids by GSPL ........................................................................128 Chart 6: Rolling Price/EPS trend.......................................................................................131 Chart 7: Rolling PBV trend................................................................................................131 Chart 8: Rolling EV/EBITDA trend ....................................................................................131
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Equity Research
Petronet LNG
Positives in the price
Target price Rs116
HOLD
Rs125
Reason for report: Initiating coverage

Petronet LNG, with ONGC, GAIL, Bharat Petroleum Corporation (BPCL) and Indian Oil Corporation (IOC) holding 12.5% each in it, operates Indias largest regasification terminal at Dahej, Gujarat. Its business model is led by regas margins from long-term gas contracts and additional marketing margin from term/spot contracts. Petronets profitability has surged on further spot LNG volumes, which will likely make up for the recent dip in KG D6 volumes. In our view, this is a short-term upside, while in the long term as domestic supplies rise Petronets earnings will mostly be led by long-term LNG contracts. Based on our analysis, Petronets current valuations capture most positives (volume & margin upside). Recommend HOLD with a DCF target price of Rs116. Current surge in profitability unsustainable. Petronet has always benefited from the demand-supply gap in natural gas, bridging it from high-margin LNG spot volume and term contracts. The dip in gas production from KG-D6 has been a sweetener for Petronet (KG-D6 gas is preferred due to cost advantage and long-term availability), triggering a shift to spot LNG volume. With the current gas demand-supply gap favourable, Petronet should continue to import spot volumes, at least till D6 volumes ramp up to 87mmscmd. RoE should dip to ~20% by FY13E from 25% in FY11. Kochi terminal, a concern. Petronet is setting up a greenfield LNG regasification capacity of 5mmtpa at Kochi (to start by December 12). The feasibility of 1.4mmtpa LNG supply contract with Gorgon for the terminal is a worry as the delivered gas would cost ~US$12-14/mmbtu. This is unviable for its anchor customer, NTPCs Kayamkulam power plant. The power sector has preferred low-cost domestic gas production and the viability of any incremental LNG regasification capacity would be threatened by a sharp rise in domestic gas supply. As Petronet is incurring Rs40bn capex for the terminal, the viability of the project is crucial to Petronets valuations. Long-term LNG pricing decisive. LNG would help bridge the demand-supply gap in the domestic gas industry, but as incremental demand is power sector led, price is a concern. Long-term LNG contracts, at a lower cost, would aid high utilisation. Led by excess LNG capacity of 25-30mmtpa globally in the next three years, Petronet should be able to tie up long-term supply and maintain >80% utilisation. Fairly valued; initiate with HOLD. At the current market price, the stock trades at 14.3x FY13E EPS. We value Petronet on DCF at Rs116/share. The planned diversification into gas-based power business at Dahej and Kochi is a key valuation trigger. However, we are skeptical on the competitiveness of LNG import-based power plants vis--vis coal.
Market Cap Reuters/Bloomberg 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$/'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs93.9bn/US$2.1bn PLNG.BO/PLNG IN 750 132/77 50.0 10.8 6,639 (0.1) 56.1 (5.6) 8.3 Year to Mar Revenue (Rs bn) Net Income (Rs bn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield (%) RoCE (%) RoE (%) FY10 106,491 4,045 5.4 (22.0) 23.2 8.3 13.2 1.4 11.0 19.2 FY11E 130,827 6,024 8.0 48.9 15.6 11.6 9.9 1.6 12.2 24.6 FY12E 167,288 6,212 8.3 3.1 15.1 13.3 9.8 1.7 10.1 21.6 FY13E 215,760 6,570 8.8 5.8 14.3 15.1 7.5 1.7 10.9 19.8
Price chart
140 130 120 110 100 90 80 70 Aug-10 Nov-10 Mar-11 Jun-10 Apr-10 Jan-11
(Rs)
Rohit Ahuja
Prolin Nandu
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Petronet LNG, April 4, 2011
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TABLE OF CONTENTS
Profitability unsustainable ..........................................................................................139 Business model low risk, sans marketing margin component ....................................139 Surge in profitability from spot volumes, but not sustainable......................................140 Kochi contract, a concern...........................................................................................141 Long-term LNG pricing decisive ................................................................................142 Financials & valuations ...............................................................................................144 Earnings to trace volume growth ................................................................................144 Fairly valued; initiate with HOLD.................................................................................144 Key risks to our call .....................................................................................................145 Annexure 1: Financials (standalone) .........................................................................147 Annexure 2: Index of Tables and Charts ...................................................................151
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Profitability unsustainable
Business model low risk, sans marketing margin component
Petronet insulated from increase in LNG price for longterm contracts Petronet has contracted 7.5mmtpa LNG volumes over the long-term (25-year contract) from Rasgas of Qatar, which is backed by a similar sales arrangement (with a take-orpay clause) with three of its four promoters GAIL, IOC and BPCL in the ratio of 60:30:10. The companys gross operating income is derived from regasification charge (Rs33.5/mmbtu at present) for these volumes. These margins are built as a mark-up over the cost of LNG for calculating revenues, along with other central and state taxes. Petronet therefore operates a low-risk business model as far as these contracted volumes are concerned, with extremely limited exposure change in associated gas price and forex risks, as the overall cost for procuring these LNG volumes (including shipping charges) is passed on to the offtakers. However, from January 09, Petronets gas purchase cost from Rasgas is being revised monthly until December 13 and would then be aligned to prevailing crude prices. As per estimates, the LNG price from Rasgas for Petronet would increase to ~US$12/mmbtu by 13E at an average JCC crude price of US$100/bl. In terms of the contract signed between Petronet and Rasgas, the LNG price formula is monthly LNG FOB price = 1.90/15 * JCC. The JCC price would be the average of the preceding 12 months, excluding the last three months and including the pricing month. This price is subject to a floating ceiling and floor price linked to a JCC price. The price for the period commencing from January 1, 09, shall be subject to a floating cap and ceiling, defined as follows:
(60-N) * 20 + (N*A60) Floating cap = ------------------------------------ + 4 60 (60-N) * 20 + (N*A60) Floating floor = ------------------------------------ - 4 60
Where N = 1 for January 09, increasing by 1 each month until it reaches 60 in December 13, up to the end of the term of this agreement. A60 is the arithmetic average of JCC over the period of sixty months. As these volumes are backed by a purchase agreement with the offtakers, we do not see any major risk to volumes.
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Petronet LNG, April 4, 2011 Chart 1: Petronet Business model
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Source: Company
Surge in profitability from spot volumes, but not sustainable

RoE will dip to 20% by FY13E as spot volumes decline Spot volumes strongly boost Petronets profitability as in addition to the regas margin, Rs5-10/mmbtu marketing margins kick in, which contribute to the bottomline. Petronet has traditionally benefited from the demand-supply gap in natural gas by bridging it through high-margin LNG spot volumes and term contracts. The company started procuring spot volumes from 07, led by a sudden pick-up in gas demand from industrial consumers in Gujarat. This led to almost full utilisation of its then debottlenecked capacity of 6.5mmtpa, leading to 27-32% RoE during FY07-09. Table 1: RILs gas production from KG-D6 Basin changing the dynamics
FY06 Return/Profitability Ratio (%) RoCE RoIC RoNW Source: I-Sec Research 13.5 24.4 20.0 FY07 14.4 27.4 26.7 FY08 17.0 30.5 32.8 FY09 14.7 25.8 28.8 FY10 11.0 19.7 19.2 FY11E 12.2 22.6 24.6 FY12E 10.1 19.7 21.6 FY13E 10.9 22.1 19.8
We see a similar situation developing in FY11 as Petronet has capitalised on the drop in KG D6 volumes to garner spot volumes. The companys RoE will likely rise again to 25% levels in FY11E. However, as volumes from RILs KG-D6 and other domestic blocks expand over FY12-13, RoEs will gradually drop to stabilise at 20% in the long term. The ramp-up in gas production from the KG-D6 Basin had affected Petronets spot volumes (gas produced from the KG-D6 Basin is preferred due its cost advantage and long-term availability) in FY10, leading to a sudden drop in RoE. Therefore, it is likely that Petronets spot volumes will sharply reduce in the next two years.
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Kochi contract, a concern

Concerns exist over the feasibility of the Kochi contract as gas cost will likely be ~US$14/mmbtu, more expensive than domestic gas Petronet is setting up a 5mmtpa greenfield capacity at Kochi, to be commissioned by December 12, at an overall capex of Rs32bn. Through a provision, the capacity can be raised to 5mmtpa at an additional capex of Rs4bn. The LNG terminal will be connected to GAILs Kochi-Mangalore-Bangalore pipeline to service consumers in Mangalore. GAIL would also build a 100Kms underwater pipeline to connect the terminal with NTPCs upcoming 1,100MW Kayamkulam power plant. Petronet has entered into a 1.5mmtpa LNG import contract with Exxon Mobils Gorgon project, starting 14. The contract would be based on similar lines as the Rasgas contract as far as volume offtake is concerned the offtake ratio will be slightly different (40:30:30 for GAIL: BPCL: IOC). However, we are concerned over the feasibility of the contract as the expected gas cost reportedly is at ~US$14-16/mmbtu at an average crude price of US$100/bl. The price is definitely unviable for power plants as its anchor customer, NTPCs Kayamkulam power plant, is finding it difficult to enter into a PPA with any state electricity board (SEB) in the South. The power sector will always prefer low-cost domestic gas production; hence, the viability of any incremental LNG regasification capacity would be threatened by any sharp rise in domestic gas supply. As Petronet is incurring Rs40bn capex on this terminal, the viability of the project is of importance to Petronet so as to sustain its valuations. With ~100mmscmd incremental domestic gas production likely (primarily from east coast) over the next 5-10 years, we are skeptical over volume saleability from the Kochi terminal. Chart 2: Gas pricing Kochi contract rate more than current spot rate
60 50 (US$/mmbtu) 40 30 20 10 0 FY09
Source: Industry
LPG
Naphtha
Contracted LNG
Spot LNG
RIL - KG D6
PMT
APM
FY10
FY11E
FY12E
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Long-term LNG pricing decisive

Challenge would be pricing rather than sourcing LNG would continue to be a key source for bridging the demand-supply gap in the domestic gas industry. However, since incremental demand is led by the power sector, pricing will be a key issue in the sector. Hence, long-term LNG contracts, at a lower cost, are crucial to sustain high utilisation. Surplus LNG capacity of 25-30mmtpa would be available globally in the next three years (Table 2). This offers a good opportunity for Petronet to tie up long-term supplies and maintain >80% utilisation at its terminals. However, since most of the LNG contracts are linked to crude price, gas pricing for these contracts would be a major deterrent for Petronet to enter into long-term contracts. Table 2: Global LNG demand-supply
(bcm) Region Liquefaction Capacity Asia Pacific Europe Middle East North Africa North America South America West Africa Total: LNG Demand Asia Pacific Europe North America South & East Africa South America Total: Surplus/Deficit Source: Wood Mackenzie 2010 84.2 4.1 76.9 31.3 0.8 16.2 21.7 235.2 2011 90.4 4.1 94.5 31.3 0.2 18.7 23.8 263 2012 90.2 4.1 98.1 31.9 19.4 25 268.6 2013 88.7 4.1 98.1 35 19.4 27.9 273.2 2014 90.7 4.1 98.1 36.4 19.4 30.1 278.7 2015 104.6 4.1 98.3 41.4 19.4 30.3 298.1 2020 115.3 4.1 98.3 42.8 16.2 29.7 306.3 2025 92.1 4.1 98.3 42.8 9.4 24.6 271.2
122.1 60.4 34.6 3.2 220.2 15
132.2 69.4 44.8 4 250.4 12.6
141.9 71.2 43.6 4.2 260.9 7.7
145.9 72.2 39.3 0.3 4.2 261.8 11.4
156.3 75.3 26.9 0.3 4.3 263.2 15.5
168.1 81.1 26 0.3 4.4 279.9 18.2
186.6 148.1 20.7 0.4 5.5 361.3 -55
227.5 169 17.3 0.4 5.9 420.2 -149
Difficult to see the economics behind substituting coal with LNG in power sector
At present, India is the sixth largest LNG importing nation after Japan, South Korea and Spain. India primarily competes against Japan and South Korea for most LNG contracts. Both Japan and South Korea can absorb high LNG prices as the gas consumption in these countries is more to meet the peak power demand (mostly an alternative to nuclear power) and industry demand. On the other hand, the gas demand from the Indian power sector is highly sensitive to price since domestic power tariffs are predominantly derived from low-cost, coal-based plants. Hence, pricing is a major constraint for Petronet to enter into long-term contracts. Hence, if crude price continues to sustain at >US$100/bl, Petronets long-term utilisation at its terminals, especially Kochi, will be exposed to risk. Rasgas contract signed by Petronet for its Dahej terminal was a one-off in the LNG industry and current contracts are based on 14-16% linkage to crude, mostly without a floor or a cap.
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Petronet LNG, April 4, 2011 Table 3: LNG importing nations

