Reliance Industries: Will It Lead The Market Again?

A sudden spurt in the share price of Reliance Industries and its ongoing buyback of shares has put the stock on the investors’ radar yet again. Is this the right time to buy into RIL? Is the rise in price of the stock sustainable? Not really, says Shashikant.

On 6th August, 2012, India’s largest company by market capitalisation, Reliance Industries (RIL), saw its share price soar by more than five per cent and ended up making its shareholders richer by Rs 13000 crore, a feat that it had not achieved in the last three years. Such a spurt in the price should be viewed against the background that RIL has hugely underperformed the Nifty in the last three years. Since June 2009, the shares of RIL (after adjusting for bonus) are down by almost 34 per cent against a gain of 16 per cent by the Nifty over the same period.

So, what was the reason for such a sudden rise in RIL’s share prices, and more importantly, how sustainable is this rise? Will this momentum push RIL into the numero uno position on the bourses once again? Is this the right time to enter this counter? Here is an objective analysis of the issues at hand.

RIL operates in three main business segments, and we need to look into each of them individually to understand its future.

Refining & Marketing

Refining & Marketing, which contributed a good 78 per cent of its topline and 44 per cent of its earnings before interest and taxes (EBIT) for the quarter ended June 2012, remains the biggest segment for RIL as far as financials are concerned. The revenues from refining for the first quarter of FY13 grew by 15.8 per cent to Rs 85383 crore on a yearly basis due to the depreciating rupee, as the throughput remained nearly flat at 17.3 million tonnes (against 17 million tonnes for Q1FY12). However, due to weaker product cracks (gasoil and naphtha) and the resulting lower gross refinery margins (GRMs), the EBIT stood lower by almost 33 per cent at Rs 2151 crore.

The GRMs for Q1FY13 were USD 7.6/bbl against USD 10.3/bbl during the same quarter last year. Nonetheless, these for the quarter were better than expected due to the use of heavier crude (API of 27 against 28 earlier) and higher light-heavy differentials.

Going forward, the restarting of nuclear reactors in Japan would entail lower fuel oil demand, and thus, lower demand for heavy crudes. However, a number of simple refineries in Europe and on the East coast of US have closed down, which will mean increased demand for heavy crude as more complex refineries get operationalised. This will offset much of the expected gains.

Besides this, the current surge in GRMs are temporary as fires, mostly in US and Japan, have led to unplanned closures of refineries of approximately 1.0 mbpd, which accounts for 1.2 per cent of the global refining capacity. These have led to an increase in product spreads, and hence, in the margins. The increase in product spreads led to a USD 2/bbl surge in Singapore GRMs. Since Indian GRMs are benchmarked against the Singapore GRMs, any improvement there is reflected in the prices of RIL.

Nevertheless, the refineries hurt by these fires are likely to come online in the next six months, which will again lead to a moderation in GRMs. Moreover, a slowdown in the Chinese economy and the deepening of the Euro zone crisis will create a stress on the demand and cracks of various distillates, and consequently on the performance of this division of RIL

Oil & Gas

The Oil & Gas division of RIL, which contributes a little over two per cent of the entire revenues, brings in almost one fifth or 20 per cent of the gross EBIT of the company. For the quarter ended June 2012, this segment saw a sharp fall of 35.6 per cent in its revenues as compared to that in Q1FY12. It posted revenues of just Rs 2508 crore in Q1FY13 against Rs 3894 crore posted in Q1FY12. Such a fall in revenues was largely expected, as production from the KG-D6 block stood at 33 mmscmd in Q1FY13 as compared to 49 mmscmd in Q1FY12.

Moreover, it produced just 0.9 million barrels of crude oil, lower by 36.7 per cent over the same period last year. All this has clearly impacted the EBIT of this segment, which saw a fall of 34 per cent on a yearly basis to Rs 972 crore for Q1FY13. The decline in EBIT can also be partially attributed to the transfer of a 30 per cent Participating Interest (PI) to BP.

The saving grace for this segment were the higher oil prices and exchange gains due to the depreciating rupee. Henceforth, the performance of this segment will largely hinge upon government approvals. If recent media reports are to be believed, the ball has already been set rolling for the company after the KG-D6 Management Committee (MC) on August 7, 2012 approved a budget of USD 1.06 billion in capex for FY13 for the development of three unapproved discoveries with certain conditions. This approval was needed before RIL-BP could submit an Integrated Development Plan in Q3FY13 to develop all satellite discoveries in KG-D6.

Such approval will not boost the production of gas, but will definitely lower the decline rate of production. It will take a few years before production increases materially. However, there are other projects that need government approvals (See table: Selective View Of Project Approval Status) so that the company can realise the full potential of its upstream portfolio.

Besides these, the other important trigger for this segment is its shale gas E&P in North America, which contributed revenues of USD 134 million and EBITDA of USD 96 million for Q1FY13. The company expects this segment to contribute eight to 10 per cent of the EBITDA by 2015. However, much will depend upon how the gas prices behave, as they are still trading at multi-year lows, though they have somewhat recovered during the last quarter. Therefore, this factor too will take some time before it starts contributing to the company’s financials in a significant way.

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The Petrochemicals division remains one of the best performing segments for RIL in terms of sales, which saw a jump of 19 per cent on a yearly basis and two per cent sequentially. For Q1FY13, this segment posted sales of Rs 21839 crore, which is 20 per cent of its total sales for Q1FY13. However, the same quality of performance was not seen at the bottomline level, which saw a fall of 21 per cent on a year.

Such a fall was primarily due to two factors. First, the severe fall in the polyester margins due to the volatility in prices resulted in buyers postponing their purchases. The second factor is inventory destocking amid weak demand in China. Going forward, the influx of low-cost gas-based ethylene capacities in the US would cap the PEnaphtha margins. Other petrochemicals like polyester and polypropylene might also see their margins coming under stress due to a softer demand scenario and tightening cotton supplies in India and globally.

Valuations

The stock of RIL is currently discounting its trailing 12-month earnings by 14.14x and the EV/EBITDA stands at a little more than 7x. Although it is trading in the lower quartile of its last few years’ average, this is primarily due to the worsening return ratios of the company and the deteriorating global economic conditions. RIL’s Return on Net Worth (RONW) has seen a consistent decline since FY08. It has declined from 19.46 per cent in FY08 to 12.51 per cent in FY12.

However, going forward there are a couple of factors that will limit the downside of the stock from here on. The first is the depreciating rupee and the second is the ongoing share buyback programme. In January, RIL had announced a buyback programme of up to 1.2 crore shares at a maximum value of Rs 10440 crore from the open market. Till now, it has already purchased 3.5 crore shares at a cost of Rs 2512 crore.

However, with no fresh triggers in foreseeable future, we believe that stocks will remain range bound. Furthermore, with exports contributing more than 50 per cent of the revenue, a global slowdown is definitely impeding the company’s growth momentum, and this is reflected in its valuation. The Refining & Marketing segment will be the most affected – it is more dependent upon the external demand situation as the exports of refined products for the quarter stood at USD 8.8 billion and accounted for 9.3 million tonnes of the aggregate volumes.

Recent government approvals are expected to help the company to boost its volumes in the Oil & Gas segment, but this is still a couple of years away.

We therefore reiterate our views expressed earlier (Time To Buy These Stocks? DSIJ Vol 27, Issue No. 5, dated 26th February, 2012) and advise our readers not to get attracted by the sudden spurt in its stock prices and it is still few years before which RIL resume its leadership position of Indian equity market.