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RIL: The show continues… - Views on News from Equitymaster
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RIL: The show continues…
Apr 27, 2007

Performance summary
Reliance Industries (RIL), the private sector refining behemoth, announced its 4QFY07 and FY07 results yesterday. The company has yet again delivered good set of numbers, which were largely driven by record high GRMs (Gross refining margins). For 4QFY07, the topline and the bottomline registered a growth of 6% YoY and 14% YoY respectively. On a full year basis, the growth in topline and bottomline was even higher at 30% YoY and 20% YoY respectively. While the operating margins expanded by 170 basis points for the quarter, the same were lower by 30 basis points for the complete year.

Financial snapshot…
Particulars 4QFY06 4QFY07 Change FY06 FY07 Change
Net sales 245,420 258,950 5.5% 812,110 1,053,630 29.7%
Expenditure 204,960 211,960 3.4% 669,120 871,530 30.3%
Operating profits(EBDITA) 40,460 46,990 16.1% 142,990 182,100 27.4%
EBDITA margins (%) 16.5% 18.1%   17.6% 17.3%  
Other income 870 850 -2.3% 6,830 1,930 -71.7%
Interest expenses 2,250 2,770 23.1% 8,770 11,140 27.0%
Depreciation 9,820 10,220 4.1% 34,010 40,090 17.9%
Profit before tax 29,260 34,850 19.1% 107,040 132,800 24.1%
Tax 4,240 6,320 49.1% 16,350 23,720 45.1%
Profit after tax 25,020 28,530 14.0% 90,690 109,080 20.3%
Net profit margins (%) 10.2% 11.0%   11.2% 10.4%  
No. of shares (m) 1,394 1,394   1,394 1,394  
Diluted EPS 17.9 20.5   65.1 78.2  
Price to earnings ratio*         20.4  
* Based on FY07 earnings.

What is 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 1,385 outlets out of permitted 5,849 outlets (FY07). It is also foraying the organized retailing of the merchandise, which offers great potential for growth.

What has driven the performance?
Growth across segments: Reliance has a revenue mix, where refining segment accounts for 66% of the gross revenues and the petrochemical segment contributes 32%. Revenues from the refining segment registered a growth of 21% YoY for the full year, however for 4QFY07, revenues declined by 1% YoY. During the quarter, RIL processed 8 million tonnes of crude, reflecting an average utilization of over 98%. For the full year, the refinery processed 32 million tonnes (increase of 4% YoY) of crude at average utilization of 96%. The utilization rates are favorable as compared to the operating rates of refineries globally. RIL’s refinery utilization would have been even better for the year but for the planned shutdown of the refinery and temporary stoppage of a part of its refinery facilities due to fire in October 2006.

Marketing plans of the company have taken a backseat owing to a lack of level playing field for private players. RIL currently had around 6.3% market share at the end of FY07. It had 1,385 outlets (addition of 46 outlets during the quarter) spread across the country, representing a network share of about 4%. Due to this lack of level playing field, RIL has shifted its focus to the export markets. Aggregate export volumes of refined products grew by over 63% YoY to 17.7 million tonnes, thus accounting for 57% of aggregate refinery product volumes. For 4QFY07, RIL exported 4.2 million tonnes of petroleum products and recorded export growth of 29% YoY (in volumes) and 63% YoY (in value).

Petrochemical segment revenues registered a growth of 21% YoY and 36% YoY for 4QFY07 and FY07 respectively. The petrochemical business has benefited from higher production from expanded capacities, strong demand from the end-user segments and better prices across the value chain. For the full year, the revenues were driven by 16% growth in prices and 20% increase in revenues.

Record refining margins, volumes propel petrochemicals: Operating margins expanded by 170 basis points during the quarter, while the same was subdued with a marginal decline of 30 basis points for the full year. Consumption of raw material increased 7.4% YoY and 36.8% YoY for 4QFY07 and FY07. The increase could be attributed to increase in the crude oil prices. Other expenditure, which includes conversion costs, selling expenses, sales tax, and excise duty on stock, registered a decline of 21% YoY and 7% YoY during 4QFY07 and FY07 respectively. The decline could largely be attributed to lower sales tax outgo due to surge in export volumes for the company. Staff cost increased by 43.7% YoY and 22.4% YoY for 4QFY07 and FY07 respectively. Increase could largely be attributed to performance linked incentives and increments. However, staff cost (1.1% of net sales in FY07) continues to be competitive vis-à-vis industry peers.