North America US Canada Mexico S. & Cent. America Argentina Brazil Chile Dominican Republic 0.25 Puerto Rico 0.67 Europe Belgium 2.98 France 12.83 Greece 0.46 Italy 2.50 Portugal 1.58 Spain 21.85 Turkey 4.88 United Kingdom 0.52 Middle East Kuwait Asia Pacific China India 6.04 Japan 76.32 South Korea 30.45 Taiwan 9.61 Total 188.81 Source: BP Statistical Review 2010 2005 Imports (bcm) 17.87 % of total 9.46 0.13 0.35 1.58 6.80 0.24 1.32 0.84 11.57 2.58 0.28 0.00 3.20 40.42 16.13 5.09 2006 Imports (bcm) 16.56 0.94 0.25 0.72 4.28 13.88 0.49 3.10 1.97 24.42 5.72 3.56 1.00 7.99 81.86 34.14 10.20 211.08 % of total 7.85 0.45 2007 Imports (bcm) 21.82 2.17 % of total 9.64 0.96 0.16 0.33 1.40 5.73 0.36 1.07 1.02 10.68 2.65 0.64 1.71 4.41 39.23 15.19 4.82 2008 Imports (bcm) 9.94 3.61
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2009 Imports (bcm) 12.80 0.98 3.55 0.96 0.35 0.65 0.56 0.76 6.53 13.07 0.74 2.90 2.82 27.01 5.71 10.24 0.89 7.63 12.62 85.90 34.33 11.79 242.77
% of total 4.39 1.59 0.00 0.18 0.21 0.36 1.10 5.56 0.41 0.69 1.16 12.68 2.34 0.46 1.96 4.76 40.67 16.14 5.33
% of total 5.27 0.40 1.46 0.39 0.14 0.27 0.23 0.31 2.69 5.38 0.31 1.19 1.16 11.12 2.35 4.22 0.37 3.14 5.20 35.38 14.14 4.86
0.12 0.34 2.03 6.58 0.23 1.47 0.93 11.57 2.71 1.69 0.47 3.79 38.78 16.17 4.83
0.36 0.74 3.17 12.97 0.81 2.43 2.31 24.18 6.01 1.46 3.87 9.98 88.82 34.39 10.92 226.41
0.41 0.47 0.81 2.49 12.59 0.94 1.56 2.63 28.73 5.31 1.04 4.44 10.79 92.13 36.55 12.07 226.51
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Financials & valuations

Earnings to trace volume growth
Petronets business model highly depends on volumes contracted in the long term and regas tariffs. The companys current earnings will likely be volatile as there could be significant variance in marketing margins on spot volumes. We expect Petronet to raise regas tariffs 5% every year in the long term, as per its contractual agreement with offtakers, GAIL, IOC and BPCL. We expect the company to start generating volumes from Kochi from Q4FY13, with regas tariffs at Rs70/mmbtu. However, it will likely be difficult to implement these regas tariffs at Kochi, considering the high cost of contracted volumes. We believe that in the long-term, Petronets earnings model would be primarily driven by LNG volumes and re-gas margins, as marketing margins are non-sustainable due to increasing cost of LNG. We have, although, assumed utilisation to be stable at 80% post FY15E for both Dahej & Kochi terminals (which would be the best case for the company considering high prices for incremental LNG volumes). Table 4: Volume snapshot & assumptions
TBTU Long-term contracts % tot Spot volumes % tot Total % growth Source: Company, I-Sec Research FY10 299 75.4 98 24.6 397 23.5 FY11E 385 87.7 54 12.3 439 10.7 FY12E 411 87.0 62 13.0 473 7.6 FY13E 411 83.3 82 16.7 493 4.3
Fairly valued; initiate with HOLD

DCF valuation of Rs116/share indicates that Petronet is fairly valued at the current levels At the current market price, the stock trades at 14.3x FY13E EPS. We value Petronet on DCF at Rs116/share. The planned diversification into gas-based power business at Dahej and Kochi could offer some valuation trigger. However, we are skeptical on the competitiveness of LNG import-based power plants vis--vis coal.
Key assumptions
Long-term utilisation at Dahej and Kochi at 80% WACC at 13.4% Starting regas tariff for Kochi at Rs70/mmbtu
Table 5: DCF valuations

(Rs mn) Particulars PV of FCFF during the explicit forecast period Net debt Solid cargo Overall value No of shares (mn) Value per share Source: I-Sec Research Rsmn 71,515 (14,421) 900 86,836 750.0 116
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Higher-thanexpected domestic gas production from RIL and ONGC could impact Petronets profitability
Higher-than-expected increase in domestic gas production

Petronets profitability has already been hit due to increased domestic gas production. More-than-expected increase in production from the prospective discoveries of RIL and ONGC on the East Coast can threaten the feasibility of its long-term contracted gas volumes. Although the company has >20 years of offtake agreement for contracted volumes at both Dahej and Kochi terminals, the inability of its offtakers to sell these volumes due to abundant domestic gas can threaten Petronets regas tariffs (higher probability in case of the Kochi terminal).
Regulations
At present, regasification tariffs charged by Petronet are not being regulated by the Petroleum and Natural Gas Regulatory Board (PNGRB). However, the PNGRB is evaluating a proposal to regulate regas tariffs, on similar lines as the transmission tariffs. This can lead to a possible decline in its tariffs.
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Petronet LNG, April 4, 2011 Chart 3: Rolling Price/EPS trend

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16x 14x 100 (Rs) 12x 10x 8x 50
0 Oct-07 May-07 May-10 Mar-08 Oct-10 4x 3x 2x 1x Oct-10 Jul-06 Dec-06 Aug-08 Dec-09 Sep-05 Mar-11 Feb-06 Jan-09 Apr-05 Jun-09
Chart 4: Rolling PBV trend

200 175 150 125 (Rs) 100 75 50 25 0 May-10 Feb-09 Jul-09 Nov-07 Aug-06 Dec-09 Sep-08 Mar-11 Jan-07 Jun-07 Apr-06 Apr-08

250 200 EV/ Share (Rs) 150 100 50 0 Oct-07 Feb-06 Mar-08 Oct-10 Jul-06 May-07 May-10 Dec-06 Aug-08 Dec-09 Sep-05 Mar-11 Jan-09 Apr-05 Jun-09 5x 3x
11x 9x 7x
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Annexure 1: Financials (standalone)

(Rs mn, year ending March 31) Net Sales Total Operating Income Less: Raw Material Staff Cost Power, utilities and chemicals Insurance & other variable costs Other expenses Total Operating Expenses EBITDA EBIDTA Margin (%) Depreciation & Amortisation Other Income EBIT Less: Gross Interest Recurring Pre-tax Income Less: Taxation --Current Tax --Deferred Tax Net Income (Reported) Recurring Net Income Source: Company data, I-Sec Research FY09 84,287 84,287 FY10 106,491 106,491 FY11E 130,827 130,827 FY12E 167,288 167,288 FY13E 215,760 215,760
73,756 196 375 364 583 75,274 9,013 10.7 1,025 765 8,753 1,012 7,740 2,556 2,526 30 5,184 5,184
96,648 204 480 451 244 98,026 8,465 7.9 1,609 978 7,834 1,839 5,995 1,950 1,410 540 4,045 4,045
117,243 245 576 531 268 118,862 11,965 9.1 1,858 808 10,914 1,990 8,924 2,900 2,099 801 6,024 6,024
152,344 294 651 588 281 154,158 13,130 7.8 2,906 1,345 11,569 2,365 9,203 2,991 2,165 826 6,212 6,212
196,893 530 739 668 322 199,151 16,609 7.7 3,954 1,481 14,136 4,402 9,734 3,163 2,358 805 6,570 6,570
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Petronet LNG, April 4, 2011 Table 7: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Operational Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Other Marketable Investments Strategic & Group Investments Total Investments Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Less: Revaluation Reserve Total Fixed Assets Total Assets FY10
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FY11E
FY12E
FY13E
6,578 3,856 6,712 783 168 18,097
3,405 2,223 5,035 1,523 31 12,216
11,255 2,187 6,133 1,855 31 21,461
10,211 2,605 7,839 2,371 31 23,056
14,289 4,633 10,118 3,060 31 32,131
5,715 1,650 1,557 8,922 9,175
6,043 1,406 1,557 9,006 3,211
4,248 1,705 1,557 7,509 13,952
5,129 2,211 1,557 8,897 14,158
6,870 2,857 1,557 11,283 20,848
2722 321 3,043
4210 1,176 5,386
4210 1,176 5,386
4210 1,513 5,724
4210 1,986 6,196
19,748 5,062 14,686 18,470 33,156 45,373
35,495 6,667 28,829 13,184 42,012 50,609
36,035 8,525 27,511 23,314 50,824 70,163
75,840 11,431 64,410 458 64,868 84,750
76,380 15,385 60,996 2,332 63,328 90,372
Liabilities & Shareholders Equity Borrowings Long Term Debt Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital Reserves & Surplus Share Premium General & Other Reserve Net Worth Total Liabilities & Shareholders Equity Source: Company data, I-Sec Research
22,817 22,817 2,722
24,998 24,998 3,262
39,520 39,520 4,063
48,919 48,919 4,890
49,087 49,087 5,695
7,500
7,500
7,500
7,500
7,500
1,555 10,780 19,834 45,373
1,555 13,294 22,349 50,609
1,555 17,524 26,579 70,163
1,555 21,887 30,941 84,750
1,555 26,535 35,590 90,372
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Petronet LNG, April 4, 2011 Table 8: Cashflow statement

(Rs mn, year ending March 31) FY09 Cash Flow from Operating Activities Reported Net Income Add: Depreciation & Amortisation Deferred Taxes Less: Other Income Op.Cash Flow before Working Capital change (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Consideration paid for acquisition of undertaking Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from fresh borrowings Dividend paid including tax Other items Net Cash flow from Financing Activities (e) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 5,184 1,024 30 765 5473 FY10 4,045 1,605 540 978 5211
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FY11E 6,024 1,858 801 808 7875
FY12E 6,212 2,906 826 1,345 8600
FY13E 6,570 3,954 805 1,481 9848
(2,946) (3,382) (143) (127) 2,327 976 (3,295) 2,178
1,633 1,677 (740) 138 328 (244) 2,791 8,002
36 (1,098) (332) (1,795) 299 (2,891) 4,984
(418) (1,705) (516) 882 506 (1,251) 7,349
(2,029) (2,279) (689) 1,740 645 (2,611) 7,237
(7,887) 2,431 (5,456) (3,278)
(10,461) (2,344) (12,804) (4,802)
(10,670) (10,670) (5,686)
(16,950) (338) (17,287) (9,938)
(2,414) (473) (2,887) 4,350
765 765
978 978
808 808
1,345 1,345
1,481 1,481
7,041 (1,536) (0) 5,505 2,992
2,181 (1,531) (0) 651 (3,173)
14,522 (1,794) (0) 12,729 7,850
9,398 (1,850) 0 7,549 (1,045)
168 (1,922) 0 (1,754) 4,078
3,586 6,578 2,992
6,578 3,405 (3,173)
3,405 11,255 7,850
11,255 10,211 (1,045)
10,211 14,289 4,078
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Petronet LNG, April 4, 2011 Table 9: Key ratios

