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Reliance: One-off effect on profitability - Views on News from Equitymaster
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Reliance: One-off effect on profitability
Jan 10, 2006

Performance summary
The third quarter performance of Reliance Industries, as expected, has been mired by the planned partial shutdown of its refinery during the months of October and November 2005. The resultant decline in operating days has impacted margins of the company. Despite this, the topline grew at a marginal rate of 2% YoY in 3QFY06 led by an over-20% increase in product prices. The decline in net profit is higher than operating profit owing to lower other income during the quarter and in the first nine months of the fiscal year as well.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 177,680 181,680 2.3% 482,120 566,690 17.5%
Expenditure 144,780 151,920 4.9% 389,470 464,160 19.2%
Operating profit (EBDITA) 32,900 29,760 -9.5% 92,650 102,530 10.7%
Operating profit margin (%) 18.5% 16.4%   19.2% 18.1%  
Other income 3,310 1,800 -45.6% 9,740 5,960 -38.8%
Interest 2,050 1,940 -5.4% 11,070 6,520 -41.1%
Depreciation 9,120 8,240 -9.6% 27,420 24,190 -11.8%
Profit before tax 25,040 21,380 -14.6% 63,900 77,780 21.7%
Tax 4,130 3,620 -12.3% 11,100 12,110 9.1%
Profit after tax/(loss) 20,910 17,760 -15.1% 52,800 65,670 24.4%
Net profit margin (%) 11.8% 9.8%   11.0% 11.6%  
Effective tax rate (%) 16.5% 16.9%   17.4% 15.6%  
No. of shares 1,396.4 1,393.4   1,396.4 1,393.4  
Diluted earnings per share* (Rs)         63.6  
P/E ratio (x)         14.1  
(*trailing twelve months)            

What is the company's business?
Reliance Industries is the country’s largest private sector company having interests across the hydrocarbons value chain. The company, along with its subsidiary, IPCL, controls over 70% of the country’s domestic polymer capacity. Further, the acquisition of the German company, Trevira, by Reliance makes it the largest polyester manufacturer in the world. The company also has interests in the upstream petroleum sector, whereby it has participating interests in existing oil and gas fields, while it is likely to begin commercial production from its Krishna Godavari fields in 2007. The fuel retailing venture is gaining momentum with the total number of outlets touching 1,000 at the end of December 2005.

Refining margins at record highs: As compared to the regional gross refining margins of around US$ 2 to 4 per barrel, Reliance's margins stood at US$ 10.3 per barrel in the first nine months of the fiscal year. Though refining margins softened marginally in the third quarter (US$ 9.4 per barrel), this is still higher on a YoY basis (more importantly, refining margins tend to be influenced by both global and regional developments, which highlights the inherent volatility). There was a 15.7% decline in crude throughput in 3QFY06 owing to the partial shutdown, which is a one-time hit. While this is the development on the refining division front, the petrochemical division continues to post impressive numbers. In 3QFY06, polyester filament yarn and polyester staple fibre combined volumes grew by 8% YoY, while polyester intermediary production was flat owing to the planned shutdown.

Expenditure table
(%) of sales 3QFY05 3QFY06 9mFY05 9mFY06
Consumption of raw materials 71.4% 73.5% 70.2% 74.3%
Staff cost 1.2% 1.4% 1.2% 1.3%
Other expenditure 7.9% 13.1% 9.2% 11.7%
Change in stock 0.9% -4.4% 0.2% -5.5%

Margins - A mixed bag: While a significant reason for the decline in margins could be the planned partial shutdown, the underlying weakness in demand for petroleum products, softer gross refinery margins and discounts on crude products cannot be understated. To put things in perspective, the overall demand for petro-products was higher only by 1.1% YoY in 9mFY06 with diesel sales actually declining by 0.6% YoY (accounts for around 30% of total sales). LPG sales also have been significantly weaker in 9mFY06 with industry volumes growing only by 1.1% YoY in 9mFY06. As mentioned earlier, gross refining margins were lower in 3QFY06 as compared to 9mFY06. Looking beyond this factor, while exact details with respect to discounts to PSU oil companies on crude and natural gas sales are unavailable, we believe that this is also a key factor that has contributed to the decline in PBIT margins of the refining division. As the company increases its retail presence (1,000 outlets by the end of 9mFY06), the overall margins of the refining division will come under pressure, given the regulated pricing scenario.

Other income suppresses profits: The company has mentioned in its press release that the decline in other income was on account of the company exercising its option to convert the preference shares of Reliance Infocomm with effect from April 2005. While this was partially offset by higher income from current investments, lower interest and depreciation charges also helped matters. If one considers the past eight quarter performance of the company (graphs above), the decline in net margins in 3QFY06 is higher than the fall in operating margin, highlighting the impact of lower other income. Excluding the other income component from both the quarters, the decline in net profit is below 10% YoY in 3QFY06. In our view, the loss on account of the shutdown can be recovered in the coming fiscal, even though margins could be lower.

What to expect?
At Rs 894, the stock is trading at a price to earnings multiple of 14.1 times trailing twelve months earnings. Overall, barring the shutdown and lower other income, the performance of the company is commendable. We had done a detailed analysis of the demerger. Please click on the link below to read the same.

  • Reliance demerger: Our view

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