Reliance Industries (Q4 FY12)

CMP Rs731, Target Rs788, Upside 7.8% 

• Revenues at Rs852bn, higher by 17% yoy; better than our estimates

• OPM falls 584bps yoy driven by fall in EBIT margins of all segments and also on account of lower contribution of the high margin oil and gas segment

• GRMs were at US$7.6/bbl v/s our expectations of US$7.2/bbl

• Higher cash balance and better yields have resulted in 150% yoy jump in other income

• PAT at Rs42.4bn was in line with our expectations

• Downgrade our rating from BUY to Market Performer on the back of weakness in GRMs and petrochemical spreads along with increasing regulatory risks on the E&P segment

• Revise our 9-month price target to Rs788

Refining segment

Reliance Industries Ltd (RIL) reported GRMs of US$7.6/bbl in Q4 FY12 as against US$6.8/bbl in Q3 FY12 and US$9.2/bbl Q4 FY11. The GRMs were better than our estimates of US$7.2/bbl. Sequentially, the spread between RIL’s GRM and the benchmark Singapore GRM improved on the back of a recovery in gasoline spread. However, on yoy basis the margins were lower on account of 1) higher intake of imported LNG as availability of off-gases as well as KG-D6 gas decreased during the quarter, 2) widening heavy-light crude oil spread and 3) lower spreads of gasoline and naphtha, which contribute relatively more to RIL slate than benchmark Singapore slate. The two refineries processed 16.3mn tons of crude as against 17.2mn tons in Q3 FY12 and 16.7mn tons in Q4 FY11. The sequential fall was owing to a three week shutdown at the refinery. Revenue for the segment jumped 22% on yoy basis due to better realizations. EBIT margins for the segment were at 2.2% v/s 4% in Q4 FY11 on account of lower GRMs.

Key steps implemented during the refinery shutdown

• Implemented initiatives during planned shutdowns to achieve an annualized benefit of about US$0.25/bbl

• De-bottlenecked the following process units:

• CDU # 3
• Coker # 2
• VGOHT # 3 /# 4
• LCOHC
• DHDS # 1 /# 2
• Alkylation unit

• Additional recovery of high-value products through better operating efficiency

Outlook for GRMs

• On the supply side a total of about 1.2mbpd of refining capacity has been shutdown mainly so in US and Europe. However, new capacities are also slated to commence operations in the Middle East and Asia pacific region.

• On the demand side, there has been a slowdown across the globe. While Europe is still under the cloud of debt crisis, US demand has been slowing on the back of high prices. India and China, which have been the growth drivers over the past few years, are also seeing a marked slowdown in economic growth.

• We expect the GRMs to sustain at current levels through FY13 and increase in FY14 on the back of expected recovery in demand. 

Initiatives by RIL

• Investing US$4bn into a petcoke gasification project leading to production of syngas which is a clean fuel and cheaper than LNG

• Incremental investments directed at raising energy efficiency, managing costs and improving yield of highest value products

• On sourcing of crude the company is focusing on improving access to cheaper and heavier crude by capturing new grades to the processed crude bucket and maximise high value grade access to key South American crudes

Petrochemical segment

During Q4 FY12, petrochemical segment revenues rose by 18% yoy. While volumes were up 6% yoy, realizations were higher by 11% yoy as prices for most products have increased in line with rising crude oil prices. On a sequential basis too realizations were lower by 8%. EBIT margins for the segment fell 428bps yoy and 75bps qoq. The fall was due to fall in polymer deltas as the demand – supply balance remains in favor of supply with strong capacity adds in the Middle East. Furthermore, the chemical chain, which was witnessing a robust trend until recent past, witnessed some pressure during the quarter.

Outlook for petrochemical segment

Following continued uptrend in petrochemical prices H1 FY12, prices have now stabilized on the back of slowing demand and new capacity additions. Going ahead too, capacity addition is expected to surpass incremental demand. The new capacities are based on low cost gas, which will further put pressure on margins. Closure of select plants in Japan and Europe would provide some support to the falling spreads. The polyester chain would continue to be better off with prevailing high prices of cotton on back of declining acreage in domestic market. Integrated players such as RIL would continue to post a relatively better performance.

E&P segment

The management has given clarifications with respect to dwindling gas production at the KG-D6 field. The key reasons that were cited are as follows:

• Decline in pressure/production has been higher than originally predicted

• Volumes connected to existing wells is lower than envisaged

• Gas volume outside the main channel is not participating in production with small uneconomic volumes

The management also outlined its initiatives to arrest the decline which are as follows:

1. Extensive studies being undertaken to model and enhance field performance:

• Identify and connect potential unconnected reservoir targets in D1, D3 
• Work-over, side-track options to augment production and reduce water ingress – D1, D3 and D26
• Compression solutions to enhance recovery

2. Accelerate development of other discoveries (Satellites, R-Series & Other Satellites)

• Apply learning from D1, D3 to new developments in the block

• Engineering surveys to commence within current weather window for integrated development of discoveries

1. On the sidelines the company is working on an integrated development project to efficiently utilize the world-class infrastructure laid in the KG basin.

Update on shale gas assets

Chevron JV (prior Atlas JV)

• 5 rigs and 1 Frac crew in operation

• 46 producing wells with gross exit production rate ~80MMscfd at JV level

• RIL’s share of production at ~2.6Bcfe in Q4 FY12

• The company is working to implement systematic well cost improvement initiatives like pads, cycle-time and technology

• Cumulative investment of over US$1.04bn till date

Carrizo JV

• Gross exit rate of ~42 Mmscfed with RIL’s share at ~1.4 Bcfe for Q4 FY12

• 41 wells have been drilled of which 18 have been completed and 12 are currently producing

• For the C-County development, two initial test wells are currently under evaluation

• Cumulative investment of over US$590mn

Pioneer JV

• 12 rigs currently in operation 168 wells drilled so far with addition of 32 wells during Q4 FY12

• 137 wells producing currently; 26 wells put on production during Q4 FY12

• Gross JV exit production rate ~363 MMscfepd, including ~34,700 Bpd of condensate

• Reliance’s share of production at ~14.7Bcfe in Q4 FY12

• Midstream JV progressing on plan

• Cumulative investment of over US$21,4bn till date in both upstream and midstream JV  

Higher available cash balance drives up other income

For Q4 FY12, RIL reported 18.7% yoy fall in PBT as compared to 33.3% yoy fall in operating profit. The performance was better at the PBT level on account of 150% yoy jump in other income and 21.5% yoy fall in depreciation. Other income was higher as cash balance was at Rs702bn at end of Q4 FY12. Additionally, higher interest rates have resulted in better yields. Depreciation was lower on account of lower depletion charge because of lower production and stake reduction in E&P blocks.

Further deployment of cash and developments on E&P assets will be keenly watched

Going ahead, while refining segment will witness a stable to negative trend, petchem segment will see pressure on spreads in the near term. On the E&P side, regulatory issues have cropped up and contribution from this stream of business is expected to be on the lower side in FY13 resulting in drop in profitability for FY13. Hence we downgrade our rating from BUY to Market Performer with a revised 9-month price target of Rs788. Utilization of the cash on the balance sheet would be keenly watched.