Reliance Industries Ltd (RIL) reported GRMs (gross refining margins) of $7.3/bbl in Q1FY11 against $7.5/bbl in Q1FY10 and Q4 FY10. The GRMs were slightly better than our estimates of $7/bbl. During the quarter, RIL?s GRMs were two times the benchmark Singapore GRMs as against 1.8x in Q1FY10. The improvement was supported by a sharp rise in gasoline spreads and better crude mix management by the company. The two refineries processed 16.9 million tonnes of crude. Revenue for the segment more than doubled on a YoY (year-on-year) basis due to higher volumes arising from RPL refinery and better realisations. The Ebit (earnings before interest and taxes) margins for the segment was at 4% v/s 4.4% in Q1FY10 on account of higher depreciation and a tad lower GRMs.
Outlook for GRMs and RIL: Globally, GRMs have remained weak for the past six quarters on the back of the sharp economic downturn caused by the financial crisis. This translated into the closure of about 1.4 mbpd refining capacity based on poor economic viability as against the addition of 1.2 mbpd of new capacity. Of late, there have been signs of a strong demand recovery backed by the rising demand from India and China. The drivers for the growth have been a robust increase in automobile volumes and increasing industrial activity. Recently, developed countries such as the US are witnessing a strong demand on the back of the improving economic scenario. Over the next few years, significant capacity additions have been lined up, especially in China and the Middle East. Any delay in these capacity additions could provide some relief to the falling trend in margins.
Petrochemical segment: During Q1FY11, revenues from the petrochemical segment rose by 20% YoY. The growth was on account of higher product prices and higher Polypropylene (PP) production from the SEZ. Ebit margins for the segment fell 326 basis points YoY but rose 20 basis points QoQ . The fall was on the back of falling spreads across product categories.
Outlook for the petrochemical segment: Following strong recovery in demand from India and China, product prices have witnessed a substantial rise. However, capacity addition is expected to surpass incremental demand in the near term. New capacities are based on low-cost gas, which will further put pressure on margins. Closure of select plants in Japan and Europe would provide some support to the falling spreads. The polyester chain would continue to be better off with prevailing high prices of cotton on the back of declining acreage in the domestic market. Integrated players such as RIL would continue to post a relatively better performance.
E&P (exploration & production) segment: Scaling up gas production from KG-D6 field has been the top priority for RIL during the past four quarters. The company is currently producing about 60 mmscmd. However, future scale up to 80 mmscmd is in question because of: (i) the management?s guidance of not being able to scale up production beyond 60 mmscmd (as reported by media) and (ii) completion of capacity expansion of GAIL?s HVJ pipeline. Furthermore, offtake from few customers has not been in line with the quantity allocated to them. The company has ramped up production of oil from the field and is currently producing 30,000 bopd. The company is awaiting regulatory approval for the development of satellite fields. Hydrocarbon production from the Panna-Mukta field remained flat while gas production from the Tapti field continues to decline.
Higher depreciation and interest restrict PAT (profit after tax) growth: For Q1FY11, RIL reported 33.4% YoY rise in pre-exceptional PAT compared with the 57.8% YoY jump in operating profits. The performance impacted at the PAT level on account of higher depletion charge in the oil & gas segment and increased depreciation for the refining segment. Furthermore, interest expense was higher by 56.8% on account of lower yields.
Deployment of cash will be keenly watched: Over the last one year, RIL stock has underperformed Sensex by 9.2%. With the uncertainty on the RNRL-RIL case now over, deployment of its Rs 26,400 crore cash would be keenly watched. Though it will not impact near-term earnings, a negative outcome on the tax holiday dispute on KG-D6 by the tribunal will leave a substantial impact on valuations. However, the company believes that under the PSC (product sharing contract), it is eligible for the tax holiday. We have not factored any of these issues into our earnings or SOTP (sum-of-the-parts) valuation for RIL, but have factored in value for its two shale gas JVs. We maintain our Market Performer rating on the stock with a target price of Rs 1,139.