The lubricants for the Reliance Industries Ltd earnings juggernaut may be slowly drying out.

Reliance Industries Ltd chairman Mukesh Ambani. Photo: Bloomberg

The bottom line was given some heft by treasury income, which contributed one-fifth to net profit, but then investors will remain equally concerned about what the company plans to do with its ballooning cash pile that stands at 61,000 crore.

But the immediate concern is how it is going to ride out the downward commodity cycle. In case of refining, segment revenue is up 37% from a year ago, and earnings before interest and tax (Ebit) gained 40%. So just like the past couple of quarters, this segment has bailed out the company, but it is increasingly on shaky ground.

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Gross refining margins (GRMs)—a key measure of profitability—have declined from a quarter ago. What’s worse, the premium over Singapore GRMs is the lowest in the last 10 quarters for Reliance. Of course, light-heavy crude differentials have come down; and that does hurt Reliance, which processes the heavier variety of crude better; but, given the size and efficiency of its refineries, analysts termed the slip in GRMs as disappointing.

Not only that, the outlook for this segment doesn’t look particularly bright. With Europe and the US reporting slowing growth, demand might not increase at the expected pace.

Refinery supply is also going to increase and next year China will add another 730,000 barrels a day of capacity, according to Bank of America Corp. That might put pressure on margins.

As it is, volume growth has slowed to a trickle. Compared with a 12% growth in the last fiscal and a 6.5% growth in the June quarter, volume growth was 0.5% in the September quarter. With the company operating at 110% capacity utilization, there is limited scope for growth in this segment.

In the other cyclical business, petrochemicals Ebit margins are at a (at least) 10-quarter low. This segment had seen a slowdown in domestic demand in the June quarter, which has rebounded to some extent in the three months ended September. Brokerages reckon that the segment demand is likely to remain at these levels.

In the short term, the cyclical business should dictate the price movements. But, as a Macquarie Research report points out, “investors attribute most of the triggers to upstream, which is currently one-sixth of Ebit".

As far as the oil and gas business is concerned, the falling production, the scrap with the Comptroller and Auditor General of India, the tie-up with BP Plc are all well known. As the company and BP have indicated, a revival in volumes is still a couple of years away.

Reliance also told analysts who attended the investor meet that no drilling activity may happen for some time as it is re-evaluating the entire exploration and production portfolio along with BP.

So while the stock may have outperformed the broader market in the past couple of weeks, there is little reason to believe that this will continue.

PDF by Sandeep Bhatnagar/Mint

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