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The (il)logic of Price justification

Posted by fairval on April 22, 2008

A sample of how target prices in analyst reports dont mean much. This is from a recent report on RIL after its 4Q08 results…

Our target price of Rs2,850 is based on a sum-of-the-parts value: 1) we value
RIL’s core petrochem and downstream oil business on an EV/EBITDA of 6.5x
mid-FY10E, in line with regional chemicals and refining peers. The decrease in EV/EBITDA multiple from 7.5x earlier is to capture the impact of a possible global slowdown; 2) We value total E&P assets including oil & gas prospects and other blocks at Rs994/share based on 12x steady state (FY11E) FCF. This is lower than EV/FCF multiple of 15x used earlier as we attempt to be more conservative on valuations; 3) We value investment in RPL at 6.5x EV/EBITDA (in line with RIL); 4) We value organized retail business at Rs131/share, based on EV/sales of 1x; and 5) We value treasury stock at target price.

Lets try to understand this. This report is ‘decreasing’ the valuation of the E&P business, at a time when oil prices are at an all time high, and perhaps 15% higher than the previous report. With market having corrected, the earlier target price was perhaps too high to be justified.


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