Reliance Industries - margin expansion in polyester chain: Edelweiss

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Reliance Industries (RIL IN, INR 1,062, Hold)

n  Recent surge in cotton prices led to rise in demand/prices of PSF/PFY …

Cotton prices have surged and are probably at their all time high. The Cotlook A Index has risen 34.4% in the past one month and 17.5% in 12 days (see Chart 1 in next page). Higher cotton prices have led to spike in the demand of PSF, as the input substitutes cotton at the fibre level. Consequently, PSF/PFY prices have increased dramatically. PSF/PFY prices are currently at USD 1,750-1850/mt (40-50% higher over the past one month, 20-30% higher since November 1, 2010).

n  …leading to spike in prices of polyester intermediates (PX/PTA/MEG)

The increased demand for PSF/PFY has led to spike in the demand of raw materials (PX/PTA/MEG), increasing their prices. MEG/PTA prices are currently at USD 1,150-1,225/mt (~25-30% higher over the past one month, 15-20% higher since the beginning of November 2010). The increase has been particularly sharp in the past one week due to sharp spike in cotton prices and increase in polyester demand.

n  Margins to expand in entire polyester chain; RIL to benefit the most

Owing to the cascading effect of increase in demand and prices of both raw materials and finished products, margins in the entire polyester chain have expanded. RIL is most suitably positioned to benefit the most from this recent development, as it is a fully integrated polyester yarn/fiber manufacturer. In view of volatile prices, we expect an immediate increase in petrochemical margins for RIL from higher margins in the polyester chain.

n  Outlook and valuations: Polyester earnings to grow; maintain ‘HOLD’

We expect RIL to report better margins in Q3FY11 owing to higher polyester chain margins. Our analysis shows that, with other earnings remaining the same, RIL’s earnings from the polyester chain will increase its Q3FY11 PAT by ~10% (conservative assumptions, refer Table 2 below). While margins in the polyester chain may not sustain at the current high levels due to possibilities of correction in cotton prices, RIL’s Q3FY11 earnings will definitely show a positive impact. With improvement in refining margins, we expect RIL’s Q3FY11 numbers to be higher than those estimated by the Street, thereby offering trading opportunity for investors. We maintain our March 2012 fair SOTP value at INR 1,251/share and maintain our ‘HOLD/Sector Outperformer’ recommendation on the stock. At INR 1,062, RIL trades at FY12E P/E of 13.7x and FY12E EV/EBITDA of 7.9x.