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Reliance: Volumes absorb volatile prices - Views on News from Equitymaster

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Reliance: Volumes absorb volatile prices

Oct 19, 2007

Performance summary
  • Topline increases by 7% YoY during 2QFY08 on the back of higher volumes.

  • EBITDA margins expand to 18%, from 16.8% in 2QFY07. Lower sales tax and exchange rate help matters.

  • Other income rises by 34% YoY during the quarter.

  • Bottomline registers a growth of 28% YoY owing to operating margin expansion and lower interest expenses.

  • Topline and bottomline grow 10% YoY and 31% YoY respectively in 1HFY08.

Financial snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 300,560 320,430 6.6% 560,500 615,670 9.8%
Expenditure 249,920 262,620 5.1% 463,530 501,130 8.1%
Operating profit (EBDITA) 50,640 57,810 14.2% 96,970 114,540 18.1%
EBDITA margin (%) 16.8% 18.0% 17.3% 18.6%
Other income 1,250 1,680 34.4% 2,330 3,650 56.7%
Interest 2,970 2,570 -13.5% 5,950 5,520 -7.2%
Depreciation 12,130 11,290 -6.9% 23,140 22,540 -2.6%
Profit before tax 36,790 45,630 24.0% 70,210 90,130 28.4%
Tax 6,790 7,260 6.9% 13,150 15,460 17.6%
Profit after tax/(loss) 30,000 38,370 27.9% 57,060 74,670 30.9%
Net profit margin (%) 10.0% 12.0% 10.2% 12.1%
No. of shares (m) 1,394.0
Diluted earnings per share (Rs)* 91.5
Price to earnings ratio (x)* 27.0
(*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. It 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 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. It has signed an agreement to acquire the assets of Hualon, a leading polyester producer in Malaysia. The company also has a presence in the downstream-oil marketing segment. It has acquired a majority stake and management control of Gulf Africa Petroleum Corporation (GAPCO), a petroleum downstream company in East Africa. It is mulling on plans to enter both power generation and fertiliser sectors, thereby completing the entire hydrocarbon value chain. In addition, it is foraying in the organised retailing sector, which offers great potential for growth.

What has driven performance in 2QFY08?
Gross Refining Margins (GRM): RILís GRM for 2QFY08 was at US$ 13.6 per barrel (bbl) which is significantly higher than the 2QFY07 margin of US$ 9.1 per bbl. 2QFY08 witnessed significant volatility in global refining margins on the back of rising crude oil prices. The GRM in 2QFY08 declined compared to 1QFY08, which stood at US$ 15.4 per bbl, primarily due to a sharp fall in product cracks, mainly in gasoline and naphtha. Refining margins in the benchmark US Gulf Coast declined from US$ 18.8 to US$ 8.6 per bbl on a QoQ basis. The benchmark Singapore complex margins also declined substantially from US$ 9.5 per bbl to US$ 6.4 per bbl. Light-Heavy differential remained in the US$ 5 per bbl range. The superior configuration at the Jamnagar refinery allowed RIL the flexibility to focus on the production of middle distillate products (Gas oil and Jet Fuel) where margins remained firm with strong global demand.

Refining Segment
(Rs m) 2QFY07 2QFY08 Change
Revenues 231,900 235,750 1.7%
EBIT 14,890 23,210 55.9%
EBIT margin 6.4% 9.8%
(Rs m) 1QFY08 2QFY08 Change
Revenues 223,280 235,750 5.6%
EBIT 25,580 23,210 -9.3%
EBIT margin 11.5% 9.8%

Petrochemicals: High feedstock prices impacted RILís petrochemicals business. However, strong demand from the end-user segments, an integrated business model and market leadership in India enabled the company in selling higher volumes.

Petrochemicals segment
Production ('000 tons) 2QFY07 2QFY08 Change
Production 4,803 4,953 3.1%
Polymers 831 829 -0.2%
Polyester 355 387 9.0%
Polyester intermediates 1,112 1,214 9.2%
Results (Rs m) 2QFY07 2QFY08 Change
Revenues 128,880 129,610 0.6%
EBIT 21,020 20,250 -3.7%
EBIT margin 16.3% 15.6%

Steady topline growth: For 1HFY08, increase in revenue was due to 5% increase in prices and 4% growth in volume. The Jamnagar refinery processed 16 MTs of crude oil, an increase of 3% YoY for 1HFY08. Petrochemicals production grew by 7% YoY during the half year period.

Raw materials rise while other expenditure falls: Raw material costs increased by 8% YoY for 2QFY08, primarily on account of higher crude prices. Other expenditure, which includes conversion costs, selling expenses, sales tax, repairs & maintenance and establishment expenses, fell mainly due to lower incidence of sales tax on account of higher export of refinery products and exchange differences.

Cost break-up
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Raw materials 216,330 233,540 8.0% 394,430 442,420 12.2%
% sales 72.0% 72.9% 70.4% 71.9%
Staff cost 4,960 4,710 -5.0% 10,490 9,670 -7.8%
% sales 1.7% 1.5% 1.9% 1.6%
Other expenditure 28,630 24,370 -14.9% 58,610 49,040 -16.3%
% sales 9.5% 7.6% 10.5% 8.0%
Total cost 249,920 262,620 5.1% 463,530 501,130 8.1%
% sales 83.2% 82.0% 82.7% 81.4%

Other income surges, interest costs fall: Other income was higher by 34% for 2QFY08 on a YoY basis primarily on account of increase in interest income on higher surplus funds. Interest costs fell by 14% YoY for 2QFY08, primarily on account of appreciation of the rupee vis-ŗ-vis the US dollar.

What to expect?
RILís refining segment is expected to deliver robust GRMs going forward, on the back of superior product mix and complex refinery configuration. On the petrochemical front, margins are going to reduce gradually with incremental capacities coming on stream in the Middle East region from 2008 onwards. However with lower per capita consumption in the domestic markets coupled with a booming economy, higher volumes are going to propel the petrochemical EBIT. RIL has extended its global footprint with the acquisition of GAPCO in East Africa and Hualonís assets in Malaysia.

RILís investments in E&P, organised retail and development of special economic zones (SEZs) will all be the cornerstones for future growth. In the E&P segment, KG basin has proved to be a world-class oil and gas field for the country. RIL, 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, lack of clarity regarding the size of potential reserves along with issue in commercialisation of the large-scale CBM blocks once again make valuations difficult. 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 fertilisers space also makes appraisal difficult.

At the current price of Rs 2,473 the stock is trading at a multiple of 27 times its trailing 12 months earnings. RILís share price has registered gains on the back of positive news flows in the new ventures. 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.

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