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Refining business alone may not be enough to drive RIL’s future profits

Refining business alone may not be enough to drive RIL’s future profits
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First Published: Mon, Jul 25 2011. 11 22 PM IST
Updated: Mon, Jul 25 2011. 11 22 PM IST
Reliance Industries Ltd’s (RIL) 16.7% increase in net profit for the June quarter over a year ago may not do much to drive the stock price.
Leave aside the fact that the Street has discounted this number, a closer look shows that operations are not as strong as the profit suggests. Note that 40% of the net profit gain was from investment income and not from core operations; operating margins fell 3.7 percentage points from a year ago. Even the rise in revenue was driven by higher prices and volume growth was a weak 4.5% compared with a year ago.
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That scenario may not last. The three main segments the company operates in are commodity businesses. And the outlook for commodity businesses has changed over the past quarter. With emerging markets tightening because of rising price levels, the US facing its problems of debt and unemployment, and the European Union’s concerns about a debt contagion, there are a lot of questions over global economic growth. That does not augur well for commodities.
The question for investors is whether it is only a soft patch. At first blush, the earnings numbers do not offer much hope for at least the next couple of quarters, neither do they mitigate the problems the company is currently facing.
For one, the problem caused by lower gas production at the KG D6 basin was painfully evident in the June quarter. Revenue in the oil and gas division fell by 16.5%, while earnings before interest and tax (Ebit) declined 23.3%.
Yes, the government has approved RIL’s deal with BP Plc and there is hope that the latter will help jack up gas output with its technical know-how. But there is no knowing when that will happen. After the Comptroller and Auditor General of India accused RIL of gold-plating its development expenditure for the gas fields, the company has not been forthcoming about capital expenditure plans for this segment.
Secondly, sure, the refining business has bailed out the company in the June quarter. Gross refining margins (GRMs), the difference between the total value of petroleum products produced by an oil refinery and the price of crude oil, have improved to $10.3 (Rs 457 today) per barrel.
While that boosted segment Ebit by 57%, the premium over Singapore GRMs remains at $1.8, among the lowest in two years. Now, refining margins may have peaked as global economic growth declines and new capacities come on stream over the next couple of years, especially in the Middle East. With RIL operating at 110% capacity utilization, there is limited scope for an increase there, too.
Thirdly, the petrochemical business is expected to be weak in the near term. Brokerages forecast a bottoming of the cycle on account of higher supply and slowdown in economic growth in the Asia-Pacific region. In the June quarter, the company did record an Ebit increase of 7.9%. However, margins fell by 2.7 percentage points. Yes, RIL is doubling its polyester intermediate volumes over the next four years, but these will take some time to kick in.
Sure, the company has done exceedingly well in managing its treasury operations, as evident from its increase in other income. But over time, it will deploy its cash in telecom and retail, two big growth areas it has identified for the future. However, these segments are hyper-competitive and the results will take some time to show. Certainly, they are not going to be visible over the rest of this fiscal year.
Graphic by Sandeep Bhatnagar/Mint
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First Published: Mon, Jul 25 2011. 11 22 PM IST