Reliance Industries (RIL IN, INR 816, Buy)
Refining margins have soared recently by USD2/bbl due to unplanned large outages in refineries. While we expect moderation in refining margins as capacities come back, in the long term, we continue to remain positive on them as we believe that capacity closures will keep net capacity addition at 1.9 mbpd, lower than 2.3 mbpd demand surge. We like Reliance Industries (RIL) due to its high refining complexity, large planned capex in refining & petchem and earnings growth from investment in shale gas. Maintain ‘BUY’ with target price of INR906/share.
Unplanned outages spur refining margins
Fires, mostly in US and Japan, have led to unplanned closures of refineries of ~1.0 mbpd (1.2% of refining capacity). Most notable has been the closure of Richmond refinery in California (see table). These led to increase in product spreads and hence margins. Gasoline-Dubai and Diesel-Dubai spreads, which averaged USD14/bbl and USD 13/bbl, respectively, in Q1FY12, moved to USD19/bbl and USD18/bbl, respectively. Increase in product spreads led to USD2/bbl surge in Singapore GRMs.
Current rise temporary; positive on long-term margin
As refineries come back on line, refining margins are bound to moderate. Our readings on the outage are: (1) refineries like Richmond will be shut for around six months benefiting refiners like RIL, who can supply products to the strict Californian market; (2) sharp increase in refining margins reveals the fragility of industry supply chain; and (3) rising fires show the impact of ageing industry capacity. While we note that such temporary upsides will exist in future, we are also positive on refining margins from the long-term perspective. Our view emerges from estimated 3.2 mbpd closure of refining capacity in CY12-14, which will lead to net refining capacity addition of 1.9mbpd, much lower than demand growth of 2.3 mbpd.
Outlook and valuations: Positive; maintain ‘BUY’
We remain positive on refining and particularly RIL due to its ongoing capex in refining, petrochemicals and US shale. The company’s earnings are highly leveraged to refining margins and every USD1/bbl increase in GRMs increases PAT 9%. We estimate it to report Q2FY13 GRMs at USD8.5-9.0/bbl. Our FY13/14 base case assumes GRMs of USD8.5/9.0 per bbl. Maintain ‘BUY/Sector Outperformer’ on the stock.
Regards,
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