Wednesday, March 14, 2012

>RELIANCE INDUSTRIES: Singapore Complex GRM corrects sharply (MARCH 2012)

Singapore Complex GRM corrects sharply: The gross refining margin (GRM) of the Singapore Complex has fallen sharply to around $2.4 per barrel from $5.6 per barrel at the end of Q3FY2012. The correction in the Singapore GRM was on account of contraction in the gasoil crack. Reliance Industries Ltd (RIL) has reported a GRM of $6.8 per barrel for Q3FY2012. Its GRM was expected to improve in Q4FY2012. However, looking at the severe drop in the Singapore Complex’ GRM we believe RIL may post a sequential drop in the GRM in its Q4FY2012 report card. We have factored GRMs of $7.5 and $8 par barrel for FY2012 and FY2013 respectively. With a drop of every $1 per barrel in the GRM, our earnings estimates for FY2012 and FY2013 carry a downside risk of 3-4% for RIL.

Gas output at KG basin falling continuously; likely to reach 27mmscmd by FY2013: The gas output at the Krishna Godavari (KG) D6 oil field has been declining for more than a year now and the field is currently producing 34.5 million standard cubic metre of gas per day (mmscmd) compared to 53-54mmscmd a year ago. According to the field development plan, the production was to touch 80mmscmd by April 2012 after all the 31 wells envisaged in the development plan are drilled and brought to production. However, RIL has so far drilled 22 wells on D-1 and 3, two of the 18 gas finds in the KG-D6
block that have been brought to production, but only 18 have been put-on production. Of these 18, five have ceased due to water/sand ingress. According to the management guidance in the media reports, the gas output at the KG basin is further expected to slide to an all-time low of 27mmscmd by April-May this year due to issues with the reservoir and to about 22mmscmd by FY2014. In our estimates for FY2012 and FY2013 we have factored in gas output of around 40mmscmd. Hence with the likely drop in the gas output to around 27mmscmd in FY2013 there is a downside risk of around 3% to our FY2013 earnings estimate.

RIL demanding upward revision in the gas price: The managements of RIL and BP have sought import parity for the gas produced from KG-D6 fields in the Bay of Bengal. It means a minimum of three-fold increase compared to the current price of $4.2 per million British thermal units. However, the oil ministry has rejected the proposal stating that the price of 4.2 per mmbtu is fixed till FY2014 and could not be revised before the due date. We believe any upward revision in the gas price from $4.2 per mmbtu in the near term augurs well for the company and could support the earnings of its exploration and production (E&P) division.

Petchem margin under pressure with increase in naphtha price: The petrochemical (petchem) business, which accounts for 20% of the revenue and over 35% of the EBIT, is facing severe margin pressure. For M9FY2012 the company has posted over 360-basis-point contraction in its EBIT margin from the petrochemical division. Further, with the increase in the naphtha price (up 18% in the past two months) due to an increase in the crude oil price and a lower than expected demand the margin pressure of the petrochemical division is likely to increase. Hence, a likely drop in the petrochemical margin in the coming quarters could be a downside risk to our earnings estimates for FY2012 and FY2013.

We maintain our earnings estimates and would revise them after Q4FY2012 results of RIL: A few negative developments like the fall in the GRM, the lower than expected output from the KG basin and the margin pressure in the petrochemical division could be downside risk to our earnings estimate for FY2012 and FY2013. However, we maintain our earnings estimates for FY2012 and FY2013 and would revise them after the announcement of the Q4FY2012 results of the company. Further, in this note we are also introducing our FY2014 estimates with the earnings per share (EPS) estimate at Rs71.4.

In order to factor in the recent negative developments of falling GRM, lower than expected output from the KG basin and margin pressure in the petrochemical division, we are downgrading our valuation multiple in case of its refining and petrochemical businesses. We thus arrive at a revised price target of Rs890. However, we believe the ongoing buy-back programme to provide support to the stock price and any positive development in terms of an improvement in the GRM and the petrochemical margin could be positive triggers for the company. Currently, the RIL stock is trading at 12.8x and 11.6x of FY2012 and FY2013 estimated earnings respectively. We maintain our Buy rating on RIL with a revised price target of Rs890 (based on the sum-of-the-parts valuation method).