Reliance Industries, India’s leading private sector diversified hydrocarbons major, has witnessed gains of nearly 12% on the stock exchanges during the last quarter. However, it should be noted that during the same period, the BSE Sensex has gained 11%. In this article, we take a look at the factors that led to the gains in Reliance Industries.
Strong refining margins: High crude oil prices, supported by firm petroleum product prices in the international markets have resulted in better than expected refining margins with gains ranging between US$ 8 to US$ 11 per barrel during the quarter. Further, Reliance’s petrochemicals business is also witnessing an uptrend in prices as global demand is on the rise. The earlier loss in profits on account of exports of petroleum products (as domestic prices are higher) has been mitigated to an extent by firm product prices in the international markets, thereby resulting in better margins in exports.
Better capacity utilization: The last few months have seen firm product prices (petrochemicals and petroleum products). Since most of the raw material cost is a pass through for the refiners, strong prices have resulted in better margins for these companies. Riding high on this uptrend and the refineries’ flexibility, we believe Reliance could witness major gains during the current fiscal. As per the petroleum ministry, almost all the refineries operated at more than their rated capacity.
Giving exploration a boost: Reliance Industries plans to invest nearly US$ 2 bn along with partner Niko Resources of Canada in the Krishna Godavari fields to touch nearly 28 MMSCMD (million metric standard cubic meters per day) of gas production by FY07. Given that currently the country faces a shortage of 86 MMSCMD of natural gas, the potential is significant. Also, the company is now focusing on the downstream fuel marketing business, which shall result in better than competitor gains given the PSUs lack of major flexibility in pricing.
Reduction in duties: The recent government decision to reduce customs duties on polymers and naphtha is a mixed bag for the company, as protection from imports of polymers has reduced, while duty cuts on naphtha are likely to bring down its raw material costs. Duty cuts on polymers will not have any major impact on Reliance as substantial protection still exists for the domestic product prices. At the same time, Reliance’s focus on premium brands is likely to provide a competitive edge. Naphtha constitutes 50% of its raw material costs and the cut in duties is likely to help reduce these costs to some extent.
Low offtake of petroleum products: Reliance Industries was a major supplier of petroleum products to the oil marketing PSUs such as BPCL, IOC and HPCL until FY04. To put things in perspective, product offtake from Reliance’s Jamnagar refinery was over 11 MMT (million metric tonnes) in FY04. However, during the current fiscal, the offtake has declined by nearly 50% as a result of high capacity utilization and better flexibility of the PSU refineries. Also, the PSU majors are expanding refinery capacity to reduce dependence on external sources. To put things in perspective, offtake during 1QFY05 was lower by 730 TMT (thousand metric tonnes) at 632 TMT as against 1,362 TMT during the corresponding period last fiscal.
Marketing roadblocks: Reliance Industries is currently in the process of expanding its 100-odd retail outlets network so as to enter into the retail fuels (petrol and diesel) markets in a big way. However, over 22,000 retail outlets by the PSU majors have proved to be a major entry barrier for Reliance and this is likely to slow down growth in this segment. Lower than expected outlets shall hamper the company’s plans to divert its refinery products to the domestic markets thereby resulting in higher exports.
Reliance is currently trading at Rs 555, implying a P/E multiple of 13.5x 1QFY05 annualized returns. We believe with the current uptrend in its product mix (nearly 55% EBIT contributions from the refining business and 42% from the petrochemicals segment), the company is likely to gain during the current fiscal. Also, the fact that the company shall commence commercial production of natural gas from FY06 is likely to bring in more positives. However, marketing of petroleum products and gas transmission and distribution concerns remain and to that extent, any adverse decision by the government shall impact the stock.
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