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Sharekhan Investor's Eye - Apr 13 2006

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Reliance Petroleum - IPO Analysis

Rich pricing of a great dream

Though the project does not have negatives, a fall in the market can give a better opportunity to enter as the project will be commissioned only in Dec.'08

Reliance Petroleum (RPL) was incorporated as a 100% subsidiary of Reliance Industries (RIL) in October 2005 to set up a grassroot petroleum refinery and polypropylene (PP) plant in the special economic zone (SEZ) at Jamnagar. This new refinery, located adjacent to the existing refinery and petrochemical complex of RIL, will comprise secondary processing facilities to maximise the quantity of value-added products such as alkylates, diesel, aviation turbine fuel, and polypropylene.

RPL's new refinery in Jamnagar will have a capacity of 5,80,000 barrels per day (bpd) and a polypropylene unit with a capacity of 9,00,000 tonnes per annum. The estimated cost of the project is $6 billion, or Rs. 27000 crore, and it is expected to commence production only in December 2008. The refinery will be even more complex compared with RIL's existing refinery, processing lower quality crude and earn better margin.

The project will be financed by an equity of Rs. 112500 crore and debt of Rs. 157500 crore. RPL has got a syndicated loan of Rs. 6750 crore from 14 leading international and domestic banks and plans to raise an equal amount if the need arises. Further, the RIL board has resolved to provide for any shortfall in financing if RPL is unable to tie-up for its entire requirement of debt.

Recently, Chevron Corp. – world's fourth largest oil company – decided to buy 5% equity stake in RPL for $300 million. Chevron will buy RPL's 22.5 crores equity shares of Rs. 10 each from RIL at Rs. 60 each and has obtained a right to increase the stake by another 24% on completion of collaboration agreement between Reliance and Chevron. The RIL's shareholding in RPL will come down to 75% on sale of first 5%, which will further fall to 51% after the company sells 24% stake to Chevron. The exact time frame or pricing for the sale of this 24% stake is not disclosed yet. The company also entered into two MoUs with Reliance. Through these MoUs Reliance and Chevron plan to optimize the crude supply and marketing of final products apart from the refinery technology, envisage cooperation to set up a technology development centre in the country and sets out the intent to collaborate in other areas of energy value chain

RPL is offering 135-crore equity shares of Rs. 10 each at a price band of Rs. 57 to Rs. 62 each. The promoters will subscribe to 90-crore shares, leaving a net of 45 crore shares to the public. The company has privately placed 45-crore equity shares at Rs. 60 each on the eve of the IPO to raise Rs. 2700 crore.

Strengths

* RIL established its refinery in a record 36 months. RPL also expects to commission its mega refinery in another 36 months. The company has tied up with Bechtel for the execution of the project with a single responsibility cost cap contract.

* Despite the complexity, the capital cost of the refinery is going to be lower compared with similar projects in Asia as RPL will benefit from RIL's existing setup including fabrication shop, pipe shop, and an all-weather port. As it is in an SEZ, the company will not be required to pay any customs / excise duties and will also be exempt from income tax for five years from commencing business. It will get 50% income-tax exemption for the next five years, which can be extended for another five years subject to certain reinvestment conditions.

*The margin of the new refinery will be higher than the industry average due to the following factors:

• Ability to handle lower quality crude due to higher complexity will lead to a saving of $2 - $3 per barrel.
• The all-weather port in Jamnagar can handle very large crude carriers (VLCCs), translating into an estimated saving of 10 cents per barrel of crude.
• As it is in SEZ, the refinery will not be compelled to produce LPG or kerosene, which its counterparts in the domestic tariff area (DTA) have to compulsorily produce and sell at subsidised rates.
• The output from this refinery will conform to environmental norms by 2011-12. Thus, the refinery will be able to obtain some premium on its output products before other players achieve compliance.
• The large size gives the refinery the advantage of economies of scale.

RPL estimates the global demand for refined petroleum products to rise rapidly over the next decade. The refining sector world over is facing the challenge to produce cleaner fuels even as crude supplies of heavy and sour varieties are rising. The RPL refinery is well positioned to exploit both these situations.

Weaknesses

*The possible post-listing negative triggers can be:

- Fall in already high Asian refining margin (which is volatile and fluctuates every quarter).

• Natural disturbances in Gujarat (the area has experienced many natural disasters in the recent past).
• Unfavourable events affecting the supply of crude oil, which can sharply push up crude oil prices.

Valuation

With no financial track record and no operational income expected to be generated till December 2008, institutional investors will drive up and down the scrip depending on their perception of the refining margin in FY 2009-10. At the offer price of Rs 57-62, large part of the possible upside has been skimmed. Hence, until the project is commissioned, the scrip may underperform the market. Markets can also throw up better opportunities to invest in this scrip in future.