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| Concerns cloud Reliance Industries' prospects | | Declining gas production, weakness in refining and petrochemical margins prompt analysts to revise their earnings estimates downward |
| Ujjval Jauhari / Mumbai Feb 23, 2012, 00:29 IST |
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Reliance Industries Ltd (RIL), the index heavyweight enjoying almost 10 per cent weightage in the Bombay Stock Exchange Sensex, has recently seen a change in its fortunes on the bourses, which however, looks unsustainable. The stock, which underperformed broader markets between April 2010 and December 2011 (it declined 35 per cent against a 12 per cent fall in the Sensex), has outperformed lately. While the recent movement can be linked to the announcement of a share buyback programme in mid-January, the past underperformance can be attributed to the declining KG basin gas production. Lately, margins in the core refining, or GRMs, and petrochemicals businesses, too, have been under pressure, a trend unlikely to fade soon.
The Street’s hopes of KG basin production stabilising at 35 million metric standard cubic metre per day (mmscmd) and improving thereafter, consequent to UK-based BP Inc picking a stake in RIL’s exploration and production (E&P) assets, have also been dashed. Recent reports suggest gas production may decline to 28 mmscmd in 2012-13 and 22 mmscmd in 2013-14, leading to further earning downgrades. This week, analysts at BRICS Securities cut their 2012-13 and 2013-14 earnings estimates by five-six per cent.
Though approval of foreign direct investment in multi-brand retail and launch of broadband services by RIL should prove positive, there are increased chances of the stock (now at Rs 833.20) again underperforming, given the issues surrounding its core businesses.
Gas output: A cause of concern
Reliance’s gas production touched 60 mmscmd during the March 2010 quarter. But thanks to technical issues, it declined to 53 mmscmd in 2010-11, before dipping further in 2011-12.
After BP bought a 30 per cent stake in various oil and gas assets of RIL, the hope of production revival had increased. But after news of RIL intimating the Directorate General of Hydrocarbons about lower gas production estimates from the basin during 2012-13 and 2013-14, analysts trimmed their estimates. Analysts at Emkay Global, who had earlier estimated average gas production at 43 mmscmd for 2011-12, have trimmed their estimate to 30 mmscmd for 2012-13.
On the other hand, while the Street is still awaiting benefits of BP coming on board, concerns seem to have aggravated. In its December quarter earnings statements, BP reduced the estimated fair value of assets and liabilities arising out of the deal with RIL to $4.5 billion, from $5.28 billion at the end of the September quarter. An e-mail to BP on the issue remained unanswered. The move has raised concerns over the value and potential of RIL’s E&P assets.
Analysts at BRICS Securities said after BP lowered the fair value of identifiable assets in RIL-operated blocks by 15 per cent and the cautious commentary by Niko Resources, they lowered their gas production volume estimates for 2012-13 by 33 per cent to 28 mmscmd and for 2013-14 by 52 per cent to 23 mmscmd. They said RIL was modelling slower ramp-up after 2013-14, which would take the output to 80 mmscmd by 2018-19 (against previous expectations by 2016-17).
The flip side to these estimates would be a revival in production, led by efforts to revive sick wells in the KG basin. Reliance and BP’s plan to start work on six wells in the D1 and D3 fields of the KG-D6 block to increase production. RIL also expects satellite wells to contribute in a big way. Reliance and BP have also won approval to prepare a plan to develop a gas discovery in KG-D6, R1 deposit. The deposit is estimated to have 1.6 trillion cubic feet of gas and may be capable of producing more than 10 mmscmd, but only after 2015. The recent Petchem joint venture with Russian firm Sibur will boost volumes, but again from 2014-15.
Core business, too, under pressure
In the refining business, GRMs, at $6.8 a barrel during the December 2011 quarter, declined 24.4 per cent annually and 32.7 per cent sequentially. And unlike earlier, Reliance’s GRM came in below Singapore GRMs (of $7.9 a barrel).
Analysts at Emkay remain cautious on refining and petrochemical margins on the back of new capacities and weakening demand. They believe a further drop in volumes and a decrease in the margins of its petrochemical and refining business will translate into lower earnings growth for 2012-13 and 2013-14.
Analysts at HSBC say though RIL has diversified into broadband, retail, financials and defence sectors, it’s yet to spell out its strategy for the latter two. They add the outlook for these businesses is not robust; Retail is yet to turn profitable and broadband will require significant infrastructure ramp-up.
Buyback support
However, there is a silver lining. Analysts at JP Morgan observe the share buyback programme is a key positive if executed well. Purchases from the open market could give some support, as the shares bought back would later be cancelled. If RIL manages to utilise proceeds of Rs 10,440 crore earmarked for buyback (120 million shares), it would be earnings per share-accretive by two per cent and return on equity-accretive by 50 basis points to 11.3 per cent in 2013-14, estimate analysts. Further, concerns over cash deployment in non-core assets would also ease a bit.
Most analysts remain underweight on RIL for now, given the weak outlook for GRMs and petrochemical margins, gas output issues and expected tapering off of earnings growth during FY12-14. They add the absolute stock price level seems attractive, but the stock is not cheap enough on a relative basis.
Analysts at Kotak Institutional Equities observe the proposed buyback programme may provide downside support at Rs 775-800. They believe the stock may be stuck in a narrow band for some time.
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