Buy RELIANCE INDUSTRIES Improvement in earnings from refining; petrochemicals segments : Edelweiss

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􀂃 Revenue slightly above estimate; PAT in line with estimate
Reliance Industries’ (RIL) Q3FY11 INR 51.36 bn PAT was in line with our
estimated INR 51.87 bn. Higher EBIT (Q-o-Q) from refining (76.7% Y-o-Y,
11.1% Q-o-Q) and petrochemicals (+18.2% Y-o-Y and 10.6% Q-o-Q) offset
lower EBIT from the E&P segment (KG-D6 Q3FY11 gas production at 55.8
mmscmd against 59.1 mmscmd in Q2FY11).

􀂃 Earnings from refining and petrochemicals continued to improve
Refining throughput, at 16.1 MMT, was much better than expected. Despite
shutdown of CDU-I, the refinery operated at 104%. GRMs, at USD 9.0/bbl,
though marginally lower than USD 9.25/bbl estimated, increased 52.5% Y-o-Y
and 13.9% Q-o-Q. Petrochemical volumes were higher 3.7% Q-o-Q due to
absence of shutdown in Q2FY11. Integrated polyester margins, at USD
~1,200/mt, were highest in the decade.
􀂃 Uncertainty on scale up of KG-D6 gas/oil production continues
KG-D6 production scale up has been delayed due to technical and other issues
(we are not yet clear on the same). As per RIL management, there have been
discussions with the DGH/regulator on multiple issues on the company’s entire
exploration/development activity. Management believes that all the issues are
being discussed together as they need to be resolved together. Hence,
discussions are progressing at a slow pace, leading to uncertainty on timelines.
Meanwhile, natural gas and crude oil production will continue at 50-55 mmscmd
and 17,500 bopd, respectively, till further clarity emerges. We continue to
maintain KG-D6 natural gas production estimates at 57 mmscmd for FY12 and
70 mmscmd for FY13.
􀂃 Outlook and valuations: Play the upcycle in refining/ polyester/
petrochemicals; maintain ‘BUY/SO’
We believe the recent correction in the stock offers opportunity for investors to
play the refining, polyester, and petrochemical upcycle. On the E&P front, while
gas production may not scale up for the next 2-3 quarters, we are positive on
the outcome and believe it may start scaling up FY13 onwards. We have
maintained our SOTP for the company at INR 1,251/share. At INR 987, RIL
offers 27% upside from the current level and the recent correction in the stock
could be a good entry point. Hence, we maintain ‘BUY/Sector Outperformer’
recommendation/rating on the stock. At INR 987, the stock is trading at 12.9x
and 11.4x our FY12E and FY13E EPS, respectively

  

􀂃 Results in line; higher other income the only surprise factor
RIL’s reported revenue for Q3FY11 stood at INR 597.9 bn (INR 1833.7 bn for April-
December 2010), up 4.0% Q-o-Q. Revenue growth was robust at 5.2% Y-o-Y on higher
refining volumes, refining margins, and crude prices. Q3FY11 top line was broadly in line
with our estimate of INR 574.8 bn.
EBIT, at INR 61.9 bn, registered a growth of 22.5% Y-o-Y and 2.8% Q-o-Q. Y-o-Y EBIT
improvement was driven by improvement in refining (throughput and margins) and E&P
EBIT (ramp up of KG-D6 gas production). EBIT for the quarter improved primarily on the
back of refining and petrochemicals segments, partially offset by the O&G segment.
Employee expenses, at INR 6.6 bn, jumped 14.8% Y-o-Y due to increased benefits to
employees.
Interest expenses, at INR 5.5 bn, were flat both Q-o-Q as well as Y-o-Y. Other
income, at INR 7.4 bn, increased 45.9% Y-o-Y and 10.27% Q-o-Q, driven by higher
cash balance (INR 318.3 bn) with the company.
Depreciation expenses dipped marginally Q-o-Q to INR 33.6 bn (INR 33.8 bn in
Q2FY11). However, depreciation expenses catapulted 20.2% Y-o-Y due to increased
depreciation in the O&G and refining segments.
Tax rate was slightly below our estimate at 19.5% (20.3%) compared with 19.9% in
Q2FY11.
Consequently, core profit jumped 28.1% Y-o-Y and 4.3% Q-o-Q to INR 51.36 bn in
line with our estimate of INR 51.87 bn.