(Year ending March 31) FY09 Per Share Data (Rs) Diluted Recurring Earning per share (DEPS) Diluted Earnings per share Recurring Cash Earnings per share (CEPS) Free Cashflow per share (FCPS-post capex) Reported Book Value (BV) Adjusted Book Value (ABV) ** Dividend per share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value Price to Adjusted Book Value Price to Sales Ratio EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Op. Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Raw Material Consumed / Sales Other Income / Pre-tax Income Other Operating Income / EBITDA Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT Current Ratio Turnover Ratios Inventory Turnover Ratio (x) Assets Turnover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research 6.9 6.9 8.3 (4.4) 26.4 26.4 1.8 FY10 5.4 5.4 8.3 (6.4) 29.8 29.8 1.8
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FY11E 8.0 8.0 11.6 (7.6) 35.4 35.4 2.0
FY12E 8.3 8.3 13.3 (13.3) 41.3 41.3 2.1
FY13E 8.8 8.8 15.1 5.8 47.5 47.5 2.2
18.1 15.1 4.7 4.7 0.0 11.9 1.3 49.3 (32.8) 1.4
23.2 15.2 4.2 4.2 0.0 13.2 1.0 13.9 (23.2) 1.4
15.6 10.8 3.5 3.5 0.0 9.9 0.9 23.7 (20.8) 1.6
15.1 9.4 3.0 3.0 0.0 9.8 0.8 17.5 (12.9) 1.7
14.3 8.3 2.6 2.6 0.0 7.5 0.6 17.2 28.6 1.7
9.2 4.2 28.6 4.1 9.2
(22.0) (0.7) 26.3 (6.1) (22.0)
48.9 40.2 22.9 41.3 48.9
3.1 14.5 27.9 9.7 3.1
5.8 13.9 29.0 26.5 5.8
10.7 10.4 9.2 6.2 87.5 9.9 33.0
7.9 7.4 5.6 3.8 90.8 16.3 32.5
9.1 8.3 6.8 4.6 89.6 9.1 32.5
7.8 6.9 5.5 3.7 91.1 14.6 32.5
7.7 6.6 4.5 3.0 91.3 15.2 32.5
14.7 25.8 28.8 25.3
11.0 19.7 19.2 32.4
12.2 22.6 24.6 25.4
10.1 19.7 21.6 25.4
10.9 22.1 19.8 25.0
1.2 5.7 8.6 2.0
1.1 (0.4) 4.3 1.4
1.5 3.8 5.5 2.9
1.6 4.7 4.9 2.6
1.4 7.3 3.2 2.8
31.0 2.1 26.1 21.7 22.5
31.9 2.2 21.2 20.1 22.2
53.3 2.2 23.9 15.6 16.0
63.7 2.2 30.7 15.2 11.2
54.6 2.5 29.6 15.2 11.1
150
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Tables
Table 1: RILs gas production from KG-D6 Basin changing the dynamics.......................140 Table 2: Global LNG demand-supply ...............................................................................142 Table 3: LNG importing nations ........................................................................................143 Table 4: Volume snapshot & assumptions .......................................................................144 Table 5: DCF valuations ...................................................................................................144 Table 6: Profit & Loss statement.......................................................................................147 Table 7: Balance sheet .....................................................................................................148 Table 8: Cashflow statement ............................................................................................149 Table 9: Key ratios ............................................................................................................150
Charts
Chart 1: Petronet Business model .................................................................................140 Chart 2: Gas pricing Kochi contract rate more than current spot rate ...........................141 Chart 3: Rolling Price/EPS trend.......................................................................................146 Chart 4: Rolling PBV trend................................................................................................146 Chart 5: Rolling EV/EBITDA trend ....................................................................................146
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Bharat Petroleum Corporation

Dj vu
HOLD
Rs606
Target price Rs562
Promoters Institutional investors MFs and UTI 7.4 Insurance 0.1 Company FIIs 7.4 Others 17.4 Source: www.nseindia.com Jun '10 54.9 27.7 Sep '10 54.9 27.6 8.2 0.1 8.2 17.4 Dec 10 54.9 27.7 8.5 0.2 7.6 17.4
Bharat Petroleum Corporation (BPCL) is one of the largest integrated oil marketing companies (OMCs) in India, enjoying >21% share in the domestic market. It is commissioning a greenfield Bharat Oman Refinery (BORL) at Bina, which will raise its overall refining capacity to ~30mmtpa. BPCL has struck gold in the E&P space with prolific oil & gas discoveries in Mozambique and Brazil, appraisals for which can yield strong, long-term valuation upside. However, under-recovery concerns override the positives as we estimate crude price to average at US$100/bl in the next two years. The Governments inability to undertake subsidy reforms has hit BPCLs profitability hard, threatening its valuation outlook. We reinitiate coverage on BPCL with HOLD (target price of Rs562/share, at 1.1x BV) since E&P triggers provide some respite in the long term. Subsidy concerns override positives. The subsidy-sharing mechanism continues to be uncertain for OMCs. BPCL is losing ~Rs10.5/litre on diesel, Rs4.25/litre on petrol, Rs21/litre on SKO and Rs290/cylinder on LPG. BPCLs gross under-recovery is expected to be Rs165bn in FY11E based on the current crude price. BPCLs net under-recovery share is expected at a lower~Rs28bn (will increase to Rs43bn in FY13E), given the likely compensation from the Government at Rs83bn and upstream assistance of Rs55bn. However, the precise contribution from the Government is still uncertain, which can hurt earnings going forward. E&P to be a long-term trigger. BPCLs E&P business is on a good wicket through its stakes in prolific exploration blocks in Brazil & Mozambique. In the past three years, BPCL has made hydrocarbon discoveries in Brazil (Wahoo I-II) and significant gas finds in Mozambique (Windjammer, Lagosta, Bargentine & Tubaroa fields). These discoveries are in the appraisal stage, so limited information is available on the reserve potential. However, as these discoveries are appraised and developed in the next 3-5 years, significant long-term valuation triggers will come into play. Commissioning of the Bina refinery, a positive. BPCL is expected to commission the 6mmtpa Bina refinery by April 11. The refinery will likely boost BPCLs marketing plans for the North and the North East, where it has limited presence. Though the overall refinery cost has slightly increased to Rs110bn, its high complexity of 9.1 would ensure a premium of at least US$2-3/bl over Singapore Complexs GRMs in the long term.
Market Cap Reuters/Bloomberg Shares Outstanding (mn) 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs219bn/US$4.9bn BPCL IN/BPCL IN 361.54 840/488 45.1 7.6 12,550 (8.2) 19.1 (5.6) 8.3 Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield RoCE (%) RoE (%) FY10 17,387 48.1 167.8 12.7 88.0 11.8 2.5 5.9 12.7 FY11E 15,971 44.2 (8.1) 13.8 87.5 9.4 2.5 6.0 10.9 FY12E 8,572 23.7 (46.3) 25.7 70.2 10.2 1.3 4.1 5.6 FY13E 9,942 27.5 16.0 22.2 75.9 9.4 1.5 4.4 6.2
Price chart
850 750 (Rs) 650 550 450 Jun-10 Jul-10 Jan-11 Nov-10 Sep-10 Mar-11 Apr-10
1,238,167 1,582,589 1,809,775 1,814,905
Rohit Ahuja
Prolin Nandu
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Bharat Petroleum Corporation, April 4, 2011
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TABLE OF CONTENT
Subsidy concerns override positives ........................................................................155 Profitability under pressure .........................................................................................156 E&P upsides long-drawn.............................................................................................157 Encouraging discoveries in Mozambique ...................................................................157 High potential in Brazil ................................................................................................159 Bina refinery to bridge the refining-marketing gap..................................................160 Flexibility to process different qualities of crude .........................................................160 Fiscal incentives by the Madhya Pradesh government ..............................................161 Valuations Positives factored in .............................................................................162 Key assumptions.........................................................................................................163 Key risks to our call .....................................................................................................163 Annexure 1: Financials (consolidated)......................................................................164 Annexure 2: Index of Tables and Charts ...................................................................168
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Subsidy concerns override positives

Brent crude price surging beyond US$100/bl is a dj-vu for OMCs. Concerns on surging under-recoveries and ad-hoc compensation by the Government makes BPCLs profitability event based rather than fundamental. Hence, valuations are volatile, both short term and long term. At present, BPCL enjoys a comfortable refining-to-marketing ratio of ~1, which makes its marketing under-recoveries less volatile. BPCL is losing ~Rs10.5/litre on diesel, Rs4.25/litre on petrol (apparently de-regulated), Rs21/litre on SKO and Rs290/cylinder on LPG. The overall under-recovery for BPCL is expected to be Rs165bn in FY11E based on the current crude price. BPCLs share in subsidy sharing is expected at a lower ~Rs28bn, due to likely compensation from the Government at Rs83bn and upstream assistance of Rs55bn. However, the precise contribution from the Government is still uncertain, which can hurt BPCLs earnings going forward. Table 1: Surging under-recoveries
(Rs mn) Total Upstream % total Total Government % total Total Downstream % total Total Under Recoveries FY08 257,080 33.3 352,900 45.8 161,250 20.9 771,230 FY09 320,000 31.0 712,920 69.0 334 1,032,920 51,810 522,860 282,250 176,000 1,032,920 FY10 144,300 31.3 260,000 56.5 56,210 12.2 460,510 51,510 92,790 173,640 142,570 460,510 FY11E 258,615 33.3 387,922 50.0 129,308 16.7 775,844 22,059 321,047 186,671 246,067 775,845 FY12E 371,914 33.3 557,871 50.0 185,957 16.7 1,115,741 29,260 599,396 223,076 264,009 1,115,741 FY13E 386,755 33.3 580,133 50.0 193,378 16.7 1,160,266 31,016 635,360 221,960 271,930 1,160,266
Petrol 73,320 Diesel 351,660 Kerosene 191,020 LPG 155,230 Total 771,230 Source: Infraline, I-Sec Research
Under-recoveries should hit the roof in FY12 we expect Brent prices to average around US$100/bl. The Governments inability to undertake any major price revision on subsidised products spiked under-recoveries as a whole to Rs1,111bn, crossing FY09 levels of Rs1,030bn. BPCLs share is expected to be at a lower Rs41bn, given Rs122bn compensation by the Government and upstream assistance of Rs82bn. Table 2: Under-recovery sharing
(Rs mn) IOC % total BPCL % total HPCL % total Total downstream Upstream assistance ONGC OIL GAIL Total Source: Infraline, I-Sec Research FY09 149 44.6 96 28.8 89 26.6 334 273,740 29,319 16,937 319,996 FY10 23,784 58.1 8,540 20.9 8,602 21.0 40,926 114,560 15,267 13,854 143,681 FY11E 74,700 57.8 27,608 21.4 26,999 20.9 129,307 206,373 32,129 19,170 257,672 FY12E 107,158 57.6 40,802 21.9 37,997 20.4 185,957 304,782 44,988 22,143 371,914 FY13E 111,692 57.8 42,557 22.0 39,129 20.2 193,378 315,239 46,823 24,694 386,755
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Profitability under pressure

BPCLs profitability is expected to take a hit from FY12E as RoEs decline to sub 6%, among the lowest for the company. This is almost a repeat of FY09, indicating that the companys valuations can retest the low levels of FY09. Table 3: Pressure on profitability
(%) Recurring net income margin RoCE RoNW Source: I-Sec Research FY09 0.83 6.16 5.0 FY10 2.26 5.93 12.7 FY11E 1.46 5.99 10.9 FY12E 0.79 4.06 5.6 FY13E 0.90 4.40 6.2
BPCLs profitability in the next 2-3 years is a major concern as it is highly dependent on the Governments subsidy sharing mechanism and product pricing policy. We expect BPCLs cashflows to witness pressure from FY12, led by higher-thanexpected working capital requirement. The company would find it difficult to manage inventories, leading to pressure on short-term debt levels and interest payments. Table 4: Pressure on cashflow
(Rs mn) Operating cashflow Working capital changes Capital commitments Free cashflow Source: I-Sec Research FY09 (140,133) 26,111 (57,902) (171,925) FY10 (10,705) (39,399) (62,627) (112,731) FY11E 16,435 13,598 (38,612) (8,579) FY12E 17,002 (25,445) (19,377) (27,820) FY13E 20,238 (34,988) (15,000) (29,750)
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E&P upsides long-drawn

