Mumbai: In the September quarter, Reliance Industries Ltd’s (RIL’s) refining business accounted for 56.8% of total earnings before interest and tax (Ebit), the highest in the previous 10 quarters at the time. That record has been broken in the December quarter, surprising analysts and helping the company beat Street estimates. For the December quarter, the refining business accounted for 58.1% of total Ebit.
To be sure, a big reason for the increasing contribution from refining is that the oil and gas business is doing badly. Nevertheless, the refining business has again emerged as a saviour for RIL and the performance on this front has surprised the Street by a good margin, although investors were expecting this after Essar Oil Ltd’s gross refining margin (GRM) for the December quarter came in at $9.75 per barrel on Tuesday. The RIL stock has risen 6.3% since then.
RIL’s December quarter GRM came in at $9.6 a barrel, even higher than the $9.5 per barrel in the September quarter and compared with expectations of $8.5 per barrel. This is despite the Singapore GRM having declined over the quarter. RIL maintains that the Arab light-heavy crude differential expanded significantly by $1.5 per barrel during the December quarter as fuel oil cracks weakened due to poor bunker demand, and complex refiners benefited as a consequence of this widening. The refining business Ebit margins, though, were marginally lower sequentially.
But while it’s clear the refining business has been a star performer, what’s interesting is that the petrochemicals business, too, has done well and perhaps has had a stronger impact on overall profitability. Here’s what has happened: even as the petrochemicals business revenue has remained stable sequentially, the Ebit contribution has increased to 31% in the December quarter from 28% in the September quarter. In fact, the petrochemicals Ebit margin came in a bit higher on a sequential basis. One reason for the improvement in the petrochemicals business is better price. Also positive is the fact that analysts are slowly turning positive on the petrochemicals business. “For 2013F, we estimate global ethylene demand to grow by 4.9 million tonnes (mt) while capacity should increase by 4.1 mt. This suggests a tighter market than in 2011-12. We forecast ethylene margin to increase to $297/tonne in 2013F, from $262 in 2011/ $274/tonne in 2012,” Nomura Equity Research analysts wrote in a 16 January note.
As has become typical by now, the oil and gas business has disappointed. The contribution from the business to total Ebit has been the lowest for the past several quarters at 9.5%. This is, of course, because of falling production from the company’s gas assets. Also, the proportion of “other income” has not been unusually high as seen in some previous quarters, which improves the quality of earnings.
In sum, RIL’s December quarter net profit of Rs.5,502 crore is far higher than the Bloomberg estimate of Rs.5,079 crore. The stock has outperformed during this fiscal year from its lows. While the Sensex has gone up 25.6% from its lows in May 2012, the RIL stock has risen by 31% during the same period.
What of the future? While the refining business has delivered a superb performance in the December quarter, analysts are not very upbeat about the outlook, the key reason being that capacity addition is likely to outstrip demand, thus putting pressure on margins. Investors would do well to keep tabs on whether the petrochemicals cycle actually shows signs of a recovery. But it’s the oil and gas business that will be the major driver for any re-rating. All eyes are meanwhile on what happens to the C. Rangarajan panel recommendations that will determine gas prices.