RIL: Market shrugs off gas price hike news

Stock falls 5% in a month as investors continue to focus on issue of 'cost recovery' and ignore catalysts like higher gas realisations & GRMs

Reliance Industries Ltd (RIL) has underperformed the benchmark indices by 40 per cent over the past three years, largely due to its falling gas volumes and consistent downgrades. Analysts believe this trend of earnings downgrades is largely over for RIL. With the company redefining petrochemical and refining as its core businesses, the exploration and production business is no longer factored into valuations.

The Street may be discounting the E&P business, but there is no denying that the company will benefit from higher gas prices. The Petroleum Minister Veerappa Moily had recently conveyed to analysts and operators that the government was set to notify the gas price hike regulation anytime now.

This is an immediate trigger for the company, which continues to produce gas from its flagship Krishna Godavari basin (D6). Gas output has steadily fallen, but the company has also conveyed to analysts that production is set to increase in the coming financial year, as the company has dug more wells in the block.  According to Morgan Stanley, which believes that gas price hike is a key catalyst for the company, the company’s ‘cost recovery’ issue is overdone. The company's stock does not reflect this change in the policy environment. The RIL stock has remained stagnant over the past three months (up 1.5 per cent) and underperformed the benchmark by 14 per cent. In fact, over the past month, its shares have fallen five per cent.

The company’s investments in its downstream projects, too, are expected to generate incremental operating profits of $3.5 billion, as the expansion nears completion. Analysts who are bullish on the stock believe the consensus view on the company is not factoring in any of these triggers.

Morgan Stanley expects RIL’s F15 earnings per share to increase by Rs 6 or 10 per cent, assuming a gas price of $6.8/mmbtu in FY15. Higher volumes may lead to earnings impact of over 20 per cent after FY15. The stock is currently under-owned by foreign institutional investors due to its consistent underperformance and downgrades. RIL accounts for five per cent of total FII ownership while the stock's weight on the MSCI India Index is 7.6 per cent.  In the current quarter, analysts believe that refining margins are down $0.7 a barrel compared to the quarter ended September, largely due to weak gasoline cracks. Refining margins have also suffered due to fewer refinery outages and increase in capacity across geographies. However, Credit Suisse believes that gross refining margins may recover in the winter due to seasonality issues.

Also, smaller refiners are struggling for cash flows and this may result in some closures. Even if margins remain flat, Credit Suisse expects the company to deliver 20 per cent CAGR in operating profit between FY14-17. A recovery in refining margins globally and a gas price hike in India would be near-term triggers.