BPCL has witnessed major successes in the E&P space through its stakes in prolific exploration blocks in Brazil and Mozambique. The company operates through its subsidiary, Bharat Petro Resources (BPRL) and has a 50:50 JV with Videocon Industries for investments in these blocks. In the past three years, the company has struck hydrocarbon discoveries in Brazil in Wahoo I-II and made significant gas finds in Mozambique at Windjammer, Lagosta and Bargentine fields. These discoveries are in the appraisal stage; hence, limited information is available on the reserve potential. However, as these discoveries are appraised and developed in the next 3-5 years, significant long-term valuation triggers will emerge.
Encouraging discoveries in Mozambique

In the Rovuma Basin in offshore Mozambique, BPCL has made four major discoveries Windjammer, Barquentine, Lagosta and Tubarao. Anadarko is the operator with 36.5% working interest in Offshore Area 1. Co-owners of the block are Mitsui E&P Mozambique Area 1 (20%), BPRL Ventures Mozambique B.V. (10%), Videocon Mozambique Rovuma (10%) and Cove Energy Mozambique Rovuma Offshore (8.5%). Empresa Nacional de Hidrocarbonetos, eps 15% interest is carried through the exploration phase. Windjammer was the first to hit a natural gas net feet pay of 550ft in February 10, indicating the start of a major success in terms of exploration potential. The deepwater discovery lies at a depth of 14,000ft, 30 miles east of the Mozambique coastline. Barquentine was the next to follow in October 10, hitting 416ft of natural gas pay. The Barquentine exploration well was drilled to a total depth of ~16,880ft, in a water depth of ~5,200ft. The third major discovery in the block, at Lagosta was the largest providing 550ft net pay of natural gas. This discovery is located ~16miles to the south of the previously announced Barquentine discovery and 14miles to the southeast of the Windjammer discovery. Tubarao was the latest discovery to be announced, offering 110ft of net pay, the smallest of them all. Though it is too early to ascertain the total size of the discoveries announced till the appraisal programme is completed, initial results indicate that this could be one of the largest natural discoveries globally, which augurs well for BPCL in the long term. However, as per our interaction with the industry, it would be difficult to assess the reserve potential based on the initial net feet pay, as the actual recovery of the reserves is critical to determine the precise commercially viable reserve.
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Bharat Petroleum Corporation, April 4, 2011 Chart 1: Mozambique discoveries

Four major discoveries Lagosta - 550 Net Feet of Pay
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Barquentine - 416 Net Feet of Pay Windjammer - 555 Net Feet of Pay Tubaro - 110 Net Feet of Pay
Planned activity in 11 Dedicated Rig Add Second Rig in Q4 Appraise Discoveries Source: Anadarko Presentation
We are positive over BPCLs Mozambique prospects and there is a strong possibility of major reserve accretion from the block, which could be a huge trigger for valuations. The JV plans to drill further exploratory wells so as to estimate the reserve. We conservatively factor in 30% chances of the Mozambique find to be of 20tcf size and ascribe a 50% recovery factor to this estimate. We value these reserves at US$4/bl and discount it to arrive at a fair value of Rs38/share. Chart 2: Mozambique development plan
Source: Anadarko Presentation
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Bharat Petroleum Corporation, April 4, 2011 Table 5: Mozambique block valuation

Initial estimate (tcf) Gross recoverable reserves (mn bl) BPCL stake (%) BPCL share of recoverable reserves (mn bl) Ev/bl Value (US$ mn) Value (Rs mn) Present value Value/share (Rs) Source: I-Sec Research
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20 1,080 10.00 108 4.0 432 19,872 10,197 31
High potential in Brazil

BPCLs JV in Brazil has made discoveries in the BM-C-30 block. Anadarko is the operator of the block, holding 30% stake, while BPCL holds 12.5%. The company has announced two major discoveries in the block Wahoo I and II. While in Wahoo I, gross recoverable reserves estimates are at 200mnbl, Wahoo II is still under the appraisal stage. Therefore, significant upsides exist as the JV will drill two more exploratory wells in the block in the next six months. The JV has further acreage in three more blocks in Brazil, which could add value in the long term. Table 6: Valuation of BPCLs stake in Wahoo
Gross recoverable reserves (mn bl) BPCL stake (%) BPCL share of recoverable reserves (mn bl) EV/bl valuation multiple (US$/bl) Discount on valuation multiple due to higher royalties & taxes in Brazil (%) Effective EV/bl multiple for valuing E&P assets in Brazil (US$/bl) Value (US$ mn) Value (Rs mn) Present value of Wahoo discovery to BPCL (Rs mn) Value/share (Rs) Source: I-Sec Research 200 12.50% 25 19.0 30 13.3 333 15,295 9,497 29
EV/bl basis
Rs46/US$ exchange rate assumed 10% discount rate Shares outstanding adjusted for treasury stocks
Chart 3: Brazil discoveries

Country Region Field Block Discovery date Reserve type Current status Water depth Operator Anadarko BP IBV Brazil Petroleo BPRL Videocon Maersk Source: Anadarko Presentation Brazil Presalt Wahoo BM-C-30 Nov 08 Oil Discovery (Appraised) 1,417 m / 4,676 ft Anadarko 30% 25% 25% 12.50% 12.50% 20%
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Bina refinery to bridge the refining-marketing gap

BPCLs marketing-to-refining ratio (in volumes terms) is just above 1, with marketing volumes being 2.7mmtpa higher than the refining capacity of 23mmtpa. Hence, BPCLs profitability is slightly sensitive to marketing margin fluctuation. HPCL, with a ratio of ~2, is the most sensitive of all the three companies, while IOC, with a refining capacity of 64mmt and sales of 62mmt has a marketing-to-refining ratio of <1. Table 7: Refining-marketing volumes through Q4FY09-Q3FY11
Q4FY09 Crude throughput (MT) 4.87 Market sales (MT) 7.09 Throughput to Sales 0.7 Source: Company, I-Sec Research Q1FY10 4.17 6.94 0.6 Q2FY10 5 6.5 0.8 Q3FY10 5.55 7 0.8 Q4FY10 5.69 7.25 0.8 Q1FY11 5.57 7.34 0.8 Q2FY11 5.6 6.6 0.8 Q3FY11 5.03 7.4 0.7
The commissioning of BPCLs greenfield refinery, BORL, would help it bridge the refining-marketing gap, thus curtailing profit volatility due to crude price movement. BORL would be a 6mmtpa refinery with a Nelson complexity of 9. The refinery would be commissioned by Q1FY12 and would primarily target Euro IV compliant products (in 11 cities in India). We value BPCLs investment in BORL at 1x P/BV, which provides an upside of Rs73/share.
Flexibility to process different qualities of crude

The Nelson complexity index (NCI) of BORLs new refinery is expected to be 9.1, one of the highest in India. The only comparable domestic refineries are that of Reliance Industries (RIL) at Jamnagar (NCI of 11.1), RILs SEZ refinery (NCI of 14) and Essars refinery (NCI of 9). The configuration of BORLs proposed refinery will facilitate the processing of a wide variety of low-cost Middle Eastern and other kinds of crude. This will help the refinery benefit from the cost differentials between low sulphur, low residue crudes and sour high residue crudes, while simultaneously allowing it to produce high quality Euro III and Euro IV auto fuels. All of BORLs refined products are intended to conform to the Bureau of Indian Standards (BIS) specifications. The refinerys output of auto fuels will meet Euro III and Euro IV standards, currently proposed for 10 and beyond (Table 8). Table 8: Product slate
Products LPG Naphtha Euro III Regular Motor Spirit Euro IV Regular Motor Spirit Aviation Turbine Fuel Superior Kerosene Oil Euro III High Speed Diesel (1) Euro IV High Speed Diesel Sulphur Petroleum Coke Fuel & Loss (2) Source: Company, I-Sec Research TMTPA 222 241 385 400 550 487 1610 1181 109 410 405 % of total 3.7 4.0 6.4 6.7 9.2 8.1 26.8 19.7 1.8 6.8 6.8
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Fiscal incentives by the Madhya Pradesh government

BORL has entered into a Memorandum of Understanding (MoU) with the Madhya Pradesh (MP) Government to enjoy the following fiscal incentives: Exemption from the Central Sales Tax (CST) on product sale from the refinery outside Madhya Pradesh for 15 years from the date of commercial production. The maximum CST exemption will be limited to the project cost of Rs75bn (as per the MoU). This positively impacts BORLs GRMs by ~US$0.5/bl. BORLs crude supply is exempted from entry tax for 15 years from the commercial operation date of the refinery. Exemption from entry tax of capital goods and work contract tax during the project implementation period.
Other financial incentives are: A concession in basic customs duty for capital goods import Exemption from paying income tax for seven years from the date of commercial operation of the refinery.
The MP Government will have the first right of refusal on Naphtha sale from the refinery.
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Valuations Positives factored in

We value BPCL at 1.1x FY13E BV, at a discount to long-term mean P/BV of 1.2x after adding its investments in the BORL refinery at 1x book value and in OIL/Petronet/IGL at a 80% discount to the current market price, we arrive at a target price of Rs562. BPCLs core business book multiple of 0.6x is derived from its normalized RoEs of 10%, considering some support from the government to maintain these RoEs over the long-term. We prefer to value BPCL on BV, especially in the current environment of high crude price and considering that the Government would disallow erosion in BPCLs net worth, mainly through cash subsidy (oil bonds) and upstream discounts. The stock had seen a sharp re-rating in the past year to ~1.8x due to partial deregulation of subsidised product prices undertaken by the Government. However, this scenario should change as the quantum of cash support from the Government for limiting BPCLs under-recoveries is uncertain. In our view, BPCLs valuations should come under threat in the next two years, as ad-hoc price revision by the Government would at best provide marginal support. BPCLs valuations are hit by a sharp decline in its RoE to 6% from 11% in FY11E, lower than its five-year mean RoE of 11%. As long as crude price is high, we assume a lower profitability environment for BPCL and expect its multiples to 1.1x, below its five-year mean. Chart 4: Rolling price-book trend
1,000 900 800 700 600 (Rs) 500 400 300 200 100 0 2.0x 1.5x
1.0x 0.5x Apr-02 Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11
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Bharat Petroleum Corporation, April 4, 2011 Table 9: P/BV valuations

Particulars FY13E BV Core business multiple (x) Core business value Add: Brazilian discoveries Mozambique discovery OIL stake Indraprastha Gas Petronet LNG BORL (Rs mn) Other investments Total value Implied P/BV Source: I-Sec Research
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Rs/share 495 0.6 317 29 31 17 23 28 43 73 562 1.1
Key assumptions
Average Brent prices in FY12E-13E at US$100/bl Marginal revision in diesel and LPG prices Under-recovery sharing. 50% of under-recoveries would be compensated by the Government, 33% by upstream (ONGC, OIL and GAIL) and the rest will likely be borne by BPCL

