Diversified Sector
Reliance Industries Ltd
Important note - Still Indian Markets are directionless and indecisive due to which any further market correction may bring some more pressure on all researched stocks mentioned in following subsections.
The market volatility situation is for short term duration and in long term the markets will recover as Indian companies are having good fundamentals and good growth prospects.
Taking into consideration current market situation it is advisable to buy stocks in steps rather than buying in bulk in single trade.
Reliance Industries Ltd
Company’s updates
1. In the aftermath of falling crude prices and decelerating global growth, the
company’s profitability was seen coming under pressure, particularly its
refining business, which accounted for a little over 54 per cent of profits in
FY08. It was hardly surprising that for the first time in almost twelve quarters,
Reliance Industries (RIL) reported a decline in total net profits (down nearly
10 per cent on a y-o-y basis, adjusted for extra-ordinary items). In addition,
the downturn in the petrochemical cycle has not been helping the fortunes of
the company either. If these weren’t enough, the dispute over gas with
Reliance Natural Resources (RNRL) and NTPC, too, meant a delay in
production from the gas-rich Krishna-Godavari basin (KG basin) impacting
profitability.
While the decision of the Mumbai High Court, on Friday (January 30, 2009),
brings partial respite in terms of lifting the stay on gas production, it also
indicates that the uncertainty over gas pricing will continue for a few months.
2. While the start of production is positive, issues pertaining to gas pricing are yet to be resolved. The ongoing dispute involves the sale
of gas by RIL to RNRL (28 mmscmd) and NTPC (12 mmscmd). RIL contends that it should be eligible to sell the gas to the selected
parties at $4.2 per mbtu (million British thermal unit), as per the government’s pricing formula. Whereas, RNRL claims that it should
be allowed to lift the gas at $2.34 per mbtu, as per its agreement with RIL. Analysts expect the stock valuations of RIL to remain
under pressure until further clarity emerges on the pricing front for the 40 mmscmd gas of KG-basin. Given that the price difference is
as much as 45 per cent and volumes involved huge, the stakes too, are equally high.
3. To give an indication, if the final judgment works out in favour of RIL, it would be eligible to sell the gas at $4.2 per mbtu. Analysts
say, assuming production volumes of 40 mmscmd in FY10, it would mean revenues of about $2 billion. And, after accounting for
expenses, government’s share of profits, royalties and taxes, the addition to RIL’s profit could be as high as $11.1 billion in FY10.
In the worst-case scenario, if RIL has to sell the 40 mmscmd gas at $2.34 per mbtu to the two companies (and assuming that the
government’s share in profit is 10 per cent of revenues, as in the first case), then profits (for KG-basin gas business) could be lower
by as much as $400-500 million in profits in FY10 (or EPS of about Rs 16). Meanwhile, there is no uncertainty over gas produced
over and above the 40 mmscmd under dispute, which can be sold at the higher price.
4. As a large part of the infrastructure is already in place for D6, future development of new discoveries in the basin would be more
rapid. In addition to D6, over the next 3-4 years, RIL would develop its gas finds in the CBM and NEC blocks. On development of
these finds, we expect the contribution of upstream to earnings to further increase, beyond FY11.” The overall EBIT (earnings before
interest and tax) contribution from oil and gas business could increase from around 15 per cent now, to around 50 per cent in the
next two years. That includes the additional gas production of 40 mmscmd (taking the total to 80 mmscmd) by FY11, which could
be sold at $4.2 per mbtu. The overall capex is estimated to be more than $11 billion in exploration, of which, RIL has already
incurred about $6 billion. However, with strong operating cash flows, infusion of cash ($3.5 billion) by promoters in end-2008
(conversion of warrants) and available leverage to raise funds, there is decent room to take care of the remaining capex requirement.
(Updated - Mar 2009)
2. These uncertain times, however, could cause a problem for a number of weaker players. But, as analysts say, Reliance has
enough ammunition to tide over this slowdown which would help it sustain profit levels in FY10, with an increase expected
thereafter.
Among these are the recent start-up of refining operations of its 70.4 per cent subsidiary, Reliance Petroleum and a sharp
increase in contribution from the upstream business (gas and crude oil production). The upstream business in fact, is likely to
provide substantial cash flows in the coming year with its share in earnings expected to increase to almost half.
