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Reliance Industries: A well-refined performance! - Views on News from Equitymaster
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Reliance Industries: A well-refined performance!
Jan 19, 2007

Performance summary
Riding on the back of firm petrochemical prices and record high GRMs, Reliance Industries, India’s largest private sector refining major, has declared good set of numbers for the third quarter and nine months ended December 2006. While the topline and bottomline grew by 46% and 58% YoY respectively during 3QFY07, the same stood at 40% and 23% YoY for the nine months ended Dec 2007. However, it should also be borne in mind that the numbers for the quarter are not strictly comparable owing to a maintenance shut down of its Jamnagar refinery during 3QFY06.

Financial snapshot…
(Rs. m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 181,680 264,720 45.7% 566,690 794,680 40.2%
Expenditure 151,920 217,630 43.3% 464,160 659,570 42.1%
Operating profit(EBDITA) 29,760 47,090 58.2% 102,530 135,110 31.8%
EBDITA margins(%) 16.4% 17.8%   18.1% 17.0%  
Other income 1,800 420 -76.7% 5,960 1,080 -81.9%
Interest expenses 1,940 2,930 51.0% 6,520 8,370 28.4%
Depreciation 8,240 10,620 28.9% 24,190 29,870 23.5%
Profit before tax 21,380 33,960 58.8% 77,780 97,950 25.9%
Tax 3,620 5,970 64.9% 12,110 17,400 43.7%
Profit after Tax 17,760 27,990 57.6% 65,670 80,550 22.7%
Net profit margin(%) 9.8% 10.6%   11.6% 10.1%  
No.of shares(m) 1,394 1,394   1,394 1,394  
Diluted earnings per share 12.7 20.1   47.1 57.8  
Price to earning ratio         17.8  

What is the company’s business?
Reliance Industries (RIL) is the country’s largest private sector company having interests across the hydrocarbons value chain. The company has a 26% share of the total refining capacity in India and along with its subsidiary, IPCL, controls over 70% of the country's domestic polymer capacity. RIL is also a major player in the polyester fiber and year with a combined capacity of 2 million tonnes RIL has also ventured into the upstream sector, whereby it has participating interests in existing oil and gas fields. RIL is the largest exploration acreage holder in the country with 34 domestic exploration blocks in addition to 1 exploration blocks each in Yemen and Oman. RIL also has exploration and production rights to 5 coal bed methane (CBM) blocks. The company also has a presence in the downstream segment and has commissioned 1,339 outlets out of permitted 5,849 outlets (FY06). It is also foraying the organized retailing of the merchandise, which offers great potential for growth.

What has driven the performance?
Growth across all segments: As far as the revenue mix of Reliance is concerned, the refining operations accounted for 64% of the gross revenues, petrochemicals accounted for 34% and ‘others’ accounted for the remaining 2%.

Refining segment registered a stellar growth of 37% YoY and 30% YoY during 3QFY07 and 9mFY07 respectively. RIL’s refinery processed 23.6 MT of crude during 9mFY07, registering a capacity utilisation of 95% during the said period. For the nine months ended December 2006, the increase in revenue was driven by 18% YoY increase in realisations and 12% YoY increase in volumes. RIL’s share in the retail business has grown from 2% (decline from 13% due to pricing difference vis-à-vis peers) to 6%. During 9mFY07, export of refined products was worth US$ 8.3 bn accounting for 76% of the total exports.

Petrochemical segment revenues registered a growth of 48% YoY and 42% YoY during the period 3QFY07 and 9mFY07. The nine-month revenues were driven by 24% increase in volumes and 18% increase in realisations. During 3QFY07, RIL production of petrochemical products increased by 34% YoY.

Robust refining margins, petrochemical volume kicker: Operating margins for RIL registered a 140 basis point increase in 3QFY07, while the same contracted by 110 basis points during 9mFY07. During 3QFY07 and 9mFY07, consumption of raw material increased by 54% YoY and 50% YoY respectively on the back of higher input cost (majorly crude oil prices). Increase in employee costs was on account of performance linked incentives and increments. Other expenditure, which includes conversion costs, selling expenses, sales tax, excise duty on stock registered a significant decline of 14% YoY for 3QFY07. The decline could be attributed to decline in prices of chemicals used for processing the crude and reduced selling expenses for export (due to higher expenditure in 2QFY07).

Expenditure break-up…
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Consumption of raw material 125,530 194,290 54.8% 390,330 584,660 49.8%
as a % of sales 69.1% 73.4%   68.9% 73.6%  
Staff Cost 2,510 2,860 13.9% 7,630 8,880 16.4%
as a % of sales 1.4% 1.1%   1.3% 1.1%  
Other expenditure 23,880 20,480 -14.2% 66,200 66,030 -0.3%
as a % of sales 13.1% 7.7%   11.7% 8.3%  

Refining segment delivered robust set of numbers during 3QFY07. GRMs, a barometer of the refining performance, jumped to its highest ever levels of US$ 11.3 per barrel compared to US$ 9.1 per barrel during the same period last year. The superior GRMs could be attributed to following reasons

  • Increased processing of heavy crude: Given the price differential between light and heavy crude (US$ 4 to 5 per barrel), the increased processing of heavy crude has improved the performance of the refining segment. Heavy crude as a % of the total crude has increased from 58% (in 3QFY06) to 62% (in 3QFY07).

