Reliance Industries: On track to recovery; Rating 'Outperform'

Updated: Jul 28 2014, 16:40pm hrs
Reliance IndustriesRIL reported a 6% year-on-year growth in standalone profit after tax to Rs 56.5 bn.
Q1 result highlights

* RIL reported a 6% year-on-year growth in standalone profit after tax to Rs 56.5 bn (estimate of R54.4 bn). Consolidated earnings (reported for the first time quarterly) were at R59.6 bn, growth of 14% y-o-y, led by US shale and retail turnaround.

* Refining margins at $8.7/bbl marginally beat est of $8.6/bbl, driving Ebit of R37.7 bn (+28% y-o-y, 3% above the rest) But petchem disappointed with Ebit of R18.9 bn (-10% quarter-on-quarter) well below estimates.

* Ebitda (earnings before interest, taxes, depreciation, and amortisation) at R75.3 bn, came in 11% below estimates. A sharp increase in other opex (operating expenses) due to a one-time increase in fuel and power expenses drove this miss. We believe opex would moderate to normative levels over the rest of FY15e.

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* KG D6 volumes at 13 mmscmd (million metric standard cubic metre per day), -15% y-o-y. Improvement q-o-q in E&P (exploration and production) Ebit was led by a 16% y-o-y increase in PMT (Panna-Mukta & Tapti) oil volumesuptick from infill wells on the block, expected to sustain at higher levels over next two years)

Refining Middle distillates under pressure, Light distillates steady: Despite a slowdown in global supply additions and the recovery in the USA, refining margins remain subdued, with (i) rising exports from the USA, which has ramped up refining throughput in view of cheap feed stock (ii) muted demand growth in emerging economies as well as western Europe and (iii) gradual ramp up of additional refining capacity in the Middle East, which were commissioned in earlier years but are getting fully synchronised only now. This has led to a pressure on middle distillates, as diesel exports have ramped up from the US and Middle East into Europe, while a gradual reduction in subsidy in India and slower demand from China has depressed Diesel consumption in Asia.

Petchempace of capacity additions moderating but demand growth tepid: The petrochemical segment has seen divergent trends over the last few quarters, with steady polymer/ plastic spreads being offset by weakening spreads in the polyester segment. This quarter has been no different, with q-o-q increase in spreads for PE and PP (polyethylene and polypropylene), which were offset by very weak spreads across the polyester chain. Despite relatively better spreads, polymer demand domestically remains weak owing to weak demand in key consuming sectors of automobiles, construction, etc. We believe that margins from this segment will remain muted over the medium term.

Petchem spreads globally have been muted for much of the last three years, and we do not see that changing over FY15/16e. However, the estimates of capacity additions are seeing downgrades, with latest estimates of global capacity upgrades for CY13/14e seeing downgrades from earlier forecasts. We remain conservative on margins for the next two years.

A look at Ebit trends clearly reflects the predominance of the downstream business segment in the overall business of RIL. The rapid decline in E&P volumes over the last few quarters has meant that the relative importance of upstream in overall business.

E&Pgas price notification the key: There was momentum in RIL's exploratory activity and upstream business over the past year, with success on the MJ1 exploratory well (two appraisal wells completed) and approvals for well work-over on the MA field. Also, news reports indicate the government might allow RIL to retain three discoveries (D29, 30,31) that have been held up for development due to DGH (upstream regulator) not allowing extension sought by RIL to conduct further drill stem tests. However, all these, along with the companys plans to develop the R Series/Satellite fields, are contingent on a higher gas price for the fields, the level and modalities of which has become uncertain post the deferment of a decision by the oil ministry. We believe that RIL will not invest meaningfully in the newer assets before the actual gas price is intimated to it, so expect further momentum only post Q2FY15 on this segment.

Shale gas: gaining material scale: Volumes from the shale gas business (net to RIL) increased 27% y-o-y and 10% q-o-q, due to more aggressive fracking at Pioneer JV and higher volumes from the Chevron JV. Muted gas prices q-o-q, coupled with flat NGL (natural gas liquids)/condensate prices meant that revenue/Ebitda from this segment was flat on a q-o-q basis. We value the segment at R60/share or $2.9 bn.

Valuations & view: RIL remains on track to reverse the last three years track record of stagnant earnings and moderating return ratios over FY15-17e, via the $12 bn downstream expansion and improving regulatory environment. RIL now trades at attractive multiples of 12x EPS and 8.5x FY16e Ebitda. Reiterate Outperformer

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