1. Neutral rating on Reliance Industries; Near-term refining headwinds building up

Neutral rating on Reliance Industries; Near-term refining headwinds building up

RJio to be positioned as end-to-end solution provider; rollout likely by December

By: | Updated: August 3, 2015 12:39 AM

Reliance Industries Ltd reported a consolidated net profit of Rs 62.2 bn (up 4.4% year-on-year and down 2.5% quarter-on-quarter), marginally lower than our and consensus earnings (Rs 63 bn). RIL also outlined its strategy in the telecom space, highlighting the focus on an ecosystem approach, rather than a simple voice/data offering. Refining performance remained robust, with GRMs (gross refining margins) at multi-year highs, with gasoline cracks strong.

Petrochemicals Ebit (earnings before interest and taxes) were 17% higher q-o-q with robust polymers, and an improvement in polyester intermediates. E&P (exploration and production) earnings were pressured, with the drop in commodity prices impacting the shale operations in particular. Ebitda was ahead of estimates with both refining and petchem strong.

The company, on telecom, highlighted two things: (i) launch before the end of the year; and (ii) total investments would be over Rs 100 bn with investments totalling Rs 92 bn (including deferred spectrum payment) already incurred. While refining had a strong Q1, cracks have come off sharply with benchmark GRMs also down.

Our commodities team highlights that Asian product demand is softening, while supplies remain elevated (new start ups, higher runs, higher Chinese exports). This would likely result in refining earnings falling q-o-q. The stock has had a sharp run up, but near-term headwinds on core refining are building up. Consolidated net debt rose to Rs 834 bn (from Rs 764 bn in Q4FY15), with Rs 320 bn of capex spends for the quarter.


Reliance Jio-Digital Ecosystem approach unveiled—not just a voice offering: RIL, for the first time, also had a section on the soon-to-be-launched telecom business. Post-the chairman’s comments in the annual general meeting, there was a detailed walk through RJio’s Digital ecosystem approach. There were also details on the infrastructure being put in place in RJio. Among other things, RJio highlighted that it is not positioning as another voice player but an end-to-end solution provider.

n Refining margins at six-year highs: RIL GRMs were at $10.4/bbl ($2.6/bbl—barrel—above Singapore benchmarks), the highest level in six years. Refining Ebit stood at Rs 52.5 bn. Strong demand and cracks (gasoline) and favourable crude differentials aided margins (narrowing of Brent-Dubai). RIL highlighted that while current margin levels may not be sustainable, given the capacity overhang in the market, demand growth continues to surprise on the upside (it expects 1.4-1.6m bopd-barrels of oil per day—in 2015/16), and refinery closures (Asia-Pacific and Europe) will help balance the market.

n Gasoline cracks robust, gasoil likely to remain soft until the winter: Gasoline cracks were strong, driven by high demand (demand up 592kbopd YTD, driven by the US, China and India), while pre-Ramadan buying boosted Asian demand as well. Refinery turnarounds, along with slower ramp up of some new capacities, also aided cracks. Some of this strength has receded as capacities come back on stream, and demand moderates. Gasoil was weaker, with increased supplies from new capacities, elevated European refinery runs and higher Chinese exports.

n Polymer deltas high, polyester a mixed bag: Polymer deltas strengthened, with both PP and PE (polypropylene and polyethylene) above five-year averages, and firm domestic demand, cracker turnarounds and low oil prices aiding Asian cracker competitiveness. As maintenance turnarounds end, margins could see moderation, however, delays to CTO/MTO (coal/methanol to olefins) projects are a positive. Polyester intermediate (PX, PTAs—paraxylene/purified terephthalic acid) deltas staged a recovery during the quarter, with unplanned shutdowns in the region. Yarn/fibre deltas were compressed with the rise in intermediate prices, and relatively modest demand growth limiting overall chain margin growth. The company does expect demand to improve heading into H2FY16.

E&P sharply lower on falling commodity prices: Shale operations were impacted by lower commodity prices, reporting an Ebit loss of Rs 490 mn. The company is scaling back drilling operations, and focusing on high yield plays within its acreages to improve profitability, with capex likely to be $800-900m a year over the next two years. Domestic upstream profitability was lower, with gas prices revised downwards, and lower crude realisations. DD&A (depletion, depreciation and amortisation) costs were higher, with de-booking of some reserves. D6 output was 11.5mmscmd (million metric standard cubic metre per day).

* Movement on domestic E&P regulatory issues: RIL has received government approval to carry out DSTs (drill stem tests) on discoveries pending a declaration of commerciality. DSTs will be carried out on discoveries in the D6 and NEC-25 blocks. Work-over, side-tracks continue in the D1-D3 area, with the near-term aim of maintaining output levels.

* Telecom ecosystem—seen as a large untapped opportunity: The company highlighted the opportunity in the digital space in India, with low internet penetration rates, despite having one of the largest internet user bases globally. With growth in incomes, and a rise in the middle-class population, the potential to increase revenues per user is significant (adjusted for inflation and real increases, ARPUs—average revenue per user—are at R627, the same level as 2008). The company stressed that it remains focused on offering a bouquet of services built around the telecom platform (payments, movies/TV, etc.) to drive revenues.

* User uptake rate could be rapid: The company highlighted that user uptake for LTE (long term evolution, broadband tech) services has seen a sharp move upward in other markets, with 16m users added in China every month, and monthly traffic also growing very rapidly. An easing of hardware constraints, with devices now available for <$65, along with rapid improvements in VoLTE (voice over LTE) call interconnect quality, has also aided penetration.

* Key infrastructure build out complete; Dec roll out targeted: The company aims to roll services out by the year end (aiming to cover 80% of the population at launch), with beta testing now underway. A significant portion of infrastructure is in place, with over 75000 eNodeB towers at launch (approx. 30,000 owned). These towers use electricity, with battery back-up, thus reducing operating costs. A significant fibre network ensures that in many areas, ‘small cells’ will be sufficient, reducing the extent of towers required. The company also highlighted that customer acquisition costs are usually under.65% of first month ARPU—the company is aiming to reduce this using online channels for on-boarding, etc.

* Retail—steady growth continues; e-commerce roll out to begin: Retail revenues were up 18% y-o-y, with Ebitda margins at 4.3%. LFL (like-for-like) growth across formats was 13%, with private label sales rising at a healthy rate. RIL plans to roll out e-commerce initiatives over the coming months, with pilot programmes now underway.

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