One of the main reasons for the overhang in the Reliance Industries Ltd stock is the production problem at the KG-D6 natural gas block off India’s east coast. Production has fallen to 54.5 million metric standard cu. m per day (mmscmd) in the December quarter from 58 mmscmd in September quarter and 60 mmscmd in the June quarter.
In a post results note, analysts from Standard Chartered Bank wrote, “As of now, D6 is producing 52-55 mmscmd of gas with D1/D3 producing 43-45 mmscmd. Production from D1/D3 is down from the peak of 55 mmscmd.”
This is a cause for worry, given that the street is assigning considerable value to the exploration and production (E&P) business in their sum-of-total-parts valuation for the stock. While Reliance’s net profit for the quarter ended December increased by 4.3% over the September quarter to Rs5,136 crore, broadly in line with street estimates, it was greatly helped by 10% jump in other income to Rs741 crore, half a percentage point decline in depreciation cost and slower pace of 1.3% growth in interest expenses and tax outgo.
Other income is likely to continue to show strong growth, as the company’s cash pile increases. Operating profit increased at a relatively slower pace of 1.6% on a revenue growth of 4%, as operating costs rose at a faster pace leading to a 38 basis points decline in operating margin to 15.96%. One basis point is one-hundredth of a percentage point.
Performance of the petrochemical and refining business offset underperformance in E&P in the quarter. Earnings before interest and tax (Ebit) in E&P fell 11.8% against the September quarter, while that in refining and petrochemicals increased 11% and 10.5%, respectively, with higher gross refining margins helping.
The outlook for the petrochemicals and refining business has improved, and analysts had upgraded their ratings on Reliance. But some analysts say that the recent improvement in the refining business is unlikely to sustain.
“We expect the refining business to remain subdued for the next 15-18 months given 3.2 mn b/d (barrels per day) of refining capacity additions and one mn b/d of additional NGL supply in calendar year 2011-12E will offset likely increase of 2.6 mn b/d in global oil demand,” wrote analysts from Kotak Institutional Equities in their post-results note.
If the refining recovery story does not sustain, then the focus would shift back to E&P. More clarity on timelines in the business would be a positive.