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Home / Market / Mark-to-market /  For RIL, refining is the ultimate rescuer

The refining business saved the blushes for Reliance Industries Ltd (RIL) in the March quarter. A sharp recovery in gasoline cracks helped by planned and unplanned refinery turnarounds, and continued demand growth in Asia and the US allowed RIL to report a gross refining margin of $9.3 per barrel, ahead of Street expectations.

The contribution of the refining business to earnings before interest and tax (Ebit) was as high as 59.67% in the quarter. Unfortunately for shareholders, this did not translate into a commensurate increase in the firm’s net profit, which, at 5,631 crore, just about managed to meet analysts’ estimates. It was little changed from a year ago.

A tepid showing at RIL’s other two key businesses—petrochemicals and exploration and production (E&P)—prevented any significant increase in profits. Moreover, other income, though still significant at 2,036 crore, fell 9.2% from a year ago.

Sure, the petrochemicals business’s Ebit increased 10.6% from a year ago, but it was lower than in the December quarter. That was mainly owing to lower margins across product categories. Nonetheless, the segment’s performance is unlikely to come as a big blow for investors as expectations weren’t high.

On the other hand, the E&P business, which had surprised positively in the December quarter, tumbled yet again. The business has been facing production problems for a while now, although the shale gas business performed well during the quarter, helped by better realizations.

The March quarter earnings may well thus disappoint investors looking for earth-shattering gains from here on. The RIL stock has run up sharply in recent months; it has gained about one-fifth from its lows in 2014 so far, compared with a 7% gain in the Sensex. Yes, the stock is still trading at only 11.6 times its estimated earnings for fiscal year 2015, but there are concerns in the medium term.

The delay in the gas price hike remains an overhang on future earnings and the stock as well. According to calculations by JPMorgan, a reduction in the expected gas price by $1 per million British thermal unit would cut RIL’s fiscal years 2015 and 2016 earnings per share by 3%. Not only that, it would potentially affect the viability of new deepwater exploration/development, causing a potentially larger impact on long-term production estimates, the brokerage firm points out.

Second, the sustainability of refining margins is another factor shareholders should watch out for. There is not much headroom for an improvement from here on and excess capacity addition in the global refining industry may affect refining margins adversely.

The story is the same with petrochemical margins, as China and other Asian nations are expected to add significant capacity over the next 18 months, according to IDFC Securities Ltd.

Of course, a new business-friendly government at the Centre may provide a fillip for RIL by looking at its E&P issues afresh, but that remains uncertain for at least a month more.

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