Expenditure break-up…
Particulars 4QFY06 4QFY07 Change FY06 FY07 Change
Consumption of raw material 171,790 184,530 7.4% 562,120 769,190 36.8%
as % of net sales 70.0% 71.3%   69.2% 73.0%  
Staff cost 2,150 3,090 43.7% 9,780 11,970 22.4%
as % of net sales 0.9% 1.2%   1.2% 1.1%  
Other expenditure 31,020 24,340 -21.5% 97,220 90,370 -7.0%
as % of net sales 12.6% 9.4%   12.0% 8.6%  
Total as % of net sales 83.5% 81.9%   82.4% 82.7%  

Refining segment continued with its strong show as company registered its highest ever GRM of US$ 13 per barrel for 4QFY07 (US$ 10.4 per barrel in 4QFY06), reflecting a premium of US$ 6.2 per barrel over benchmark Singapore crack margins. For the full year, the GRMs stood at US$ 11.7 per barrel compared to that of US$ 10.7 per barrel in FY06. The spread differential (premium) over the Singapore crack margins have historically ranged between US$ 3 to US$ 4 per barrel. However, the same has been higher over the last 2-3 quarters. The increase in the spread could be attributed to higher processing of sour crude, superior product mix, superior product placement in international markets and enhanced focus on export markets. Refining EBIT margins too improved from 8.2% to 10.8% in 4QFY07, registering an increase of 260 basis points. For the full year, EBIT margins improved from 8.3 %( in FY06) to 9% in FY07.

Refined performance…
Refining margins ( US$/ barrels) 4QFY06 FY06 4QFY07 FY07
Reliance industries 10.4 10.3 13 11.7
Singapore 4.6 6.5 6.8 6.1
US gulf coast 6.5 9.7 7.5 9.7
Rotterdam 5.0 6.7 4.1 6.7
Mediterranean 4.8 5.6 5.7 5.6

On the petrochemical front, higher input prices lead to reduction in the EBIT margins from 12.1% in 4QFY06 to 10.7% in 4QFY07. The same during FY07 stood at 12.8% compared to 13.8% in FY06. Within the petrochemical business, PE, PP witnessed improved margins while PTA, PVC and polyester products witnessed margins pressure. Polymer margins were at historical highs during second quarter primarily due to lower naphtha prices. During the second half of the year, the margins declined and remained weak due to softening of polymer prices and higher naphtha cost (an input for the petrochemical business). Contrary to polymer margins, polyester margins were weak during the first half of the year due to high input cost, however the same revived during the second half of the year with softening of the intermediate prices.

Segmental analysis…
Particulars 4QFY06 4QFY07 Change FY06 FY07 Change
Segmental sales            
Petrochemicals 88,200 106,700 21.0% 310,140 422,260 36.2%
Refining 212,480 210,690 -0.8% 711,170 860,090 20.9%
Others 5,220 6,610 26.6% 18,730 23,800 27.1%
Total gross revenues 305,900 324,000 5.9% 1,040,040 1,306,150 25.6%
Segmental EBIT            
Petrochemicals 10,650 11,370 6.8% 42,900 53,950 25.8%
Refining 17,410 22,770 30.8% 59,160 77,260 30.6%
Others 3,260 3,220 -1.2% 11,120 13,350 20.1%
Total EBIT 31,320 37,360 19.3% 113,180 144,560 27.7%

Bottomline strength continues: Lower investment surplus owing to investment of the same in RPL led to significant decline in the other income component for the year. Interest expenditure increased by 27% YoY and 23% YoY for FY07 and 4QFY07 respectively. Increase could be attributed to capitalization of interest, increase in borrowings and exchange rate fluctuations. Depreciation expenditure increased by 17.9% YoY in FY07 and 4.1% YoY for 4QFY07. In a nutshell, improved operating performance has helped the company to register a bottomline growth of 20% YoY and 14% YoY in FY07 and 4QFY07 respectively. Cash profit for the year increased by 20% YoY in FY07 and stood at Rs 157,680 m (US$ 3.63 bn).