Sharp variation in Brent prices, which can influence Governments policy Lower crude price can encourage implementation of a subsidy sharing formula or freeing up of diesel price, which can be very positive for BPCL Major changes in estimation of hydrocarbon reserves in Wahoo or Mozambique blocks can impact valuations
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(Rs mn, year ending March 31) Gross Sales Less: Excise Duty Net Sales Oil bonds Total Operating Income Less: Raw Materials Consumed Power and Fuel Personnel Expenses Selling & Distribution Expenses Total Operating Expenses EBITDA (incl bonds) Depreciation & Amortisation Add: Other Income EBIT Less: Gross Interest Recurring Pre-tax Income Add: Extra Ordinary income Less: Extra Ordinary expenses Less: Taxation Current Tax Deferred Tax Less: Minority interest Net Income (Reported) Consolidated Recurring Net Income Source: Company data, I-Sec Research FY09 1,311,204 107,797 1,203,407 162,164 1,365,571 FY10 1,284,841 99,324 1,185,517 52,650 1,238,167 FY11E 1,617,354 117,590 1,499,763 82,825 1,582,589 FY12E 1,819,664 132,294 1,687,370 122,405 1,809,775 FY13E 1,819,516 132,283 1,687,233 127,672 1,814,905
1,235,642 736 19,813 75,647 1,331,838 33,733 12,617 14,358 35,474 24,043 11,431 (156)
1,099,836 2,448 22,522 82,823 1,207,629 30,539 14,446 23,652 39,745 11,247 28,498 (1,064)
1,435,338 2,623 22,294 84,450 1,544,705 37,884 15,652 14,985 37,217 13,820 23,397 -
1,661,404 2,884 22,982 85,902 1,773,172 36,603 16,799 8,545 28,349 13,986 14,363 -
1,659,172 3,171 23,671 87,307 1,773,322 41,583 17,505 7,446 31,524 15,114 16,410 -
4,034 6,885 (2,851) 904 6,338 6,494
10,235 13,248 (3,013) 876 16,324 17,387
6,704 6,907 (203) 722 15,971 15,971
4,979 4,803 176 812 8,572 8,572
5,639 5,401 237 830 9,942 9,942
164
Bharat Petroleum Corporation, April 4, 2011 Table 11: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Goodwill (On consolidation) Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Total Fixed Assets Total Assets LIABILITIES AND SHAREHOLDER'S EQUITY Borrowings Short Term Debt Long Term Debt Total Borrowings Deferred Tax Liability Minority Interest Share Capital Paid up Equity Share Capital Reserves & Surpluses General & Other Reserve Less: Misc. Exp. not written off Net Worth Total Liabilities & Shareholder's Equity Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
13,486 78,706 15,059 29,782 31,026 168,058
7,690 141,092 26,009 36,468 38,012 249,271
7,964 115,060 23,404 36,468 38,228 221,123
5,785 148,368 26,682 36,468 39,102 256,405
951 182,377 26,680 36,468 39,976 286,452
69,009 53,741 18,209 140,960 27,099
90,969 69,948 27,652 188,568 60,702
76,146 69,948 27,652 173,745 47,378
88,161 69,948 27,652 185,760 70,645
88,054 69,948 27,652 185,653 100,799
25,891 138,109 164,000 3,855
33,550 85,773 119,323 3,855
38,550 80,773 119,323 3,855
43,550 60,773 104,323 3,855
48,550 55,773 104,323 3,855
263,546 120,483 143,062 61,727 204,789 399,742
302,023 134,929 167,094 78,217 245,311 429,190
330,511 150,581 179,930 83,341 263,271 433,826
347,202 167,380 179,823 81,026 260,849 439,671
359,008 184,885 174,123 79,221 253,343 462,320
209,143 33,249 242,392 15,257 9,015
222,468 44,453 266,921 11,477 9,396
227,468 34,254 261,722 11,274 9,839
227,467 34,254 261,720 11,450 10,338
243,253 34,254 277,507 11,688 10,847
3,615
3,615
3,615
3,615
3,615
129,497 33 133,079 399,742
137,814 33 141,396 429,190
147,408 33 150,991 433,826
152,579 33 156,162 439,670
158,695 33 162,277 462,319
165
Bharat Petroleum Corporation, April 4, 2011 Table 12: Cashflow statement

(Rs mn, year ending March 31) FY09 a) Cash Flow from Operating Activities Consolidated Net Income Add: Depreciation & Amortisations Deferred Tax Less: Other Income Net Extra-ordinary income Operating Cash Flow before Working Capital chg (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Sale of Investments Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from fresh borrowings Dividend paid including tax Others Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 6,338 12,093 (2,851) 155,869 (156) (140,133) FY10 16,324 14,446 (3,780) 38,759 (1,064) (10,705)
ICICI Securities
FY11E 15,971 15,652 (203) 14,985 16,435
FY12E 8,572 16,799 176 8,545 17,002
FY13E 9,942 17,505 237 7,446 20,238
36,544 1,621 (11,829) 18,340 (28,424) 9,858 26,111 (114,023)
(62,386) (10,950) (6,685) (6,986) 21,960 25,649 (39,399) (50,104)
26,032 2,605 (216) (14,823) 13,598 30,033
(33,308) (3,278) (874) 12,015 (25,445) (8,443)
(34,009) 2 (874) (107) (34,988) (14,750)
(48,914) (8,988) (57,902)
(54,967) (7,659) (62,627)
(33,612) (5,000) (38,612) (8,579)
(14,377) (5,000) (19,377) (27,820)
(10,000) (5,000) (15,000) (29,750)
(171,925) (112,731)
72,898 14,358 87,255
68,536 23,652 92,188
5,000 14,985 19,985
20,000 8,545 28,545
5,000 7,446 12,446
81,733 (3,504) 4,192 82,422 (156) (2,404)
24,529 (6,450) (1,175) 16,904 (2,157) (5,796)
(5,199) (6,377) 443 (11,132) 274
(1) (3,401) 499 (2,904) (2,179)
15,786 (3,826) 510 12,470 (4,834)
15,889 13,486 (2,404)
13,486 7,690 (5,796)
7,690 7,964 274
7,964 5,785 (2,179)
5,785 951 (4,834)
166
Bharat Petroleum Corporation, April 4, 2011 Table 13: Key ratios

(Year ending March 31) FY09 Per Share Data (Rs) Diluted Recurring Earning per share (DEPS) Diluted EPS (adjusted for treasury stock) Recurring Cash Earnings per Share (CEPS) Free Cash flow per share (FCPS - post capex) Book Value (BV) Dividend per Share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Operating Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Raw Material Consumed / Sales SGA Expenses / Sales Other Income / Pre-tax Income Other Operating Income / EBITDA Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Long Term Debt / Total Debt Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT Debt Servicing Capacity Ratio (DSCR) Current Ratio Cash and cash equivalents / Total Assets Turnover Ratios Inventory Turnover Ratio (x) Assets Turnover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research 18.0 19.3 52.9 (475.5) 368.1 8.2 FY10 48.1 49.8 88.0 (311.8) 391.1 15.2
ICICI Securities
FY11E 44.2 48.7 87.5 (23.7) 417.6 15.0
FY12E 23.7 26.1 70.2 (76.9) 431.9 8.0
FY13E 27.5 30.3 75.9 (82.3) 448.8 9.0
34.0 11.5 1.7 8.5 0.2 (2.0) (1.4) 1.3
12.7 6.9 1.6 11.8 0.3 (33.7) (2.9) 2.5
13.8 7.0 1.5 9.4 0.2 21.6 (37.0) 2.5
25.7 8.7 1.4 10.2 0.2 21.9 (12.0) 1.3
22.2 8.0 1.4 9.4 0.2 19.4 (11.9) 1.5
(60.5) (34.9) 22.8 (5.5) (60.5) (73.9) 2.47 2.60 0.83 0.47 102.7 6.3 125.6 480.7 35.3
167.8 66.6 (9.3) (9.5) 167.8 (0.4) 2.47 3.21 2.26 1.38 92.8 7.0 83.0 172.4 35.9
(8.1) (0.7) 27.8 24.1 (8.1) (7.3) 2.39 2.35 1.46 1.00 95.7 5.6 64.0 218.6 28.7
(46.3) (19.8) 14.4 (3.4) (46.3) (37.1) 2.02 1.57 0.79 0.47 98.5 5.1 59.5 334.4 34.7
16.0 8.2 0.3 13.6 16.0 26.9 2.29 1.74 0.90 0.55 98.3 5.2 45.4 307.0 34.4
6.2 5.9 5.0 42.3
5.9 3.6 12.7 30.5
6.0 5.0 10.9 30.8
4.1 3.8 5.6 30.6
4.4 4.4 6.2 29.7
194 19 3 148 165 39 38
197 20 12 353 446 52 22
181 17 9 269 354 46 20
175 17 15 203 288 53 15
178 16 22 209 290 58 12
12.7 3.9 11.1 4.4 24.6
10.0 3.0 12.9 5.8 26.5
11.2 3.7 12.5 5.6 21.2
12.6 4.2 11.9 5.0 18.0
10.1 4.0 17.2 5.4 19.4
167
ICICI Securities

Tables
Table 1: Surging under-recoveries ...................................................................................155 Table 2: Under-recovery sharing ......................................................................................155 Table 3: Pressure on profitability ......................................................................................156 Table 4: Pressure on cashflow..........................................................................................156 Table 5: Mozambique block valuation ..............................................................................159 Table 6: Valuation of BPCLs stake in Wahoo ..................................................................159 Table 7: Refining-marketing volumes through Q4FY09-Q3FY11.....................................160 Table 8: Product slate .......................................................................................................160 Table 9: P/BV valuations...................................................................................................163 Table 10: Profit and loss statement ..................................................................................164 Table 11: Balance sheet ...................................................................................................165 Table 12: Cashflow statement ..........................................................................................166 Table 13: Key ratios ..........................................................................................................167
Charts
Chart 1: Mozambique discoveries ....................................................................................158 Chart 2: Mozambique development plan ..........................................................................158 Chart 3: Brazil discoveries ................................................................................................159 Chart 4: Rolling price-book trend ......................................................................................162
168
Equity Research
Hindustan Petroleum Corporation

Subsidised value
Target price Rs298
SELL
Rs352

Hindustan Petroleum Corporation (HPCL) is among the most focused oil marketing companies (OMCs) in India, enjoying >20% share in the domestic market. The company is currently commissioning a greenfield refinery at Bhatinda, which will raise its overall refining capacity to ~26mmtpa. This would be a key asset for the company as its refining-marketing ratio is the lowest among OMCs. However, under-recovery concerns impact HPCL the most as we estimate crude price to average at US$100/bl in the next two years. The Governments inability to undertake subsidy reforms hits HPCLs profitability hard, threatening its valuation outlook. We reinitiate with SELL (target price of Rs298, at 0.8x FY13E BV) as HPCL is impacted the most among OMCs from rising under-recoveries. Derailed by rising under-recovery. The subsidy-sharing mechanism continues to be a swinger for HPCL as there is no firm decision by the Government on the sharing formula. HPCL has a low refining-marketing ratio, which hits it the most among OMCs, when crude price rises. At present, HPCL is losing ~Rs10.5/litre on diesel, Rs4.25/litre on petrol, Rs21/litre on SKO and Rs290/cylinder on LPG. The overall under-recovery is expected to be Rs171bn in FY11E based on the current crude prices. Of this, we expect HPCL to bear ~Rs36bn (Rs42bn in FY12E), supported by the Government compensation at Rs81bn and an upstream assistance of Rs54bn. However, there is still uncertainty on the precise contribution from the Government, which can hurt HPCLs valuation outlook going forward. Commissioning of Bhatinda refinery crucial. HPCL will likely commission the 9mmtpa Bhatinda refinery by December 11. The refinery is expected to trigger the companys marketing plans in North India, where it has limited presence. The overall cost for the refinery is expected at Rs190bn, the refinerys high complexity of 9.1 would ensure a premium of at least US$2-3/bl over Singapore Complex GRMs in the long term. This refinery contributes Rs63/share to HPCLs valuations; hence, its commissioning is critical. Valuations impacted the most; reinitiate with SELL. HPCLs profitability will likely dip sharply in the next two years, leading to a sharp drop in RoE to ~7% by FY13E. Based on the current uncertain environment, valuing the company on book value would be appropriate. High sensitivity to under-recovery entails a 0.8x implied multiple for HPCL, leading to a fair value of Rs298. Reinitiate with SELL.
Market Cap Reuters/Bloomberg 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs119.2bn/US$2.7bn HPCL.BO/HPCL IN 338.63 556/292 48.9 8.3 10,850 (11.1) 13.8 (5.6) 8.3 Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield RoCE (%) RoE (%) FY10 20,633 60.9 372.9 5.8 72.7 6.0 3.4 7.8 18.5 FY11E 7,215 21.3 (65.0) 16.5 59.9 9.2 2.0 4.3 6.1 FY12E 6,717 19.8 (6.9) 17.8 60.9 6.1 2.0 4.2 5.5 FY13E 8,458 24.9 25.9 14.1 69.0 6.2 2.3 4.3 6.7
Promoters Institutional investors 35.9 36.6 MFs and UTI 12.4 12.6 Insurance Company 0.0 0.4 FIIs 6.5 8.7 Others 13.0 12.3 Source: www.nseindia.com Jun '10 51.1 Sep '10 51.1 Dec '10 51.1 36.0 11.3 0.9 8.3 12.9
Price chart
560 520 480 440 400 360 320 280 Dec-10 Sep-10 Mar-11 Apr-10 Jul-10
(Rs)
1,013,475 1,355,766 1,665,419 1,671,494
Rohit Ahuja
Prolin Nandu
169
Hindustan Petroleum Corporation, April 4, 2011
ICICI Securities
TABLE OF CONTENT
Derailed by rising under-recovery .............................................................................171 Profitability under pressure .........................................................................................172 Commissioning of Bhatinda refinery important .......................................................174 High complexity advantage.........................................................................................174 Bhatinda project Details ...........................................................................................175 Key assumptions.........................................................................................................175 Valuations Strong downside....................................................................................176 Key assumptions.........................................................................................................177 Key risks to our call .....................................................................................................177 Annexure 1: Financials (consolidated)......................................................................178 Annexure 2: Index of Tables and Charts ...................................................................182 Annexure 4: International financial reporting standards Impact on oil & gas sector ............................................................................................................................183 Likely impact on Indian companies .............................................................................183
170
ICICI Securities
Derailed by rising under-recovery

