Buy Reliance Industries – 3QFY2011 Result Update- Angel Broking

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Reliance Industries – 3QFY2011 Result Update

Angel Broking maintains a Buy on Reliance Industries with a Target Price of Rs. 1,160.

RIL reported 28.1% yoy growth in bottom-line on account of higher refining

and petchem margins. On a sequential basis, PAT grew by a mere 4.3% on

account of the dip in natural gas output from KG-D6 and lower refining

volumes. However, the numbers were below our expectations on the top-line

and bottom-line fronts on account of the lower-than-expected refining

margins and we had not taken into consideration the lower refining volumes

on account of the refinery shutdown. We maintain a Buy on the stock.

Earnings post sequential as well as yoy growth: Top-line increased by 5.2% yoy to

`59,789cr (`56,856cr) primarily on the back of the 9.4% yoy growth in refining

revenues to `52,5242cr (`48,00cr) and 8.2% yoy increase in petchem revenues

to `15,962cr (`14,756cr). Despite planned shut down of one train of the crude

distillation unit for 22 days during the quarter, the refining segment reported

growth due to higher product prices. Crude oil processed during the quarter was

lower by 3% yoy to 16.1mn tonnes (16.6mn tonnes). KG-D6 gas production fell

qoq with average production at 54.5mmscmd (58.5mmscmd). Operating profit

grew 21.7% yoy to `9,545cr (`7,844cr), which was 6.9% lower than our estimate

on account of the lower-than-expected refining throughput and refining margins.

Outlook and Valuation: Upside in the upstream business has increased on the

back of the newer ventures and initiatives by RIL. Timely ramp up in the producing

fields is expected to improve investor sentiment and aid them factor in other

prospective basins also. Nonetheless, the macro headwinds would persist owing

to which we expect the refining and petchem margins to stabilise around current

levels. We maintain a Buy on RIL, with a SOTP-based Target Price of `1,160.

Top-line below estimates on lower-than-expected Refining volumes: RIL's top-line

was below our estimates on account of lower-than-expected refining volumes as

we had not considered the refinery shut down for 22 days during the quarter.

Top-line increased by 5.2% yoy to `59,789cr (`56,856cr) primarily on the back of

the 9.4% yoy growth in refining revenues to `52,5242cr (`48,000cr) and 8.2%

yoy increase in petchem revenues to `15,962cr (`14,756cr). Despite planned shut

down of one train of the crude distillation unit for 22 days during the quarter, the

refining segment reported growth due to higher product prices. The petrochemical

segment registered 8.2% yoy increase in top-line driven by higher polymer and

polyester prices. Crude oil processed during the quarter was lower by 3% yoy to

16.1mn tonnes (16.6mn tonnes). KG-D6 gas production fell qoq with average

production at 54.5mmscmd (58.5mmscmd).

Higher refining and petchem margins leads to improvement in OPM yoy:

During the quarter, RIL reported GRMs of US $9/bbl (US $5.9/bbl), marginally

lower than our expectation of US $9.3/bbl. Benchmark complex Singapore

margins, during the quarter, stood at around US $5.5/bbl. Thus, RIL managed to

earn a spread of US $3.5/bbl. On the petchem side, it was the best-ever quarter

for the company. Petrochemical EBIT margins improved by 66bp qoq to 15.2%

(14.6% in 2QFY2011) during 3QFY2011 due to higher polymer and polyester

margins owing to tighter cotton market. The oil and gas segment's EBIT margin

declined by 584bp yoy and 365bp qoq to 36% (39.6% in 2QFY2011) due to

higher proportion of KG-D6 production compared to production from the PMT

field. As a result, overall OPM expanded by 217bp yoy 16% (13.8%). Operating

profit grew by 21.7% yoy to `9,545cr (`7,844cr). However, margins stood lower

on qoq basis by 38bp due to lower capacity utilisation of the refinery and dip in

production of natural gas at the KG basin.

Depreciation, other income increase: Depreciation during the quarter increased

20.2% yoy primarily on account of higher depletion charge in the oil & gas

segment and increased depreciation in the refining business. Interest expenditure

stood flat both on qoq and yoy basis. Other income increased by 45.9% yoy to

`741cr (`508cr) and 10.3% qoq on account of higher cash balance.

PAT grew 28.1%: PAT grew 28.1% yoy to `5,136cr (`4,008cr), which was below

our expectation of `5,535cr. The deviation was mainly on account of the lowerthan-

expected refining volumes and margins.

Segment-wise performance

Refining and marketing (R&M): During the quarter, crude processing stood at

16.1mn tonnes (16.6mn tonnes), down 3% yoy, with the refinery reporting capacity

utilisation of 104%. Crude processing was lower on account of the planned shut

down of one train of the crude distillation unit for 22 days during the quarter.