􀂄 O&G: Lower KG-D6 production leads to lower EBIT from the segment
The O&G segment reported EBIT of INR 15.0 bn, down 11.8% Q-o-Q due to lower KG-D6
natural gas production (55.8 mmscmd for Q3FY11 against 59.1 mmscmd for Q2FY11)
partially offset by higher production from PMT fields.
KG-D6 block: KG-D6 natural gas production declined 5.7% Q-o-Q to 55.8 mmscmd
(gross production) as the company continues to struggle to find solution to problems
related to the reservoir. For the same reason, liquid production (crude oil + condensate)
from MA-1 field declined 21.5% Q-o-Q to 20.6 kbpd. Operating costs for fields have also
increased due to lower production of natural gas.
PMT fields: Crude production from PMT fields 0.11 mmt (net to RIL) increased 188% Qo-
Q while natural gas production increased 26.9% Q-o-Q to 299 mmscm (net to RIL) due
to impact of restart of production from the Panna-Mukta fields on October 27, 2010. The
Panna-Mukta fields were shut on July 20, 2010, after a leak in a pipeline linked to single
point mooring (SPM). Before the shutdown, the fields were producing about 40,000 bopd
of crude and about 5.5 mmscmd of gas. In Q3FY11, Panna-Mukta fields produced 4.0
mmscmd natural gas.


RIL guidance and plans: KG-D6 production scale up has been delayed due to technical
and other issues (we are not yet clear on the same). As per RIL management, there
have been discussions with the DGH/regulator on multiple issues on the entire
exploration/development activity of RIL—performance, commerciality, rig moratorium,
calculations, audit, rig drilling, exploration, among others. RIL management believes all
the issues are being discussed together as they need to be resolved together. Hence,
discussions are moving at a slow pace, leading to uncertainty on timelines. Meanwhile,
natural gas and crude oil production will continue at 50-55 mmscmd and 17,500 bopd,
respectively, till further clarity emerges. FDP of NEC-25 block, which till Q2FY11 was
guided by RIL management to be in advance stages, is also under discussion with the
government and are also related to issues mentioned above. Exploration of MN-D4 block
may happen later as commitments are expiring in 2013.
We continue to maintain KG-D6 natural gas production at 57 mmscmd for FY12E and 70
mmscmd for FY13E. Our estimates assume that the company will start scaling up natural
gas production Q3FY13 onwards.
Exploration: Currently, two deepwater rigs are under operation for exploration appraisal
activities. No discoveries were notified during Q3FY11. During Q1FY11 and Q2FY11 six
discoveries were notified to DGH:
• Dhirubhai-47 in Well AF1 in CB10 block
• Dhirubhai-48 in Well AJ1 in CB10 block
• Dhirubhai-49 in Well AT1 in CB10 block
• Dhirubhai-50 in Well AN1 in CB10 block
• Dhirubhai-51 in Well AR1 in CB10 block
• Dhirubhai-52 in Well W1 in KGVD3 block
􀂃 Refining capacity utilisation at 104%; GRMs marginally lower at USD 9.0/bbl
RIL’s throughput, at 16.1 MMT (higher than estimate of 15.5 MMT), dipped 4.8% Q-o-Q
due to shut down of its CDU-I of the old refinery (50% capacity of nameplate 33.0
mmtpa) for 20 days, while the capacity utilisation was also lower at 103.9% in
comparison to Q2FY11 (109%). GRMs disappointed at USD 9.0/bbl (cumulative USD
8.1/bbl for 9mFY11) against our estimate of USD 9.25/bb. However, GRMs improved
52.5% Y-o-Y and 13.9% Q-o-Q. Consequently, refining EBIT, at INR 24.4 bn, improved
76.7% Y-o-Y and 11.1% Q-o-Q, but was lower than our estimate of INR 25.6 bn. We
maintain our FY11E and FY12E GRM at USD 8.5/bbl and USD 10.5/bbl, respectively. We
remain structurally bullish on refining margins and believe the same should remain
strong for the next few years.
Export of refined products was at 8.9 mmt in Q3FY11, 55% of overall refining throughput.