Brent crude price has surged beyond US$100/bl, in a repeat of the situation in FY09. Surging under-recoveries and ad-hoc compensation by the Government makes HPCLs profitability event based rather than fundamental. Hence, HPCLs valuations can be volatile, both in the short term and the long term. At present, HPCL is losing ~Rs10.5/litre on diesel, Rs4.25/litre on petrol (apparently deregulated), Rs21/litre on SKO and Rs290/cylinder on LPG. HPCLs current refining-to-marketing ratio is the lowest among OMCs at 0.6, which makes its marketing under-recovery the most volatile among OMCs. Hence, HPCLs profitability is hit the most in case of a major fluctuation in crude. HPCL is the most risky bet among OMCs and can hit a rock bottom in a sustained high crude price scenario. Table 1: Refining-to-marketing volumes
Q4FY09 Crude throughput (MT) 4.17 Market sales (MT) 6.83 0.6 Throughput to sales Source: Company, I-Sec Research Q1FY10 4.10 6.84 0.6 Q2FY10 4.02 6.26 0.6 Q3FY10 3.73 6.66 0.6 Q4FY10 3.91 6.51 0.6 Q1FY11 3.29 6.73 0.5 Q2FY11 3.04 6.03 0.5 Q3FY11 4.10 7.05 0.6
Chart 1: HPCLs stock price vis--vis Brent

600 500 400 (Rs/share) 300 200 100 0 Oct-09 May-10 Dec-08 Nov-07 Dec-10 Feb-08 Sep-08 Feb-10 Sep-10 Apr-07 Mar-11 Jan-07 Jul-07 Jun-08 Apr-09 Jul-09 HPCL Brent (RHS) 160 140 120 (US$/bbl) 100 80 60 40 20 0
Source: Bloomberg
HPCLs overall under-recovery is expected to be Rs171bn in FY11E based on the current crude prices. Its net share is expected at ~Rs36bn, reduced to a major extent by expected compensation from the Government at Rs81bn and upstream assistance of Rs54bn. However, there is still uncertainty on the precise contribution from the Government, which can hurt the companys earnings going forward.
171
Hindustan Petroleum Corporation, April 4, 2011 Table 2: Surging under-recovery

(Rs mn)
ICICI Securities
FY08 257,080 33.3 352,900 45.8 161,250 20.9 771,230 FY09 320,000 31.0 712,920 69.0 334 1,032,920 FY10 144,300 31.3 260,000 56.5 56,210 12.2 460,510 FY11E 258,615 33.3 387,922 50.0 129,308 16.7 775,844 FY12E 371,914 33.3 557,871 50.0 185,957 16.7 1,115,741 FY13E 386,755 33.3 580,133 50.0 193,378 16.7 1,160,266
Total upstream % total Total government % total Total downstream % total Total under-recovery Petrol Diesel Kerosene LPG Total Source: Infraline, I-Sec Research
73,320 351,660 191,020 155,230 771,230
51,810 522,860 282,250 176,000 1,032,920
51,510 92,790 173,640 142,570 460,510
22,059 321,047 186,671 246,067 775,845
29,260 599,396 223,076 264,009 1,115,741
31,016 635,360 221,960 271,930 1,160,266
The under-recovery should hit the roof from FY12, when we expect Brent prices to average above US$100/bl. The Governments inability to undertake any major price revisions for subsidised products will spike overall under-recovery to Rs1,111bn, crossing the FY09 levels of Rs1,030bn. HPCLs share in FY13E is expected to be at Rs44bn, which is reduced by the Governments compensation of Rs132bn and upstream assistance of Rs88bn. Table 3: Sharing of under-recovery
(Rs mn)
IOC % total BPCL % total HPCL % total Total downstream Upstream assistance ONGC OIL GAIL
Total Source: Infraline, I-Sec Research
FY09 149 44.6 96 28.8 89 26.6 334
FY10 23,784 58.1 8,540 20.9 8,602 21.0 40,926
FY11E 74,700 57.8 27,608 21.4 26,999 20.9 129,307
FY12E 107,158 57.6 40,802 21.9 37,997 20.4 185,957
FY13E 111,692 57.8 42,557 22.0 39,129 20.2 193,378
273,740 29,319 16,937

319,996
114,560 15,267 13,854

143,681
206,373 32,129 19,170

257,672
304,782 44,988 22,143

371,914
315,239 46,823 24,694

386,755
Profitability under pressure

HPCLs profitability will take a hit FY12E onwards, as RoEs decline to sub 6% levels, one of the lowest for the company. This is worse than FY09, indicating that valuations can retest all-time lows. Table 4: Pressure on profitability
(%)
RoCE RoNW Source: I-Sec Research
FY09 5.6 7.4
FY10 5.7 4.1
FY11E 7.8 18.5
FY12E 4.3 6.1
FY13E 4.2 5.5
HPCLs profitability in the next 2-3 years is a major concern as it is highly dependent on the Governments subsidy sharing mechanism and product pricing policy.
172
ICICI Securities
We expect BPCLs cashflows to witness pressure from FY12, led by higher-thanexpected working capital requirement. The company would find it difficult to manage inventories, leading to pressure on the companys short term debt levels and interest payments. Table 5: Pressure on cashflows
(Rs mn) Operating cashflow Working capital changes Capital commitments Free cashflow Source: I-Sec Research FY09 (55,198) 53,113 30,515 (138,825) FY10 (131,702) (29,411) 32,086 (134,377) FY11E 3,039 2,151 48,047 (47,158) FY12E (60,688) (28,774) (35,418) 3,503 FY13E (106,023) 632 (103,432) (3,223)
173
ICICI Securities
Commissioning of Bhatinda refinery important

As HPCL has one of the lowest refining-marketing ratios, commissioning of its 9mmtpa greenfield Bhatinda refinery is crucial for its valuations. We expect HPCLs profitability to become less volatile as this ratio moves closer to 0.9 from 0.6 currently. Post commissioning of its expansion project at Vizag refinery over the next 3-4 years, this ratio is expected to move closer to 1. BPCL, with a ratio close to 0.9, is the second highest, followed by IOC at >1. The Bhatinda refinery is expected to be commissioned by Q1FY12 and would primarily target Euro IV (Euro V from 13) compliant products (in 11 cities in India). We value HPCLs investment in this refinery on DCF, which provides an upside of Rs63/share.
High complexity advantage

The Nelson complexity index (NCI) of the Bhatinda refinery is expected to be 9.1, one of the highest in India. The only comparable domestic refineries are that of Reliance Industries (RIL) at Jamnagar (NCI of 11.1), RILs SEZ refinery (NCI of 14) and Essars refinery (NCI of 9). The configuration of the proposed refinery will facilitate the processing of a wide variety of low cost Middle Eastern and other crudes. This flexibility to be able to process sour crudes will enable the refinery to take advantage of the cost differentials between low sulphur, low residue crudes and sour high residue crudes whilst simultaneously allowing it to produce high quality Euro IV and Euro V auto fuels. All of Bhatindas refined products are intended to conform to the Bureau of Indian Standards (BIS) specifications. The refinerys output of auto fuels will meet Euro IV-V standards. Table 6: Product slate
Products PP LPG Naphtha MS- Regular MS- Premium SKO ATF HSD MTO Sulphur Pet Coke Hexane Fuel & Loss Source: Company, I-Sec Research % slate 4.00 7.58 4.49 8.33 2.78 1.00 5.56 42.42 0.28 2.24 10.36 0.06 10.92 000mmt 360 682 404 750 250 90 500 3818 25 202 932 5 983
174
ICICI Securities
Bhatinda project Details

HPCL would hold 49% stake Grass root refinery of 9mmtpa Cross-country crude oil pipeline (~1,014Kms) from Mundra to Bhatinda, traversing through the states of Gujarat, Rajasthan and Haryana Crude receipt facilities Single point mooring (SPM) buoy capable of handling very large crude carriers (VLCC) for crude import located at Mundra, Gujarat Crude oil terminal (COT) ~6Kms away from the sea shore at Mundra, Gujarat Captive power plant of 165MW for refinery power and steam requirements
Value (Rs mn) 88,295 227,120 81,868 170,163 126,377 43,786 21,455 63
Table 7: Valuations
Particulars PV of FCF to FY2020E Terminal value PV of terminal value Firm Value Less Net Debt NPV Value for HPCL Value/share for HPCL Source: I-Sec Research
Key assumptions
Commissioning by Q2FY12 Long-term average GRMs at US$9/bl WACC 9.6%, terminal growth 2%
175
ICICI Securities
Valuations Strong downside

We value HPCL at 0.8x FY13E book value, at a discount to long-term mean P/BV of 1x. We have factored in HPCLs investments in the Bhatinda refinery based on DCF and OIL/MRPL at 80% discount to the current market price to arrive at a target price of Rs298. BPCLs core business book multiple of 0.5x is derived from its normalized RoEs of 8%, considering some support from the government to maintain these RoEs over the long-term. We prefer BV to value HPCL, especially in the current environment of high crude price considering that the Government would disallow the erosion in HPCLs net worth (HPCL will report some profits), primarily through support in the form of cash subsidies (or oil bonds) and upstream discounts. The stock had seen a sharp re-rating in the past year to ~1.5x due to partial deregulation of subsidised product prices undertaken by the Government. However, this scenario should change as the quantum of cash support from the Government for limiting BPCLs under-recoveries is uncertain. We see a major threat to companys valuations in the next two years, as ad-hoc price revisions by the Government would provide at best provide marginal support. HPCLs valuations are hit by a sharp decline in its RoE to 7% from 11% in FY11E, lower than its five-year mean RoE of 9%. As long as crude prices are high, we can assume a lower profitability environment for HPCL. We expect BPCLs multiples to decline to 1.1x, below its five-year mean. Chart 2: Rolling price/book trend
800 2.0x 600 1.5x
(Rs)
400
1.0x
200 0.5x 0 Oct-02 May-03 Mar-06 Dec-03 Nov-07 Dec-08 Sep-06 Aug-05 Sep-10 Mar-11
Value (Rs/share) 381 0.5 173
Table 8: P/BV valuations

Particulars FY13E BV Core business multiple Core business value Add MRPL stake (Rs mn) OIL stake (Rs mn) Bhatinda refinery Total value Implied PBV Source: I-Sec Research
Feb-10
Jun-04
Jan-05
Apr-02
Apr-07
Jun-08
Jul-09
45 17 63 298 0.8
176
ICICI Securities
Key assumptions
Average Brent prices in FY12E-13E at US$100/bl Marginal revision in diesel and LPG prices Under-recovery sharing. About 50% of under-recoveries will likely be compensated by the Government, 33% by Upstream (ONGC, OIL and GAIL) and the rest by HPCL.

