RIL’s profits depend on how soon gas prices are raised
Although Reliance Industries Ltd’s net profits of R5,589 crore for the March 2013 quarter were up 1.6% sequentially and came in ahead of the Street’s estimates, the firm’s turnover has fallen 10% qoq, as have the operating profits. Again, while the firm notched up strong gross refining margins (GRM) of $10.1 per barrel, a muted performance by the petrochemicals piece—ebit margin at just 8.6%—as also the refining segment reflect the tough global environment. The continuing sluggishness in the exploration and production (E&P) space has resulted in the RIL stock having largely underperformed the benchmark Sensex over the last year, and a re-rating for the stock seems possible only if the falling production of gas at the KG-D6 basin—now at just 16 mmscmd and way below the peak of 60 mmscmd in Q1FY11—is reversed.
As of now, visibility remains poor since RIL’s partners Niko and BP have indicated that KG-D6 gas production would increase only once other discoveries are developed. However, RIL chairman Mukesh Ambani and BP chief executive Bob Dudley’s visit to the PMO, on Monday, suggest some action on gas pricing needs to be on the cards—without sufficiently high profits, it would not be possible to develop new gas fields. A hike in the price of natural gas to $8/mmBtu from the current $4.2/mmBtu, as recommended by the Rangarajan Committee, would help boost profits—a $1 increase in the price of gas gives RIL roughly R800 crore of ebitda—but that would kick in from FY15. More importantly, a better realisation will make it viable for companies like RIL to continue to explore and produce gas. In the meantime, RIL’s fortunes would depend to a large extent on how soon the global economy recovers and in particular on how the slowdown in the Chinese economy pans out—any further deceleration in growth in China would mean even softer prices for commodities. That would weigh on the already subdued margins of RIL’s petrochemicals business. There isn’t too much clarity on the refining business either; it’s possible margins could contract from current levels with the net addition of some 2.6 million bpd to global capacity in the next two years. The silver lining is the shale gas business in the US which seems to be going better and RIL would certainly be looking to add to its reserves in the next few years. That would be money well spent; a key concern for analysts has been that RIL will throw up cash from operations of at least R20,000 crore each year but may not be able to use it all. It’s not as though RIL hasn’t been making capital expenditure—it has both in core and non-core businesses. However, the telecom investment could take time to pay off given it will be very competitive and capital-guzzling. The retail piece appears to have broken even but again may not contribute meaningfully to the bottom line for several years. It could be a while, therefore, before shareholders see meaningful value creation.