RIL: Can't escape cyclicality - Views on News from Equitymaster

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RIL: Can't escape cyclicality

Jul 26, 2001

Since start of the calendar year the Reliance Industries Ltd (RIL) scrip has declined by 8.2%. Over the same period the benchmark index, Sensex, fell by 15.7 %. Over the past few weeks the stock has come under further pressure.The RIL scrip seems to be out of favour due to weakening of the petrochemical cycle. After the Asian crisis and global financial meltdown the cycle bottomed out in FY99 and staged a recovery over the next two years. However, the cycle has once again dipped (though not expected to drop to the same extent) with the global economy decelerating over the past seven months and engulfing most of the OECD nations (Organisation for Economic Co-operation & Development). This has led to softening of international commodity prices, including polyester & polymers, as demand slackens and inventories are built up.

Being signatories of the WTO, petrochemical import tariffs have been reducing over the past few years, which are to be reduced to WTO bound levels (basic import duty on polyester & polyester intermediates - 20%, polymer & polymer intermediates - 35%). Tariffs on polyesters are at WTO bound levels but polymers could witness further correction in import duties over the next few years. Having said that, the lower duties has increased the linkage between international and domestic petrochemical product prices and reduced the leeway available to domestic manufacturers to differ adjustment in prices. Consequently, domestic manufacturers could face pressure on realizations from lower international prices.

Added to that, the challenging international business environment, could impact exports (sales volumes) of domestic manufacturers. Manufactured exports, reported by RIL, in FY01 stood at Rs 29.6 bn ($635 m), which represents 11.5% of sales adjusted for merchant exports. RIL has reported exports of Rs 7.5 bn in 1QFY02, which is 9.9% lower compared to the same period of the previous fiscal (FY01 - Rs 8.3 bn). In dollar terms the decline is even lower considering the depreciation of the rupee. Decline in dollar terms is estimated to be 14.2%.

Utilisation rates
 1QFY02
Plastics110%
Polyester 95%
Fibre Int.*105%
Aggregate103%
* Fibre Intermediates
Domestic sales of RIL, consequently, represent 88.5% of turnover. On the domestic front too brakes have been applied on economic growth momentum. As per the Central Statistical Organisation (CSO) revised estimates, GDP growth in FY01 was 5.2% as compared to the earlier projections of 5.8%. Much of this slowdown was witnessed in 4QFY01, which has resulted in the malaise spilling into the new fiscal and a recovery expected only in the second half of FY02. In fact, as per recent reports, core sector growth (six key infrastructure industries) slipped to 1% for 1QFY02 compared to 9.3% in 1QFY01. The lower growth could weigh down on domestic demand leading to challenging operating environment for realizing volume growth. Interestingly, RIL has reported a 7% rise in production for 1QFY02 from 2.6 MMTPA (m metric tonnes per annum) to 2.8 MMTPA. The company operated above full capacity at 103% for the concerned period.

Adding to the pressure on volume growth, RIL has reported a drop in market share for polymers and polyester intermediates. The stabilization of operations at Haldia Petrochemicals Ltd. and the subsequent filling up of capacity could have eaten into the polymer market share, especially in the Eastern region. Competition in polyester intermediates, PTA (purified terephthalic acid), has intensified with the Mitsubishi plant ramping up utilization rates.

The increase in supply from new players and a corresponding softening in domestic demand has lead to an imbalance in the demand - supply situation. Domestic petrochemical prices, which are closely linked to the demand - supply variable, are facing downward pressure.

Corroborating this view is the performance reported by IPCL for 1QFY02. Sales for the concerned quarter rose marginally by 3% YoY, while the net profit dipped by 64.2% in this period. This could reflect significant pressure on the operating margins. The company has stated weakness in domestic and international product prices (polymers contributed approximately 72.4% to IPCL's topline). Adding to the woes, are the higher feedstock prices including naphtha, due to firm crude oil markets. All these factors portend a gloomy picture for RIL's revenues and operating margins in FY02.

The RIL scrip has been declining since the end of May '01 from a high of Rs 404. Technically, also the counter is looking weak with support at Rs 290. Breaking this level the stock has a sharp drop in support levels in the region of Rs 200. Not adjusting for foreign exchange gains in FY01 we have estimated operating profits to decline by 5.8% and PAT by 5%. However, factoring a swing in the cycle from FY02 onwards the company seems to enjoy significant earnings growth with strong cash flows.


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