Sharp variation in Brent prices, which can affect the Governments policy decision Lower crude price can encourage implementation of a subsidy sharing formula or freeing up of diesel prices. This can be positive for HPCL.
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ICICI Securities

(Rs mn, year ending March 31) Gross Sales Less: Excise Duty Net Sales FY09 1,017,351 70,502 946,848 FY10 1,030,356 72,512 957,844 FY11E 1,369,646 96,389 1,273,257 FY12E 1,654,848 116,461 1,538,387 FY13E 1,655,647 116,517 1,539,131
Other Operating Income

Total Operating Income
146,928
1,093,776
55,631
1,013,475
82,509
1,355,766
127,032
1,665,419
132,364
1,671,494
Less: Raw Materials Consumed Purchase of products for resale Power and Fuel Personnel Expenses Selling & Distribution Expenses
Total Operating Expenses EBITDA (excl bonds) EBITDA (incl bonds)
274,572 733,946 190 11,372 44,990

1,065,070 (118,221) 28,707
281,877 626,778 2,482 13,011 53,164

977,312 (19,468) 36,163
398,563 861,402 2,730 16,556 53,948

1,333,198 (59,941) 22,568
566,850 985,048 3,003 17,053 59,342

1,631,297 (92,910) 34,122
564,705 985,048 3,304 17,564 65,277

1,635,897 (96,767) 35,597
Depreciation & Ammortisation Add: Other Income

EBIT
9,813 9,057
27,951
11,644 16,462
40,981
13,095 12,263
21,736
13,939 350
20,533
14,926 608
21,279
Less: Gross Interest

Recurring Pre-tax Income
20,828
7,122
9,038
31,943
10,888
10,848
10,432
10,101
8,559
12,719
Add: Extra Ordinary income Less: Taxation Current Tax Deferred Tax Prior period tax paid/(write back)
Net Income (Reported) Consolidated Recurring Net Income Source: Company data, I-Sec Research
2,759 2,416 343 (1,387)

5,750 4,363
(7,044) 11,310 9,264 2,046 575

13,014 20,633
3,633 3,633 7,215 7,215
3,384 3,030 354 6,717 6,717
4,261 3,816 445 8,458 8,458
178
Hindustan Petroleum Corporation, April 4, 2011 Table 10: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Total Fixed Assets of which intangibles Total Assets LIABILITIES AND SHAREHOLDER'S EQUITY Borrowings Short Term Debt Long Term Debt Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital Reserves & Surpluses Share Premium General & Other Reserve Net Worth Total Liabilities & Shareholder's Equity Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
6,083 87,932 22,409 41,691 1,812 159,927
2,432 125,792 24,373 52,585 1,237 206,419
4,561 136,455 23,143 22,244 1,237 187,640
7,600 168,072 37,933 22,244 1,237 237,086
5,655 191,065 37,951 22,244 1,237 258,152
56,439 48,944 12,176

117,558 42,369
73,913 70,586 21,052

165,551 40,868
81,778 70,586 21,052

173,416 14,224
127,553 70,586 21,052

219,191 17,895
127,377 70,586 21,052

219,015 39,138
14,903 127,062 141,965
26,289 87,584 113,872
34,278 67,584 101,862
38,278 57,584 95,862
38,278 47,584 85,862
202,088 85,541 116,548 50,011 166,558
249,884 96,817 153,067 38,876 191,943
285,162 109,912 175,250 41,188 216,438
314,343 123,851 190,493 31,607 222,099
347,486 138,777 208,708 7,879 216,588
350,892
346,683
332,524
335,856
341,587
195,824 31,728 227,552

16,034
177,415 35,609 213,024

18,080
159,780 34,646 194,426

18,080
159,780 33,684 193,464

18,433
169,781 23,684 193,465

18,878
3,390
3,390
3,390
3,390
3,390
11,538 92,379 107,306

350,892
11,538 100,652 115,580

346,683
11,538 105,090 120,018

332,524
11,538 109,031 123,958

335,856
11,538 114,316 129,244

341,587
179
Hindustan Petroleum Corporation, April 4, 2011 Table 11: Cashflow statement

(Rs mn, year ending March 31) FY09 a) Cash Flow from Operating Activities Consolidated Net Income Add: Depreciation & Amortisations Less: Oil bonds Other Income Net Extra-ordinary income Op.Cash Flow before Working Capital change (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) as a % of Operating Cash Flow Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Consideration paid for acquisition of undertaking Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Sale of Investments Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from fresh borrowings Dividend paid including tax Others Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
6,093 9,133 146,928 9,057 (140,759)
15,060 11,276 30,341 16,462 (7,044) (13,422)
7,215 13,095
7,071 13,939
8,903 14,926
80,998 127,032 132,364 12,263 350 608 (72,951) (106,372) (109,142)
(32,270) 5,303 (10,539) 1,317 12,536 (5,757)

29,411 (111,348)
37,860 1,964 10,894 (574) (17,475) (30,519)

(2,151) (15,573)
10,663 (1,231) (30,341) (7,865) 28,774
31,617 14,790 (45,775) (632)
22,994 18 176 (23,188)
(44,178) (107,004) (132,330)
23,239 8,847
32,086 (143,434)
36,661 11,386
48,047 (63,620)
37,590 19,600 9,415 (73,009) (123,032) (132,364)

(35,418) (103,432) (122,949) (8,760) (3,572) (9,381)
82,180 9,057
91,237
69,819 16,462
86,281
20,000 12,263
32,263
10,000 350
10,350
10,000 608
10,608
59,685 (2,080) (2,265) 55,340

3,143
(14,528) (4,738) (19,266)

(7,044) (3,649)
(18,597) (2,776) (21,374)

2,130
(963) (2,776) (3,739)

3,038
1 (3,173) (3,172)
(1,945)
2,940 6,083 3,143
6,083 2,432 (3,651)
2,432 4,561 2,130
4,561 7,600 3,038
7,600 5,655 (1,945)
180
Hindustan Petroleum Corporation, April 4, 2011 Table 12: Key ratios

(Year ending March 31) FY09 Per Share Data (Rs) Diluted Recurring Earning per share (DEPS) Diluted Reported Earnings per share Recurring Cash Earnings per Share (CEPS) Free Cash flow per share (FCPS - post capex) Book Value (BV) Adjusted Book Value (ABV) Dividend per Share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value Price to Adjusted Book Value EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Operating Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Raw Material Consumed / Sales SGA Expenses / Sales Other Income / Pre-tax Income Other Operating Income / EBITDA Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Long Term Debt / Total Debt Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT Debt Servicing Capacity Ratio (DSCR) Current Ratio Cash and cash equivalents / Capital employed Turnover Ratios Inventory Turnover Ratio (x) Assets Turnover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
12.9 17.0 41.8 (423.1) 316.5 316.5 5.2
60.9 38.4 72.7 (187.7) 340.9 340.9 12.0
21.3 21.3 59.9 (25.8) 354.0 354.0 7.0
19.8 19.8 60.9 (10.5) 365.6 365.6 7.0
24.9 24.9 69.0 (27.7) 381.2 381.2 8.0
27.4 8.4 1.1 1.1 6.9 0.2 (1.4) (1.4) 1.5
5.8 4.8 1.0 1.0 6.0 0.2 (16.1) (3.4) 3.4
16.5 5.9 1.0 1.0 9.2 0.2 (2.8) (23.7) 2.0
17.8 5.8 1.0 1.0 6.1 0.1 (2.0) (58.6) 2.0
14.1 5.1 0.9 0.9 6.2 0.1 (2.0) (23.6) 2.3
(41.7) (11.3) 13.4 82.2 (41.7)
372.9 73.9 (7.3) 26.0 372.9
(65.0) (17.6) 33.8 (37.6) (65.0)
(6.9) 1.7 22.8 51.2 (6.9)
25.9 13.2 0.4 4.3 25.9
2.6 2.6 0.6 0.4 106.5 4.8 127.2 511.8 38.7
3.6 4.0 3.1 2.0 94.9 5.6 51.5 153.8 35.4
1.7 1.6 0.8 0.5 99.0 4.2 113.0 365.6 33.5
2.0 1.2 0.6 0.4 100.9 3.9 3.5 372.3 33.5
2.1 1.3 0.8 0.5 100.7 4.2 4.8 371.8 33.5
5.3 5.5 4.1 30.9
7.6 7.3 18.5 31.2
4.3 2.8 6.1 32.9
4.1 5.9 5.5 35.3
4.2 5.7 6.7 32.1
227.0 19.6 10.3 134.2 142.6 37.7 37.9
200.0 23.2 11.1 453.5 546.9 44.9 26.0
177.1 24.8 2.9 199.6 286.4 49.6 21.7
170.9 24.6 3.1 196.8 296.9 56.7 19.4
164.3 20.0 9.8 248.6 389.5 60.7 15.6
9.7 3.4 18.5 7.1 83.4
8.5 3.0 15.0 8.3 84.4
9.6 4.0 7.4 6.3 71.3
10.2 5.0 3.5 6.7 67.4
8.6 4.9 6.2 8.4 82.4
181
ICICI Securities

Tables
Table 1: Refining-to-marketing volumes ...........................................................................171 Table 2: Surging under-recovery ......................................................................................172 Table 3: Sharing of under-recovery ..................................................................................172 Table 4: Pressure on profitability ......................................................................................172 Table 5: Pressure on cashflows........................................................................................173 Table 6: Product slate .......................................................................................................174 Table 7: Valuations ...........................................................................................................175 Table 8: P/BV valuations...................................................................................................176 Table 9: Profit and loss statement ....................................................................................178 Table 10: Balance sheet ...................................................................................................179 Table 11: Cashflow statement ..........................................................................................180 Table 12: Key ratios ..........................................................................................................181
Charts
Chart 1: HPCLs stock price vis--vis Brent......................................................................171 Chart 2: Rolling price/book trend ......................................................................................176
182
ICICI Securities
Annexure 4: International financial reporting standards Impact on oil & gas sector
Compiled by: Structured Finance Group, ICICI Securities, Headed by Mr Charanjit Attra
Likely impact on Indian companies uncertain

The following companies have been reviewed on the basis of quantifiable and nonquantifiable differences:
ONGC
Under IFRS, the net worth of ONGC, as of March 31, 10, could be positively impacted by the following: Amortisation of goodwill in the current year to be written back. As per IFRS, goodwill is not subject to amortisation but is to be tested annually for impairment. Such amortised amount of goodwill has been written back. Foreign exchange translation reserve (negative balance) being added back to the net worth.
Offset by: Foreign exchange loss, which has been capitalised, would be written off in the profit & loss account under IFRS. Unamortised miscellaneous expenditure would be charged to profit & loss account under IFRS. Capital reserve on consolidation would be charged to profit & loss account.
The following differences have not been considered due to lack of information in the public domain. Successful method of accounting is followed for oil & gas accounting. However as per IFRS 6, only costs that qualify to be treated as E&E assets are capitalised. All other costs are to be charged to profit and loss. The liability towards cost of dismantling & restoration is recognised when wells are complete. As per IFRS, decommissioning/restoration costs are to be provided for at the restoration cost of present value of such expenses, the cost being included in the gross block Loans are provided to employees. If such loans are provided at lower interest rates, the same are to be fair valued and such unrealised gains/ losses are to be taken to CIS. The company has doubtful debts of more than six months, which are to be tested for impairment annually. Fixed assets are to be depreciated over their estimated useful life on the basis of each components of the asset
183
ICICI Securities
Bharat Petroleum Corporation