Despite the lower crude throughput, higher petroleum product prices led to 9.4%

yoy increase in R&M revenues to `52,524cr (`48,000cr). On the margins front, RIL

reported GRMs of US $9/bbl (US $5.9/bbl) as against our expectation of

US $9.3/bbl. Thus, refining margins were marginally lower than our expectations.

Singapore margins during the quarter averaged at US $5.5/bbl. Thus, RIL

managed to earn a spread of US $3.5/bbl over the same. Improvement in the

refining margins could be traced to improved product spread of middle distillates

on account of cold weather in the US and higher Chinese demand for diesel.

Moreover, the increase in heavy-light crude oil spread by US $1/bbl (primarily due

to weak fuel oil cracks and higher demand for lighter products resulting in higher

demand for lighter crude) also increased refining margins during the quarter.

Refined product exports stood at 28.4MMT (US $20.1bn) in 9MFY2011 as against

23.6MMT (US $14.3bn) in 9MFY2010 on incremental export volumes from the

SEZ refinery.

Petrochemicals: The petrochemical segment revenues grew 8.2% yoy to `15,962cr

(`14,756cr) due to higher polymer and polyester prices yoy. Blended product

deltas were higher on yoy as well as qoq basis on account of strength in PP and

polyester margins. Polymer margins were higher on account of higher Asian

demand, and the polyester cracks were higher due to tighter cotton market. EBIT

margins of the segment increased by 66bp qoq to 15.2% (14.6%). PP delta, which

stood at US $94/MT during 2QFY2011, surged to US $239/MT during the quarter

on account of strong demand growth and stable propylene prices lending a boost

to petchem margins. However, margins were flat in the HDPE-naphtha segment at

US $485/MT v/s US $485/MT during 2QFY2011 and PVC-EDC segment were

also stable, with a margin of US $395/MT as against US $410/MT in 2QFY2011,

as increase in EDC price tracked that of PDC.

Oil & Gas: Oil and Gas EBIT registered qoq de-growth of 11.8% to `1,504cr

(`1,706cr) on account of slower ramp up in KG basin and oil production. The gas

production at KG basin was lower due to reservoir pressure constraints in the

fields. RIL’s KG-D6 gas production during the quarter averaged at 54.5mmscmd

as against 58.5mmscmd in 2QFY2011. Crude oil production from the KG basin

decreased to 19,400bpd from ~22,229bpd in 2QFY2011. After the shut down in

the previous quarter, PMT resumed production during the quarter. Thus, owing to

lower production from KG-D6, EBIT margins of the segment declined by 365bp

qoq to 36% (39.6%).

Investment Arguments

Ramp up in KG-D6 could allay many concerns over valuation: RIL is still producing

natural gas below its potential 80mmscmd due to constraints over reservoir

pressure. However, we are confident about RIL ramping up its production in the

coming quarters. The upstream segment still has significant upside in store,

considering huge untapped resources. Timely ramp up in the producing fields

would improve investor sentiment and aid them factor in other prospective basins

also. We expect KG-D6 to ramp up to its full potential during FY2013.

Core business margins to stabilise: We expect refining and petchem margins to

stabilise at current levels. The recent spurt was consequent to higher demand from

the emerging economies and stimulus led recovery in the OECD economies.

Going forward, we expect margins to stabilise due to tightening of emerging

economies and high spare capacity to meet incremental demand.

Newer ventures could be a long-term catalyst: RIL has been actively eyeing

inorganic routes for diversifying its asset portfolio by entering into newer ventures.

Significant cash pile and treasury stocks could see RIL venturing into on more

inorganic routes for growth and prove to be an upside trigger for the stock. Out of

all the company’s recent initiatives, we find the shale gas venture the most

promising one on account of the in-place reserves of ~12TCF.

Outlook and Valuation

We believe that the macro headwinds will continue to surround refining and

petchem business and any incremental demand will be absorbed by surplus

capacities globally. Thus, we expect RIL’s refining and petchem margins to stabilise

around current levels.

A significant cash pile and treasury stocks could see RIL venturing into more

inorganic avenues, which could provide upside triggers for the stock. We believe

that RIL has already made significant investments in new businesses like shale gas

and telecom, and is likely to crystallise its plans to foray into other segments. Thus,

this could address the cash redeployment concerns to a large extent. Moreover, the

proposed plans to increase capacity of the petrochemical segment and addition of

the coker in the refining segment are likely to further consolidate the company’s

position in its existing businesses.

Timely ramp up in the producing fields would improve investor confidence and aid

them factor other prospective basins also. The high potential exploratory fields

would provide further visibility once the DGH approvals are in place. Valuations

would receive further boost on any improvement in the distillate and polymer

cracks consequent to recovery in global demand.

We maintain a Buy on RIL, with a SOTP-based Target Price of `1, 160,

translating into an upside of 17.6% from current levels.