Photo: Reuters
Photo: Reuters

High margins boost Reliance Industries’ Q2 profit

The company's earnings per share came in at `22.80, a remarkable 18% higher than those estimates

A Bloomberg poll of analysts had pegged Reliance Industries Ltd’s (RIL’s) consolidated earnings per share (EPS) for the September quarter at 19.26. The company’s EPS came in at 22.80, a remarkable 18% higher than those estimates. That’s all the more commendable considering sentiment hasn’t been very upbeat for the stock. What helped the company beat the earnings expectations?

It’s a simple story. The sharp drop in crude oil prices shows up in the numbers, with revenues declining by a third compared with last year to 70,901 crore. But, despite this steep decline in revenues, profit before tax and exceptional items increased 4.5% year-on-year to 8,157 crore. This essentially means RIL gained tremendously due to stronger profit margins.

The biggest surprise came from its refining business, which accounted for as much as two-thirds of RIL’s revenue last quarter. And that at a time when the benchmark Singapore gross refining margin (GRM) had declined sequentially and it was anticipated RIL’s margins would follow suit. In complete contrast, the company’s GRM came in at $10.6 a barrel, the highest in the last seven years. This translates into a premium of $4.3 per barrel over Singapore complex margins, the highest level since early 2009. Product mix flexibility, robust risk management coupled with opportunistic crude oil sourcing and lower energy cost helped. Further, average utilization at RIL’s Jamnagar refinery was 110%.

Apart from refining, RIL’s petrochemicals business, which is its second biggest revenue contributor forming 23% of revenues, too performed well, with its Ebit (earnings before interest and tax) margin expanding 300 basis points to 11.9%. A basis point is 0.01%. Strong polymer deltas (the rate of change in prices compared with the change in unit costs) and healthy polyester chain deltas along with higher volumes boosted the segment’s profits.

The company’s organized retail business has performed well, but it’s still too small to make a meaningful difference. The exploration and production business, too, does not move the needle at this point of time.

Nevertheless, RIL’s September quarter results show core strengths—it’s worthwhile to note that other income has declined by a fifth year-on-year.

But, and this is an important but at that, what about the stock? Considering the beat in the numbers, it’s very likely that the RIL share will open in positive territory on Monday unless of course there are some unpleasant surprises in the analysts’ meet.

Post results, some earnings upgrades may happen, but in general sentiments remain low, said analysts. Currently, the RIL share trades at 9.7 times next year’s estimated earnings. This valuation was 11.2 times when the stock closed at 1,050, the year’s high, in July, two days before its June quarter results. One of the key variables that had changed during this time was benchmark refining margins, which were starting to decline after two robust quarters.

RIL’s valuations therefore look reasonable, boding well for its share performance—especially as the start-up of its $17 billion downstream projects may drive EPS up 47% in FY15-18E, pointed out Barclays Equity Research in a note on 6 October.

While the earnings beat in the September quarter is encouraging, it remains to be seen whether this will sustain in future. Excess capacity addition in the refining industry is expected to weigh on margins. Sure, the company’s ability to switch its product/crude oil mix augurs well. On the other hand, reduced crude oil prices are a concern for the petrochemical business and demand from China is likely to be uncertain. The most significant trigger is the coming launch of the telecom business. With expectations running low, the smallest signs of success may well offer comfort.

The writer does not own shares in the above-mentioned companies.