Under IFRS, the net worth of BPCL, as of March 31, 10, would be positively impacted by the following: Foreign exchange translation reserve (negative balance) being added back to the net worth
Offset by: Accounting of capital reserves on acquisition of subsidiaries Unamortised miscellaneous expenditure would be charged to profit & loss account under IFRS Indirect expenditures capitalised would be charged to profit & loss account under IFRS Deferred Government grant would be charged to profit & loss account under IFRS
The following differences have not been considered due to lack of information in the public domain. The company has booked goodwill on consolidation, which is not subject to amortisation but is to be tested annually for impairment. Successful method of accounting is followed for oil & gas accounting and all acquisition, exploration & development costs are treated as CWIP initially; once ready for commercial production such costs are capitalised. As per IFRS only such costs which can be classified as E&E assets can be capitalised, all other costs are charged to profit & loss. The company, however, can follow either successful cost or full cost method. Decommissioning/restoration costs are to be provided for at the restoration cost of the present value of such expenses, the cost being included in the gross block. Where loans are provided at lower interest rates, the same are to be fair valued and such unrealised gain/ loss are to be taken to CIS. Long-terms (unquoted) investments are valued at cost. Such investments are to be fair valued by effective interest method any change being accounted through CIS. The company has doubtful debts of more than six months, which are to be tested for impairment annually. Fixed assets are to be depreciated over their estimated useful life on the basis of each components of the asset.
184
ICICI Securities
Hindustan Petroleum Corporation

Under IFRS, the net worth of HPCL, as of March 31, 10 would be negatively (marginal) impacted by the following: Unamortised miscellaneous expenditure would be charged to profit & loss account under IFRS Government grant would be charged to profit & loss account under IFRS Borrowing cost capitalised on exploration assets would be charged to profit & loss account
Offset by: Market development reserve taken to profit & loss account
The following differences have not been considered due to lack of information in the public domain. The company has the right to use intangible assets, which are not amortised due to its perpetual nature. Such intangible assets are to be tested annually for impairment and in case of an impairment loss, such are to be charged to profit and loss. Successful method of accounting is followed for oil & gas accounting and all acquisition, exploration & development costs are treated as CWIP initially; once ready for commercial production such costs are capitalised. As per IFRS, only such costs which can be classified as E&E assets can be capitalised all other costs are charged to profit & loss. The company, however, can follow either successful cost or full cost method. Decommissioning/restoration costs are to be provided for at the restoration cost of present value of such expenses, the cost being included in the gross block. Where loans are provided at lower interest rate, the same are to be fair valued and such unrealised gain/ loss are to be taken to CIS. Long-terms (unquoted) investments are valued at cost. Such investments are to be fair valued by effective interest method any change being accounted through CIS. Fixed assets are to be depreciated over their estimated useful life on the basis of each components of the asset.
185
ICICI Securities
GAIL (India)
Under IFRS, the net worth of GAIL India, as of March 31, 10, would be positively impacted by the following: Deferred Government grant taken to profit & loss account
Offset by: Accounting for foreign exchange translation reserve Sales tax deferral account charged to profit & loss account
The following differences have not been considered due to lack of information in the public domain. The company has the right to use intangible assets, which are not amortised due to its perpetual nature. Such intangible assets are to be tested annually for impairment and in case of an impairment loss, such are to be charged to profit and loss account. The company has booked goodwill on consolidation, which is not subject to amortisation but is to be tested annually for impairment. Decommissioning/restoration costs are to be provided for at the restoration cost of the present value of such expenses, the cost being included in the gross block. Loans are provided to employees. If such loans are provided at lower interest rates, the same are to be fair valued and such unrealised gains/losses are to be taken to CIS Long-term (unquoted) investments are valued at cost. Such investments are to be fair valued by effective interest method, any change being accounted through CIS. Fixed assets are to be depreciated over their estimated useful life on the basis of each components of the asset.
Gujarat State Petronet

Under IFRS, the net worth of GSPL, as of March 31, 10, would be negatively (marginal) impacted by the following: Indirect and other unidentifiable costs, which have been capitalised, would be charged to the profit & loss account Unamortised balance of miscellaneous expenditure charged to profit & loss account
The following differences have not been considered due to lack of information in the public domain. CWIP includes other costs whose nature is not identifiable. On assumption that such costs do not qualify as either tangible/intangible/financial assets, they have been charged to CIS.
186
ICICI Securities
The company treats all expenditure on project till commissioning as CWIP, post which the same are transferred to the gross block. However, the maximum period of treating it as CWIP is not clarified nor the treatment if such a project is unsuccessful. Long-term (unquoted) investments are valued at cost. Such investments are to be fair valued by effective interest method, any change being accounted through CIS. Gas transmission pipeline are depreciated over an average period of 12 years, useful life being 30 years. All assets are to be mandatorily depreciated over their useful lives on each & every component of the asset.
Impact on group company policies Its holding company Gujarat State Petroleum Corporation (GSPC) applies the full cost method for its exploratory business. However, as per IFRS 6, only costs which qualify as E &E assets can be capitalised when incurred and all other costs are to be charged to the profit and loss account. Provision for dismantling & restoration is made as per technical assessment made by the company. However, such provisions are to be made at the restoration costs for the present value of the cost of dismantling, removal or restoration as a result of legal or construction obligation is recognised and corresponding costs are included a part of related property plant & equipment.
Reliance Industries
Under IFRS, the net worth of RIL, as of March 31, 10 would be negatively impacted by the following:
Accounting for capital reserve on consolidation Unamortised balance of miscellaneous expenditure written off to profit & loss account
Offset by: Capitalisation of exchange gain taken to profit & loss account Accounting of exchange fluctuation reserve
The following differences have not been considered due to lack of information in the public domain The company follows full cost method for Oil & gas activity. However, only costs which can be classified as E&E assets as per IFRS 6 can be capitalised; all other costs are to be charged to profit and loss account. Development costs are to be accounted as per IAS 29 (intangible assets). Long-term (unquoted) investments are valued at cost. Such investments are to be fair valued by effective interest method any change being accounted through CIS. The company has doubtful debts of more than six months, which are to be tested for impairment annually.
187
ICICI Securities
Fixed assets are to be depreciated over their estimated useful life on the basis of each components of the asset. No decommissioning costs have been provided. However as per IFRS, provisions are to be made at the restoration costs for the present value of the cost of dismantling; removal or restoration as a result of legal or construction obligation is recognised and corresponding costs are included a part of related property plant & equipment
188
ICICI Securities
189
ICICI Securities
ICICI Securities Limited has been mandated to act as one of the Book Running Lead Managers to manage the IPO of the group company of Gujarat State Petronet Limited, viz., Gujarat State Petroleum Corporation Limited. This report is prepared on the basis of publicly available information.
I-Sec investment ratings (all ratings relative to Sensex over next 12 months) BUY: +10% outperformance; HOLD: -10% to +10% relative performance; SELL: +10% underperformance
ANALYST CERTIFICATION
We /I, Rohit Ahuja, MBA (Finance); Prolin Nandu, MBA research analysts and the authors of this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.
Disclosures:
ICICI Securities Limited (ICICI Securities) and its affiliates are a full-service, integrated investment banking, investment management and brokerage and financing group. We along with affiliates are leading underwriter of securities and participate in virtually all securities trading markets in India. We and our affiliates have investment banking and other business relationship with a significant percentage of companies covered by our Investment Research Department. Our research professionals provide important input into our investment banking and other business selection processes. ICICI Securities generally prohibits its analysts, persons reporting to analysts and their dependent family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities. While we would endeavour to update the information herein on reasonable basis, ICICI Securities, its subsidiaries and associated companies, their directors and employees (ICICI Securities and affiliates) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent ICICI Securities from doing so. Non-rated securities indicate that rating on a particular security has been suspended temporarily and such suspension is in compliance with applicable regulations and/or ICICI Securities policies, in circumstances where ICICI Securities is acting in an advisory capacity to this company, or in certain other circumstances. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. ICICI Securities will not treat recipients as customers by virtue of their receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgement by any recipient. The recipient should independently evaluate the investment risks. The value and return of investment may vary because of changes in interest rates, foreign exchange rates or any other reason. ICICI Securities and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Actual results may differ materially from those set forth in projections. Forwardlooking statements are not predictions and may be subject to change without notice. ICICI Securities and its affiliates might have managed or co-managed a public offering for the subject company in the preceding twelve months. ICICI Securities and affiliates might have received compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. ICICI Securities and affiliates expect to receive compensation from the companies mentioned in the report within a period of three months following the date of publication of the research report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. It is confirmed that Rohit Ahuja, MBA (Finance); Prolin Nandu, MBA research analysts and the authors of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months. Our research professionals are paid in part based on the profitability of ICICI Securities, which include earnings from Investment Banking and other business. ICICI Securities or its affiliates collectively do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month preceding the publication of the research report. It is confirmed that Rohit Ahuja, MBA (Finance); Prolin Nandu, MBA research analysts and the authors of this report or any of their family members does not serve as an officer, director or advisory board member of the companies mentioned in the report. ICICI Securities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. ICICI Securities and affiliates may act upon or make use of information contained in the report prior to the publication thereof. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject ICICI Securities and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. This report has not been prepared by ICICI Securities, Inc. However, ICICI Securities, Inc. has reviewed the report and, in so far as it includes current or historical information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed.
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Equity Research

April 4, 2011 BSE Sensex: 19420

Oil&Gas and Petrochemicals

Play for value

Prefer Upstream and Midstream over Downstream

Oil&Gas and Petrochemicals

Play for value

Oil&Gas sector, April 4, 2011

Oil&Gas sector, April 4, 2011

Prices and Sensex as on April 1, 2011

Oil&Gas sector, April 4, 2011

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Oil&Gas sector, April 4, 2011

Oil&Gas sector, April 4, 2011

Surging under-recoveries A dj-vu for oil PSUs

Source: Company data, I-Sec Research

Table 1: Share of subsidy contribution across categories

Oil&Gas sector, April 4, 2011

Oil PSUs are back to square one

Chart 2: Under-recoveries Contribution from oil PSUs and the Government

Oil&Gas sector, April 4, 2011

Under-recoveries more or less a zerosum game for the Government

Table 2: Oil companies contribution much higher than under-recoveries

(389) 23 0 13 7 432 1,209 201 1,008

469 32 0 22 2 525 1,358 400 958

539 36 0 19 5 600 1,538 494 1,044

564 42 0 17 11 634 1,676 771 905

633 25 0 19 5 683 1,618 1,032 586

650 33 0 19 18 721 1,839 460 1,378

Oil&Gas sector, April 4, 2011

E&P, the key valuation driver

Oil&Gas sector, April 4, 2011

Table 4: Energy demand growth A close proxy of GDP growth

but rising dependence on oil imports needs to be curbed

Factors that justify strong investments in oil exploration

Oil&Gas sector, April 4, 2011 Table 5: Domestic crude balance

Table 6: Declining oil production, a concern

Table 7: Oil import details

More discoveries such as Mangala and Mumbai High needed

Oil&Gas sector, April 4, 2011 Table 8: Domestic oil production details

East coast development, a major boost through D6

Oil&Gas sector, April 4, 2011

Chart 3: Acreage holdings in KG Basin blocks (dominated by ONGC and RIL)

Source: Wood Mackenzie

Chart 4: Reserve additions in the KG Basin

Source: Wood Mackenzie

Chart 5: Worlds top exploration provinces (1999-2009) by number of discoveries

Source: Wood Mackenzie

Oil&Gas sector, April 4, 2011

Midstream players Defensive bets

Acceleration in gas production requires supporting infrastructure

Oil&Gas sector, April 4, 2011

Power and fertiliser continue to drive demand

46.9 21.8 3.1 14.2 7.3 6.6

Oil&Gas sector, April 4, 2011

Gas transmission infrastructure shaping up for increased supplies

Oil&Gas sector, April 4, 2011 Chart 6: Pipeline infrastructure in India

Oil&Gas sector, April 4, 2011

Downstream gas trading margins to be under pressure

LNG imports to surge, but pricing an issue

Oil&Gas sector, April 4, 2011

138 110 15 0 4 267 (41)

168 125 13 0 4 311 (110)

Oil&Gas Sector 4 April'11 New

Oil&Gas Sector 4 April'11 New