Petrochemicals EBIT jumps due to increase in polyester margins
EBIT for the petrochemicals segment at INR 24.3 bn (+18.2% Y-o-Y and 10.6% Q-o-Q)
was marginally better than our estimate of INR 24.0 bn. Key reason for the performance
of the petrochemicals segment was the increase in margins in the entire polyester chain
(PX, PTA, MEG, PSF, POY).
Petrochemical volumes, at 5.6 MMT, rose 3.7% Y-o-Y and 1.8% Q-o-Q, due to absence
of shutdowns during Q2FY11. Ethylene production at 505 KT was higher 16.9% Q-o-Q
due to absence of cracker shutdown. Propylene production (including refinery propylene)
at 693 KT was higher by 0.6% Q-o-Q due to higher production from refinery propylene.
Polyester and polyester intermediate production increased 4.7% Q-o-Q (449 KT) and
9.1% Q-o-Q (1200 KT), respectively.
The petrochemical segment posted high polyester margins as integrated polyester
margins (from naphtha/ethylene to polyester) moved to USD 1,200/mt, highest in the
last decade. Cracker margins dipped to USD 175/mt (-22.9% Y-o-Y, -30.3% Q-o-Q) due
to impact of increased capacity in the Middle East. Overall polymer (PE, PP, and PVC)
margins remained flat Q-o-Q (USD 197/mt).


􀂃 Other highlights
• Net cash capital expenditure for Q3FY11 was INR 19.0 bn. E&P cash capex was
INR 17.5 bn.
• Total capex guidance and break up on the ongoing capex plans are as follows:
􀂃 Off-gas cracker and downstream units: USD 4.0 bn.
􀂃 Polyester and polyester intermediates: USD 2.5 bn-3.0 bn (2 years from July
2010).
􀂃 Pet coke gasification: USD 3.0 bn-3.5 bn.
• Outstanding debt at Q3FY11 end was INR 702 bn, higher by INR 78 bn as on March
2010. Cash and cash equivalents at quarter end were INR 318.3 bn.
􀂃 Outlook and valuations: Play the upcycle in refining/polyester/petrochemicals;
maintain ‘BUY/SO’
We have broadly maintained our estimates for RIL. We believe that recent correction in
the stock offers opportunity for investors to play the refining, polyester, and the
petrochemical upcycle. On the E&P front, while gas production may not scale up for the
next 2-3 quarters, we are positive on the outcome and believe that gas may start to
scale up FY13 onwards. We have maintained our SOTP for the company at INR
1,251/share. At INR 987, RIL offers 27% upside from the current level and the recent
correction in the stock could be a good entry point. Hence, we maintain ‘BUY/Sector
Outperformer’ recommendation/rating on the stock. At INR 987, the stock is trading at
12.9x and 11.4x our FY12E and FY13E EPS, respectively.


􀂄 Company Description
RIL is the largest private player in the refining, petrochemical, and E&P sectors in India.
Historically RIL’s refining and petrochemical segments have been contributing ~90% to
its total revenues, but that is set to change, as the company scales up its E&P business
and is set to emerge as a integrated E&P player. RIL is also venturing into areas of
consumer retailing and urban infrastructure.
􀂄 Investment Theme
RIL’s strength lies in its ability to build businesses of global size and scale and execute
complex, time-critical, and capital-intensive projects, which will prove advantageous in
its huge plans in the E&P sector, organised retailing, and SEZ infrastructure. Also, there
could be a potential upward revision to our estimated in-place reserves. With its foray
into consumer retailing and SEZ infrastructure, we believe, it is an ideal company to play
the India story.
􀂄 Key Risks
RIL benefits from protected refinery margins in the Indian market ,due to duty
differential between products and crude. Reduction in the duty differential will be
negative for the company.
Rupee appreciation may impact negatively as RIL is positively leveraged to the
depreciating currency.
Slow down in global demand could impact RIL’s refining and chemical margins