Buy Reliance Industries - Gasoline spreads correct, but INR depreciation to provide support: Edelweiss

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Reliance Industries (RIL IN, INR 810, Buy)

Product spreads have corrected sharply of late, driven by gasoline spreads in particular. While this may impact refining margins in the second half of the year, we still see RIL’s GRMs for the full year not falling below USD 9/bbl. Also, the depreciation in INR will aid RIL’s earnings given that its businesses are USD denominated. Our sensitivity analysis of RIL’s EPS to lower refining margins and lower INR suggests a not more than 0‐3% risk to FY12 and FY13 earnings. We maintain our ‘BUY’ rating on the stock with a target price of INR 1,148.

Refining margins correct, driven by gasoline

Complex refining margins have seen a sharp correction recently, falling by nearly USD 3/bbl compared to Q2FY12. Restarting of refineries in Singapore and weaker than expected Asian gasoline demand growth have been the drivers behind this. Diesel demand remains strong though, rising by about USD 3/bbl compared to Q2FY12.

RIL’s margins will not fall as much

RIL’s GRMs have averaged USD 10.2/bbl in the first half of the year. Our proprietary model to predict RIL’s margins indicates that complex refining margins have come off by USD 3/bbl. Having said that, we believe the recent fall in margins is not a strict indicator of quarterly margins. Moreover, RIL being a diesel‐heavy refiner (~45% diesel output w/w) is impacted to a lesser extent compared to other global refiners.

INR depreciation will also provide cushion to RIL’s earnings

All of RIL’s business segments (E&P, refining and petrochemicals) are USD denominated. Our sensitivity analysis indicates that a 1% fall in INR will lead to a 1.5% rise in FY12 and FY13 EPS. We see low risk to RIL’s FY12/13 consensus earnings and  stress case GRMs may lead to a not more than 0-3% cut in FY12 and FY13 EPS. We maintain our BUY rating on the stock with a target price of INR1,148. At INR 810, the stock is trading at 11.3x FY12 earnings and 10.5x FY13 earnings.