It’s Oil and Gas Business
1.Reliance’s first tranche of oil production from KG-D6 block started in September 2008 with initial flow of crude oil at about 5,000 barrels per day (BPD). The output (including Mahanadi block) is subsequently expected to be ramped to 30,000-40,000 BPD annually in FY10 and FY11. Coming to the bigger contributor within upstream viz. Gas, as per initial estimates, RIL was expected to start gas production by Q3FY09, wherein production was to be ramped up to around 80 mmscmd (million metric standard cubic meters per day) in FY10. With Friday’s judgment, RIL is likely to start production by March 2009, wherein output from the KG-basin will be gradually ramped up to 80 mmscmd by March 2010.
Its refinery and petrochemical business
1. The refining as well as petrochemical businesses, which now account for more than 95 per cent of revenues and 85 per cent of
profits, have also been impacted due to the global slowdown. The decrease in crude oil prices is already weighing on RIL’s numbers.
RIL’s gross refining margins (GRMs) slipped from $15.4/barrel in Q3FY08 to $10/barrel ($13 in Q2FY09) in line with the fall in global
GRMs. However, as in the past 14 quarters, the company was able to maintain a premium over the benchmark Singapore GRMs
($6.4/barrel in Q3). However, with global demand slowing down and additional refining capacity coming on board across the world in
the next few quarters, GRMs are expected to come under pressure; analysts expect RIL’s GRMs to fall to about $8 per barrel.
2. On a positive note, the start of operations of Reliance Petroleum’s 580,000 BPD refinery on December 25, 2008 would help tide over
the slippage of margins going ahead. Reliance Petroleum refinery is more complex (Nelson Complexity Index of 14) as compared to
RIL’s existing refinery (rated 11.3), which will help it to earn better GRMs; analyst indicate a difference of $1.5 per barrel over RIL.
With Reliance Petroleum, RIL’s combined refining capacity has nearly doubled to 1.21 million BPD at its Jamnagar (Gujarat)
complex. Thus, the higher combined volumes (even assuming lower estimated GRMs of $8 per barrel) should help sustain absolute
profits from refining business in FY10 at FY09 levels.
Its other business
1. The high crude oil prices have led to RIL keeping its fuel retail plans on hold, even as it enjoyed around a tenth of market share in
high speed diesel and petrol in the past. Owing to firm crude oil prices through major part of FY08, the sales of petroleum products
had turned unprofitable as public-sector oil marketing companies were selling their produce at lower prices (helped by subsidies from
the government). In the recent past, with crude oil prices cooling off, things have started looking up. However, with the recent cut in
fuel prices and lack of free-pricing mechanism in the sector, not much action (by RIL) is seen in the near future.
2. In organised retailing, where RIL has about 900 stores and is among the top three players in the country, the company is yet to
make profits, say analysts. With the downturn in the economy, and most leading players under pressure (in terms of profitability), it
will be some time before this business could contribute in any visible manner. Even in the special economic zone (SEZ) business
(RIL is setting up five SEZs), although in nascent stages, not much is expected in the near-to-medium term.
3. On the other hand, given that RIL has explored only a small part of the total 400,000 square kilometres of acreage under its fold, any
new sizeable oil and gas discoveries (or upward revision of reserves in its existing blocks) should rub off positively on the stock.
Also, if RIL manages to sustain refining margins at current levels of $10 per barrel, as against $7-8 estimated by analysts, it could
provide further support.
Summary
Overall, the combined profits of the refining and petrochemical business (as well as their share in earnings) are seen declining, while that of the oil and gas exploration business is expected to increase significantly from FY10 onwards. A lot would also depend on the outcome of the pending gas dispute, which could have a significant impact on earnings should the judgment prove unfavourable for Reliance Industries.
Expected Returns
CMP - Rs. 1225.15
Buy - Near or low Rs.1000
Target - Above Rs.1500
Period - 2 to 3 years.
Target Acheived on 25 Mar 2009. It went high at Rs.1549
Next Target
CMP - Rs. 1522
Buy - Near or low Rs.1000
Target - Above Rs.1500
Period - 2 to 3 years.
Taking into consideration Rs.1522 as buying price following are the returns
66% Target acheived in month of 18 May 2009. It went high till Rs.2535 (Update - 22 May 2009)
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