GRMs below estimates, petrochem strong

Reliance Industries? reported Ebitda of Rs 91.4 billion, which was marginally lower than our estimate of Rs 94.6 billion (up 68% YoY and up 16% QoQ) led by lower GRM and lower E&P profitability. Q4FY10 PAT was Rs 47.1 bn (vs our estimate of Rs 48.6 bn), up 22% YoY and up 18% QoQ. RIL?s Q4FY10 reported numbers include RPL financials. So YoY numbers are not comparable on a reported basis.

Key highlights: Net debt fell significantly sequentially from Rs 540 bn to Rs 406 bn (gross debt of Rs 625 bn and cash of Rs 219 bn). But, RIL?s current liabilities increased from Rs 210 bn in FY08 to Rs 327 bn inFY09 largely due to higher payables because of capex. In FY10 the current liabilities increased to Rs 368 bn, indicating a likely increase in payables towards capex. The effective tax rate was sequentially lower at 20% from 22.2% in Q3FY10 due to higher profits from its new refinery in a tax-free SEZ.

RIL raised Rs 61 bn in January 2010 through the sale of treasury shares in two tranches. RIL sold treasury shares totalling Rs 93 bn since September 2009 in three tranches. Now treasury shares are reduced to 9.4% of its outstanding equity.

Premium over Singapore is the lowest in 18 quarters: Reported GRM was lower than our estimate at $7.5/bbl (vs our estimate of $8/bbl) against $9.9/bbl in Q4FY09 and $5.9/bbl in Q3FY10. It was at a premium over the benchmark Singapore GRM, which was $2.5/bbl (the lowest in the past 18 quarters) vs $4.4/bbl in Q4FY09 and $4/bbl in Q3FY10. Though the new refinery contributed to refinery segment profits, Ebit was up only 2% YoY (44% QoQ) at Rs 19.9 bn led by 24%YoY drop in GRM. Though GRM was marginally lower than our estimate, absolute Ebit was much lower at Rs 19.9 bn (vs our estimate of Rs 23 bn). We believe this could be because of higher operating costs and expiry of sales tax deferral benefit.

Our refining outlook: We expect refining margins to remain subdued due to new refinery start-ups, and average operating rates of sub-85% worldwide. Of the world refining capacity of 88.6mmbbl/d (2008), almost 1.6mmbbl/d (2% of total) shut down and more capacity is expected to close down. However, new refining capacity of an equal amount (1.6mmbbl/d) was commissioned in 2009, negating the effect of the closures. Besides, additional capacity of 1mmbbl/d a year is expected to be added through 2014. Given RIL?s cost advantage ($2/bbl over US refiners), it will at least be able to maintain its utilisation lof >95%, albeit at subdued margins. We model a GRM of $7.6/bbl in FY11 and $8.5/bbl in FY12.

Petrochemicals: RIL?s petrochem margins improved sequentially to 14.4% (vs 13.9% in Q3FY10). Sequential growth in margins was led by higher product margins in polymers and polyesters, along with continued 100% utilisation and low inventory days (7-8 days).

In FY10, domestic demand for polymers rose 19% and polyester/intermediates was up 15%. E&P: E&P Ebit margin continued to fall, led by higher depletion and stood at 39.4% against 64.3% in Q4FY09 and 41.8% in Q3FY10. The management indicated that higher depreciation/ depletion costs of KG-D6 resulted in lower profitability and it expects margins to increase as KG-D6 volumes ramp-up.

RIL reported E&P Ebit (KG-D6 and PMT) of Rs 17 bn (vs our estimate of Rs 18 bn). KG-D6 gas volumes averaged 60 mmscmd in 4QFY10 and a further increase remains contingent on GAIL. GAIL indicated that additional capacity of 5 mmscmd in April 2010 and 10 in October 2010 would be available. Our FY11volume assumption of 70 mmscmd for KG-D6 is in line with this debottlenecking schedule.

Valuation: RIL drilled 26 exploration/appraisal wells in FY10 (15 offshore, 11 onshore) and it plans to drill six exploration wells in FY11. The management is upbeat about the GRM outlook and expects FY11 to be better than FY10 despite new refinery start-ups due to expectations of closures of suboptimal refineries and its expectations of the petchem margin scenario to be stable due to delays/cost overruns in the new large ME capacities. We model a GRM of $7.6/bbl in FY11 and do not expect upgrades.

Key factors to watch for in the near term are: Resolution of RIL?s court cases with RNRL and NTPC; ramp-up of KG-D6 gas; and deployment of its increasing cash on the balance sheet.

Adjusted for treasury shares, RIL trades at 12.4x FY12E adjusted EPS of Rs 87.9. Our SOTP-based price for RIL is Rs 1,133 (including upside potential of Rs 205/share). Maintain Buy.