  • Superior product mix: With the recent cooling of the crude oil prices, the product crack (the difference between price of petroleum product and crude oil) has also reduced. However, the reduction has been relatively lower for high value added products such as LPG, ATF and HSD. By producing more of these high valued added products owing to the higher complexity of its refinery, Reliance has been able to boost its GRMs further.

  • Decline in chemical prices: We believe significant reduction in the other expenditure during the current quarter was on the back of reduced processing cost. Processing chemicals prices have eased to an extent, bolstering GRMs in the process.

Management has said that refining margins were optimized through better product placement globally, which might be due to its association with Chevron.

Backed by higher GRMs, the EBIT margins in the refining segment improved 610 basis points during 3QFY07.

On the petrochemicals front, higher input prices (crude oil) lead to reduction in the EBIT margins from 14.5% in 3QFY06 to 12.9% in 3QFY07. Increase in the capacity addition is expected to increase volumes and is thereby expected to drive EBIT in the future.

Segmental analysis…
Particulars 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Segmental sales
Petrochemicals 73,530 108,950 48.2% 221,940 315,560 42.2%
Refining 151,790 208,700 37.5% 498,690 649,400 30.2%
Others 4,970 6,340 27.6% 13,510 17,190 27.2%
Total gross revenues 230,290 323,990 40.7% 734,140 982,150 33.8%
Segmental EBIT
Petrochemicals 10,640 14,070 32.2% 32,250 42,580 32.0%
EBIT margins 14.5% 12.9%   14.5% 13.5%  
Refining 8,560 19,250 124.9% 41,750 59,160 41.7%
EBIT margins 11.6% 17.7%   18.8% 18.7%  
Others 3,200 3,640 13.8% 7,860 11,120 41.5%
EBIT margins 4.4% 3.3%   3.5% 3.5%  
Total EBIT 22,400 36,960 65.0% 81,860 112,860 37.9%

Robust bottomline growth: Lower investment surplus owing to investment of the same in RPL (Reliance Petroleum limited), lead to significant decline in the other income component. Interest expenditure increased by 51% YoY and 28% YoY for 3QFY07 and 9mFY07 respectively. Increase could be attributed to increase in the borrowings and exchange rate fluctuations. Depreciation expenditure also increased by 29% YoY during the quarter and 24% YoY during nine months ended December 2006. In a nutshell, superior operating performance has helped the company to register a bottomline growth of 58% YoY and 23% YoY for 3QFY07 and 9mFY07 respectively.

Performance over the recent past…
(Rs m) 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07
Sales growth(%, YoY) 26.4% 24.5% 28.2% 2.3% 37.6% 37.9% 37.4% 45.7%
Operating profit margins 19.9% 20.1% 17.9% 16.4% 16.5% 17.3% 16.0% 17.8%
Net profit margins 12.8% 13.0% 12.0% 9.8% 10.2% 10.4% 9.5% 10.6%
Net profit growth(YoY) 61.5% 60.8% 41.6% -15.1% 9.2% 10.3% 9.2% 57.6%

What to expect?
At the current price of Rs 1,380, the stock is trading at a price to earnings multiple of 17.9 times its annualised 3QFY07 earnings. The refining segment is expected to deliver robust GRMs on the back of superior product mix and complex refinery configuration. On the petrochemical front, margins are going to reduce gradually with increased capacities globally, however with lower per capita consumption in the domestic markets coupled with a booming economy, higher volumes are going to propel the petrochemical EBIT.

RIL’s share price has registered significant gain post the de-merger. These gains were on the back of positive news flows in the new ventures such as exploration and development and retailing. However, the value of the current business seems to be fairly factored into the valuation. Thus, we believe focus has now significantly shifted to execution of the new ventures. RIL has a proven track record and superior execution capabilities. However, the nature of the execution risk in the new ventures is different from what the company has faced in the past.

In the upcoming retailing venture, the lack of visibility in terms of business model and revenues from the venture makes the valuation difficult. On the exploration segment, KG basin has proved to be a world-class oil and gas field for the country. Reliance, being one of the major operators active in the area, is set to benefit from the same. There exists immense potential regarding the futher upside to the current reserves. The company’s Sohagpur East and West blocks are considered as world class CBM blocks. However, in the upstream segment, lack of clarity regarding the size of potential reserves along with issue in commercialization of the large-scale CBM blocks does once again make valuations difficult.

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