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Reliance: Can it repeat its past? - Views on News from Equitymaster
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Reliance: Can it repeat its past?
Jul 20, 2006

Performance summary
Reliance Industries has declared its 1QFY07 results. Topline for the company registered a growth of 38% YoY. However, on the back on higher input cost, operating margins tumbled by 280 basis points. Other income fell by a significant 77% YoY on the back of lower surplus funds to deploy. This resulted in lower bottomline growth of 10% as against 61% YoY growth registered in the previous quarter.

(Rs. m) 1QFY06 1QFY07 Change
Net sales 177,840 245,220 37.9%
Expenditure 142,180 202,850 42.7%
Operating profit(EBDITA) 35,660 42,370 18.8%
EBDITA margins(%) 20.1% 17.3%
Other income 1,940 440 -77.3%
Interest expenses 2,370 2,660 12.2%
Depreciation 7,910 9,070 14.7%
Profit before tax 27,320 31,080 13.8%
Tax 4,220 5,610 32.9%
Profit after Tax 23,100 25,470 10.3%
Net profit margin(%) 13.0% 10.4%
No.of shares(m) 1,394 1,394
Diluted earnings per share 16.6 18.3
Price to earning ratio.(x)* 15.0
* Based on trailing twelve months earnings.

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 fibre 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 block 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 1,218 outlets out of permitted 5,849 outlets (FY06). It is also foraying the organised retailing of the merchandise, which offers great potential for growth.

What has driven performance in 1QFY07?
Growth across segments: RIL registered a growth in revenues across various operational segments. Petrochemical revenues saw a 47% rise (as against 3% growth in the previous quarter). Volumes drove the growth in petrochemical segment (backed by 17% increase in demand for polyester in the country) accompanied by marginal prices hikes. Refining segment registered 30% growth in revenues (as against 33% in the previous quarter). The Jamnagar refinery registered a 91% capacity utilisation (96% during the previous quarter). Lower capacity utilisation was due to the maintenance shutdown. Export of the manufactured products were Rs 132 bn, registering an increase of 86% YoY.

Margins under pressure: Margins for majority of petrochemical products were under pressure as compared to previous quarter due to higher input prices (consumption of raw materials increased by 45% YoY during the quarter). EBIT margins in the petrochemical segment were 11.1%; registering a decline of 210 basis points YoY. Refining segment witnessed margin pressure thereby registering a margin of 9.8% (11.1% during the preceding quarter).

Segmental results…
Segment 1QFY06 % of total 1QFY07 % of total
Petrochemicals 8,820 31% 10,870 38%
Refining 17,880 62% 20,350 70%
Others 2,190 8% 2,840 10%
Profit before interest and tax 28,890 34,060

Expenditure break up...
(Rs m) 1QFY06 1QFY07 Change
Consumption of
raw material
120,500 175,250 45.4%
as a % of sales 67.8% 71.5%
Staff Cost 2,530 3,180 25.7%
as a % of sales 1.4% 1.3%
Other expenditure 19,150 24,420 27.5%
as a % of sales 10.8% 10.0%
RPL effect: Other income during the quarter plunged by 79% on the account of decrease in interest income due to the utilization of surplus funds towards the RPL refinery (Reliance Petroleum limited, a subsidiary of RIL). Interest expenditure increased by 12% YoY due to increase in borrowing (up 7%) and exchange differences. Depreciation also increased due to capitalisation of certain assets. Thus, lower other income along with increase in interest expenditure and depreciation lead to contraction of net margins. Excluding the impact of other income, profit margins would have stood at 15.5% (assuming same tax rate).

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

What to expect?
At the current price of Rs 997, the stock is trading at a price to earnings multiple of 15 times trailing twelve months earnings. Margins in the petrochemical segment are going to be under pressure, given the inability to pass through the impact of input prices. Refining segment can witness robust gross refining margins (GRMs). This is due to the fact that demand for the petroleum products during the quarter grew by 7.7% YoY and is expect to remain strong. Moreover, benchmark Singapore margins during the quarter were US$ 8.9 per barrel as against US$ 7.12 per barrel in the previous quarter. However, some of the gains will be absorbed by discounts and losses on the marketing front. The company raised retail prices of petrol and diesel much ahead of the government, which has had a negative impact on marketing volumes (around Rs 2.5 per litre more than PSU marketing majors as far as petrol/diesel is concerned).

Meanwhile, Reliance is making a foray into organised retailing, which is one of the under-penetrated segment in the country. The company has tied up with suppliers for sourcing of agricultural products as well as addressing other supply chain related issues. While this initiative is likely to grow faster (provided execution risk is taken care of), we continue to remain concerned about the focus of the group. Apart from retailing, large-scale capital expenditure have been lined up towards establishing SEZs (special economic zones) and exploration. Amidst promising long-term prospects, at a consolidated level, profitability may come under pressure in the medium-term because of these investments. More importantly, as we have maintained in the past, transparency in operations is an issue, which has to be addressed by the management.

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