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RIL: Petrochemicals, the savior - Views on News from Equitymaster
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RIL: Petrochemicals, the savior
Oct 20, 2006

Performance summary
Reliance Industries (RIL) announced its results for 2QFY07 and 1HFY07. Topline registered a growth of 38% and 37% for 2QFY07 and 1HFY07 respectively. However, due to increase in input costs and weakening of refining margins internationally, EBDITA margins tumbled by 190 basis points and 230 basis points for 2QFY07 and 1HFY07 respectively. Decline in other income, due to lower deployable surplus, along with increase in interest expenditure and depreciation has pressurized margins at the net level as well.

Financial snapshot…
Particulars 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 207,170 284,740 37.4% 385,010 529,960 37.6%
Expenditure 170,050 239,090 40.6% 312,240 441,940 41.5%
Operating profits(EBDITA) 37,120 45,650 23.0% 72,770 88,020 21.0%
EBDITA margins(%) 17.9% 16.0%   18.9% 16.6%  
Other income 2,220 220 -90.1% 4,160 660 -84.1%
Interest expenses 2,220 2,780 25.2% 4,580 5,440 18.8%
Depreciation 8,040 10,180 26.6% 15,950 19,250 20.7%
Profit before tax 29,080 32,910 13.2% 56,400 63,990 13.5%
Tax 4,270 5,820 36.3% 8,490 11,430 34.6%
Profit after tax 24,810 27,090 9.2% 47,910 52,560 9.7%
Net profit margins(%) 12.0% 9.5%   12.4% 9.9%  
No. of shares (m) 1,394 1,394   1,394 1,394  
Diluted EPS (Rs)*         73.9  
Price to earnings ratio (x)         16.2  

What is 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 fiber 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 blocks 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 organized retailing of the merchandise, which offers great potential for growth.

What has driven the performance?
Growth across the segments: As far as the revenue mix of Reliance is concerned, the refining operations accounts 67% of the gross revenues, petrochemicals (31%) and the rest accounted by ‘others’. The petrochemical segment saw its gross revenues climbing by 33% in 2QFY07, on the back of increased realization due to higher petrochemical prices accompanied by volume growth. Higher petrochemical prices were also on account of the closure of few petrochemical facilities in the Asia Pacific region for maintenance. In the refinery segment, RIL processed 15.7 MT of crude in 1HFY07, thereby achieving a capacity utilization of 95%. Revenues from retail marketing of the petroleum products declined, principally due to lower sales volumes owing to differential prices of petrol and diesel vis-à-vis incumbent OMCs (oil marketing companies). Given the fact that capacity utilization was higher and retail sales were lower, the company has to resort to increasing exports (8.8 MT in 1HFY07 as compared to 5.2 MT over the corresponding period previous year, up 69% YoY).

Segmental analysis…
Particulars 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Segmental sales
Petrochemicals 81,710 108,740 33.1% 148,410 206,610 39.2%
Refining 185,950 232,080 24.8% 346,900 440,700 27.0%
Others 4,410 5,550 25.9% 8,540 10,850 27.0%
Total gross revenues 272,070 346,370 27.3% 503,850 658,160 30.6%
Segmental EBIT
Petrochemicals 12,790 17,640 37.9% 21,610 28,510 31.9%
Refining 15,320 14,890 -2.8% 33,190 35,240 6.2%
Others 2,470 3,650 47.8% 4,660 6,490 39.3%
Total EBIT 30,580 36,180 18.3% 59,460 70,240 18.1%

Margins under pressure: The petrochemical division, which witnessed margin pressure during the past few quarters, posted strong margins in 2QFY07. Margins in the petrochemical segment improved due to higher prices, better sales mix and lower input cost (fuel). In the petrochemical segment, RIL’s EBIT margins improved significantly to 16.2% in 2QFY07 compared to 15.7% in the corresponding period previous year. Revival in the margins could be attributed to lower naphtha prices (due to the shutdown of petrochemical facilities in the Asia Pacific region) coupled with strong petrochemical prices. However, the margins were bit lower in the polyester business due to higher fiber intermediate prices. In the refining segment, GRMs declined to US$ 9.1 per barrel from US$ 10.4 per barrel in the previous year. Decline in the refining margins is however, lower as compared to decline in the benchmark Singapore margins over the period (US$ 4.75 per barrel in 2QFY07 as against US$ 8.13 per barrel in 2QFY06). Factors such as improved global refining utilization, lower turnaround rate, end of peak driving season in US and continued fuel switching in China and US, led to fall in refining margins across the regions. RIL’s EBIT margins from the refining segment declined by 180 basis points over the corresponding quarter previous year, while the same for the 1HFY07 was 160 basis points.

Expenditure break-up…
Particulars 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Consumption of raw material 144,290 215,120 49.1% 264,800 390,370 47.4%
% sales 69.6% 75.5%   68.8% 73.7%  
Staff cost 2,590 2,840 9.7% 5,120 6,020 17.6%
% sales 1.3% 1.0%   1.3% 1.1%  
Other expenditure 23,170 21,130 -8.8% 42,320 45,550 7.6%
% sales 11.2% 7.4%   11.0% 8.6%  

Consumption of raw material increased by 49% and 48% in 2QFY07 and 1HFY07 respectively, on the back of soaring crude oil prices. Staff cost increased by 18% in 1HFY07 on the back payment of performance linked incentives and increments to the employees. Other expenditure includes conversion costs, selling expenses, sales tax, repairs and maintenance, excise duty on stock and establishment expenses increased by 8% in 1HFY07. This can be attributed to higher selling expenses on the increased exports. Also, additional expenditure of Rs 340 m was also incurred to restore operations of its Hazira plant after floods.

Other income, depreciation and interest adds to the pressure: Lower investment surplus owing to investment of the same in RPL (Reliance Petroleum limited), coupled with higher depreciation and interest had a further drag on the bottomline for 2QFY07 and 1HFY07. These investments are likely to benefit in the long-term.

Performance over the recent past…
(Rs m) 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Sales growth(YoY) 26.4% 24.5% 28.2% 2.3% 37.6% 37.9% 37.4%
Operating profit margins 19.9% 20.1% 17.9% 16.4% 16.5% 17.3% 16.0%
Net profit margins 12.8% 13.0% 12.0% 9.8% 10.2% 10.4% 9.5%
Net profit growth(YoY) 61.5% 60.8% 41.6% -15.1% 9.2% 10.3% 9.2%

What to expect?
At the current price of Rs 1,196, the stock trades at a P/E multiple of 16 times annualized 1HFY07 earnings. Margins in the petrochemical segment have improved on the back of lower naphtha prices, coupled with strong petrochemical prices. However, naphtha prices are likely to increase going forward, with demand increasing. Thus, margins are not expected to improve significantly in the segment from the current levels. However, in the refining segment, GRMs are expected to soften marginally due to inventory losses (on the back of decline in crude oil prices) along with lower product crack in the benchmark Singapore markets. Increased exports of the products also meant lower overall tariff protection for the company. Meanwhile, RIL recently reduced prices of diesel and petrol to align with the prices of OMCs. Despite this, there is a marginal differential between RIL’s and that of OMC’s retail prices. While we expect this to benefit RIL’s retail sales, the large-scale capital investments for refinery, retail venture and establishment of SEZs can affected profitability in the medium –term.

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