Performance over the recent past…
Particulars 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07
Sales growth(YoY) 26.4% 24.5% 28.2% 2.3% 37.6% 37.9% 37.4% 45.7% 5.5%
Operating profit margins 19.9% 20.1% 17.9% 16.4% 16.5% 17.3% 16.0% 17.8% 18.1%
Net profit margins 12.8% 13.0% 12.0% 9.8% 10.2% 10.4% 9.5% 10.6% 11.0%
Net profit growth(YoY) 61.5% 60.8% 41.6% -15.1% 9.2% 10.3% 9.2% 57.6% 14.0%

What to expect?
At the current price of Rs 1,597, the stock is trading at a price to earnings multiple of 20.4 times its trailing twelve month earnings. RIL has applied and secured necessary approvals for the conversion of its Jamnagar complex as Export oriented unit (EOU). With this the tax rate of the company will continue to remain lower. This is a positive for the company especially considering the fact that domestic marketing activity of the company has taken a back seat with lack of level playing field.

Refining segment has yet again given positive surprises with higher premium spread to the benchmark Singapore margins. This is largely due to RIL’s product mix, which is tilted towards higher value added products such as MS and diesel (which currently has higher crack margins of these products). We expect the crack margins of these high ended products to remain strong, thus maintaining the increased spread between RIL’s GRMs and benchmark Singapore margins. RIL has also entered high growth aviation fuel segment. Company has established its aviation fueling station at five airports and is working at adding 12 more at different airports. The move is a positive for the company as it will improve the product mix further.

Merger of IPCL with RIL is going to be an EPS accretive one for RIL shareholders. The merger will also strengthen the business mix of RIL as it will lead to tax savings from inter-party transactions. It is also likely to improve the presence across the value chain for the company, which will help it to mitigate the downturn in the petrochemical cycle to an extent. RIL has also recently entered into a memorandum of understanding (MOU) with Rohm and Haas to explore the construction of acrylic monomer complex with an installed capacity 2, 00,000 tonnes per annum. Though the move is not likely to benefit the company immensely due to the small capacity size, we believe such steps are indicative of its foray into high margin downstream specialty polymers and chemicals. Also, the plans to establish a 2 MMTPA cracker at Jamnagar with a capex of US$ 3 bn with inputs from refinery plants will make it a cost efficient plant. Delays in the commissioning of new capacities in the Middle East is likely to ensure that margins in the segment decline more gradually than expected.

Company is also scaling up faster in its retail foray. It currently operates around 135 ‘Reliance Fresh’ outlets covering around 16 cities with a total square footage of over 3, 70,000. RIL has also recently launched its first consumer durable and IT pilot specialty store branded as ‘Reliance Digital’. However, given the lack of visibility along with infrastructural issues associated with scale makes us cautious in incorporating the benefits of the venture into our numbers.

On the upstream front, development efforts in the KG D6 block are on schedule for production in 2008. The preparation of development plan and fast track implementation of RIL’s oil discovery in KGD6 has also progressed well towards production in latter half of 2008. The company has had a big success in the exploration segment with discoveries in 30 of its 48 wells drilled (a success ratio of 63%). During the year, RIL drilled six exploratory wells and made four new discoveries (3 in KGD6 and 1 in NEC25). These discoveries have led to the addition of 172 MMBOE, taking aggregate proved drill bit reserves to 1,241 mmboe as on date. We can see further exploratory success for the company going forward, thus taking the total reserves even higher.

Funding of the upcoming retail venture and development of the gas fields, has been taken care of by preferential allotment of the share to the promoters at a price of Rs 1,402 per share along with an ECB of US$ 3 bn. With these arrangements and potential placement of treasury stocks going forward, the capex requirements are likely to be met with ease. With cash profits to the tune of US$ 3.8 bn and debt to equity ratio of 0.44 times, the funding risk is eased to a significant degree. However, the current rich valuation awarded to the stock largely factors in the positives from a medium term perspective.

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