BackImproving fundamentals at RIL
The improving refining margins matter because the refining business has been the saviour for RIL in many of its recent quarterly results
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Reliance Industries Ltd (RIL) has been in the news recently for a series of videos aimed at countering some allegations made by the Aam Aadmi Party (AAP). Investors, however, do not seem perturbed by AAP’s accusations. The RIL stock has gained 10% since 12 February, when the company released its first announcement denying the allegations. But then, the overall market sentiment has been upbeat and the oil and gas index has done very well during this period on hopes of reforms. Indeed, if we take the last three months, RIL has underperformed the S&P BSE Oil and Gas index.
Of far more importance is the business outlook for the company. What has changed since its last quarterly results? Reports say its retail unit will post a profit by the end of this fiscal. But then the company had anyway informed analysts during the last quarterly results meet that the retail venture had started generating net profits.
RIL has made some announcements relating to its telecom venture, mainly the spectrum acquisition in the 1,800 MHz band. But analysts aren’t assigning much value to the company’s telecom adventure for the near-term because of the long gestation period. There’s also good reason to be cautious on the telecom venture due to the high competitive intensity. “Despite aggressive growth, return on capital employed is likely to be sub-par till FY18E (about 3%), potentially recovering cost of capital only in FY19E," wrote analysts from Standard Chartered Bank in a note last month. The way to evaluate RIL’s non-core businesses is to gauge whether things can get worse and, at least by that yardstick, matters seem to be satisfactory at present, according to an analyst.
On RIL’s core business, there is something to cheer about. That’s the improvement in refining margins. This is a welcome relief from the December quarter, when the refining environment was weak. Still, margins remain lower on a year-on-year basis. Gross refining margins (GRMs) firmed up marginally in Q4FY14 to $6.5 a barrel, compared with $4.2 per barrel in Q3FY13. But they are still lower than the $8.5 per barrel notched up in Q4FY13, pointed out Religare Institutional Research in a note on 15 March.
Improving refining margins matter because the refining business has been the saviour for the company’s bottom line in many of its recent quarterly results. For the nine-month period ended December, RIL’s refining business accounted for as much as 53.7% of its earnings before interest and tax. However, from a medium-term perspective, refining margins are expected to remain range-bound, primarily on account of additional refining capacity.
RIL’s second main business, petrochemicals, which delivered a disappointing performance last quarter, may perform better. According to ICICI Securities Ltd note, petchem earnings can improve every quarter from Q4FY14 as polyester capacities get commissioned. On the flip side, rupee appreciation is a concern.
RIL’s oil and gas business has been a spoilsport for a while, facing production declines, but that’s adequately discounted by the stock. Of course, all eyes will be on 1 April for the expected gas price hike. But, perhaps, the bigger story for the stock is still some quarters away when shareholders start factoring in the benefits of its petrochemicals expansion plans.
Currently, the stock trades at 10.7 times its estimated earnings for the next fiscal. A boost to the stock could also come from a new, business-friendly government at the centre. “RIL would also be one of the key beneficiaries of a change in government, offering a fresh look on E&P (exploration and production) business issues with an intent to complete the arbitration process and put an end to the dispute," according to another ICICI Securities note.
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