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RIL: Complexity and Petrochemicals - Views on News from Equitymaster

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RIL: Complexity and Petrochemicals
Jul 31, 2007

Performance summary
  • Topline increased by 14.4% in 1QFY08

  • Due to a relatively lower growth in expenditure at 12.8%, EBITDA grew by 22.2% over the corresponding quarter last year and margins were higher by 120 basis points

  • Other income swelled by 139% on the back of interest income on higher surplus funds

  • Bottomline registered a growth of 28.2%

Standalone Financial snapshot
(Rs m) 1QFY07 1QFY08 Change
Net sales 245,220 280,560 14.4%
Expenditure 202,850 228,790 12.8%
Operating profit (EBDITA) 42,370 51,770 22.2%
EBDITA margin (%) 17.3% 18.5%
Other income 440 1,050 138.6%
Interest (net) 2,660 2,880 8.3%
Depreciation 9,070 9,580 5.6%
Profit before tax 31,080 40,360 29.9%
Tax 5,610 7,720 37.6%
Profit after tax/(loss) 25,470 32,640 28.2%
Net profit margin (%) 10.4% 11.6%
No. of shares (m) 1,394 1,394
Diluted earnings per share (Rs)* 73.1 93.7
Price to earnings ratio (x)** 22.1
(* annualised, ** on trailing twelve months earnings)

What is the companyís business?
Reliance Industries (RIL) is the countryís largest private sector company having interests across the hydrocarbons value chain. 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. It also has exploration and production rights to 5 coal bed methane (CBM) blocks. It has recently followed up on its KG basin success with finds in the Cauvery basin. 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 yarn with a combined capacity of 2 million tonnes. The company also has a presence in the downstream-oil marketing segment. Itís mulling on plans to enter both power generation and fertilizers sectors, thereby completing the entire hydrocarbon value chain. In addition, it is foraying the organized retailing of the merchandise, which offers great potential for growth.

What has driven performance in 1QFY08?
Gross Refining Margins (GRMs): The GRMs for this quarter were $ 15.4 per barrel, up from $ 12.4 per barrel for the corresponding period last year. The differential in light and heavy margins has been growing in the past few quarters and is hovering around $5-5.5 per barrel currently. RIL benefits from the increasing differential as that allows the company to process an increased volume of heavy and sour crude at its high-complexity Jamnagar refinery. It processed 8.01 MT (million tonnes) of crude in 1QFY08, up by 7% YoY.

Moreover, the advantage of a coastal location and export-oriented production (given the shortage of refining capacity across the developed world) contributes to margins. Export of petroleum products also helps avoid the under-recoveries and subsidies bind, which plagues the PSU (public sector undertaking) oil marketing companies that cater to the domestic market. The company also manages its supply chain logistics with a sharp eye on economies of scale. For example, the containers used to bring in oil to Jamnagar are all VLCCs (Very Large Crude Carriers), which can handle upto 2 million barrels per consignment.

Profit Margins
(Rs m) Revenue Profit Margin
Petrochemicals 108,440 14,810 14%
Refining 227,940 25,580 11%

Petrochemicals realisations: The dark horse this quarter for oil & gas companies has been petrochemicals. Companies having a presence in the segment have benefited from the boost in margins in the segment. The general expectation was around 11% for 1QFY08; hence a 14% margin came as a pleasant surprise.

Revenue Mix
(Rs m) 1QFY07 1QFY08 Change
Petrochemicals 97,870 108,440 11%
Refining 208,620 227,940 9%

Costs: The increase in raw material costs is chiefly due to higher crude prices. Employee costs shot up by 17% on the back of hikes and performance-based incentives. The decrease in other expenditure is mainly on account of lowered sales tax given the higher export of refinery products this quarter vis-ŗ-vis same quarter last year.

Cost break-up
(Rs m) 1QFY07 1QFY08 Change
Raw materials 175,250 205,550 17.3%
% sales 71.5% 73.3%
Staff cost 3,180 3,710 16.7%
% sales 1.3% 1.3%
Other expenditure 24,420 19,530 -20.0%
% sales 10.0% 7.0%
Total cost 202,850 228,790 12.8%
% sales 82.7% 81.5%

What to expect?
At the current price of Rs 1,841, the stock is trading at a price to earnings multiple of 22.1 times its trailing 12 months earnings. The refining segment is expected to continue 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.

RILís share price has registered gains 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 complicated. The recent news of RIL entering into the power and fertilizers space also makes appraisal complex.

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 further upside to the current reserves as is evidenced from its recent success in the Cauvery basin (CY-DWN-2001/2). The companyís 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 once again make valuations difficult.

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