Can RIL sustain the jump in refining margins?

Mumbai: Even as Reliance Industries (RIL) is planning to ramp up the capacity of its twin-refineries at Jamnagar in Gujarat, brokerages are wary of RIL maintaining its refinery margins.

The stock is up 1 percent after Reliance posted its fourth consecutive drop in quarterly profit on Monday but met market estimates, as refining margins rebounded and treasury gains from its huge cash pile bolstered profits.

The company’s guidance on the refining margins is largely going to determine its profitability going forward.

However, HSBC has said RIL is unlikely to sustain the sharp spike in refining margins that boosted its earnings and fueled its stock recently. The brokerage has cut RIL to ‘underweight’ from ‘neutral’ and maintained its target price at Rs 800. “Key risks are improvement in refining and petrochemical margin, increase in gas output and deployment of cash in earning accretive businesses,” it said in a note today.

Even Citigroup in neutral on the stock as RIL lacks earnings growth over the next three years since it faces challenges in all three core businesses. “We expect refining margins for RIL to improve moderately in the near term but this could come under pressure in the medium-long term as global refining capacity additions outstrip demand growth,” said Citi in a report today.

Even Morgan Stanley is bearish on the stock, citing expectations of a weaker margin environment in refining and a subdued outlook on petrochemicals . “The recent strength in GRMs (gross refining margins) is largely driven by unexpected refinery shutdowns globally, which we now expect to reverse. Coupled with additional new refinery capacity in China in 4Q12 and onwards,
this should put downward pressure on GRMs,” the brokerage said in a report today.

The company, which operates the world’s biggest refining complex in India, reported a gross refining margin of $9.5 a barrel for the quarter, compared with $10.1 a year earlier. It had posted a refining margin of $7.6 a barrel in the June quarter.

Refining margins have risen over the past quarter, helped by higher demand and unplanned refinery shutdowns in Asia. Analysts had expected Reliance to report a margin of around $9/barrel.

Profits from the refining segment, which accounts for nearly 80 percent of the company’s revenue, rose 15 percent.

“Maintaining similar profitability in coming quarters appears challenging for Reliance Industries given the macro economic trends that would put pressure on margins of refining as well as petrochemical segments,” Sandeep Randery, head of research with BRICS Securities was quoted as saying by the Economic Times.

Clearly investors are unimpressed with the improvement in margins and are looking for cues from regulatory issues like KG capex and natural gas price revisions post 2014. But even though RIL has submitted a revised field development plan for enhancing production at its gad fields, it will take at least 3-4 years from the date of government approvals for these discoveries to start producing. This implies, volumes will continue to hover at current levels.

Gas output at Reliance’s main D6 block has shrunk and is projected to decline further to 20 million standard cubic metres a day (mscmd) in 2014/15, a third of the 60 mscmd it was producing in 2010.

Reliance and partner BP have blamed a decline in pressure and water ingress for falling production, and have asked for an increase in gas prices to justify higher expenditure to develop the block, but the government remains unconvinced.

Reliance’s petrochemicals business posted a 1 percent rise in revenue on higher demand and prices, but margins declined. The petchem business is likely to see growth from the first quarter of 2013, the company said.

Revenue for its oil and gas business fell 37 percent, mainly due to lower production at its main KG-D6 block.

Reliance held Rs 79160 crore in cash reserves at the end of September, up from the $12.7 billion in the previous quarter. The company has seen its cash hoard multiply in the last two years, resulting in a disproportionate increase in profits from treasury operations.

Other income of Rs 2112 crore, most of it through treasury gains, accounted for 31 percent of the company’s pretax profit for the quarter.