Reliance Industries set to gather steam in H2 on improving outlook

The Reliance Industries (RIL) stock continues to gain on the bourses and has risen above 8 per cent since the corporation tax rate was cut late last week. The stock has gained more than 3 per cent in the last two sessions, even as the broader markets have been weak following the initial euphoria.

While the corporation tax cut will benefit RIL, it is the improving growth outlook that is driving the stock. The tax cuts are likely to lead to a rate reduction of 2-3 per cent at the consolidated level, said analysts at Credit Suisse. On Friday, Finance Minister Nirmala Sitharaman cut the corporation tax rates from 30 per cent to effectively 25.7 per cent. It also cut the minimum alternate tax (MAT) to 15 per cent from 18.5 per cent. 

Jio, RIL’s telecom arm, pays the MAT and stands to benefit from the reduction. Retail operations are at marginal tax rates and will also gain from the cut in levies.

Analysts, however, see limited benefit for refinery and petrochemical (petchem) operations, as they already gain from exempted income. For them, the tax rate is about 25-27 per cent. The refining and petchem businesses, however, are expected to see improved outlook. The two contributed more than 60 per cent to consolidated operating profits during FY19. 

Rising refining margins are expected to boost net profit. Refining margins have continued to be under pressure for some time, and the benchmark Singapore refining margins at $3.5 per barrel during the June 2019 quarter were down from $6 per barrel in the June 2018 quarter. However, as the benchmark is rebounding, analysts expect better refining margins ahead. The same is also likely to be aided by implementations of the International Maritime Organization (IMO) norms. 

The IMO will enforce a new 0.5 per cent global sulphur cap on fuel content from  January 1, 2020, down from the present 3.5 per cent. This will aid RIL’s refining margins, given it has complex refining capacities.  

Analysts say that as shippers prepare for IMO, Asian refining margins have risen and diesel, which forms nearly half RIL’s refined product output, has seen near-record high margins. Estimates of Macquarie Research suggest the segment’s earnings before interest, tax, depreciation, and amortisation (Ebitda) could improve by 71.6 per cent in FY21, compared to FY20.  

While the petchem segment, a key contributor to RIL’s operating profits is under pressure, analysts feel that soft liquefied natural gas (LNG) prices and slowing capacity additions should boost margins. 

It is not surprising then, that Morgan Stanley Research remains overweight on RIL, as it says earnings growth is starting to be de-risked as headwinds of H12019 turn and become key tailwinds in 2020.  They expect refining margins to rise with improved demand. Slower capacity growth, cheaper gas costs, and improved margins from a slowdown in petrochemical capacities in 2020 — in particular for polyethylene — support the rise in chemical margins. Morgan Stanley expects RIL’s energy earnings to grow 13 per cent annually over FY19-21 and to be among the highest vis-a-vis global integrated oil and Asian peers. 

Analysts also remain positive on telecom subscriber additions that remain steady. The firm has launched Jio fiber offering landline, WiFi, DTH and content services. The digital services business Ebitda that was less than tenth of overall in FY19, however is seen growing 76 per cent in FY20 and almost 58 per cent in FY21, according to analysts at Macquarie. Notably, the profit from this segment will contribute above 20 per cent to consolidated operating profit by FY21 and higher than petchem profit contribution of about 18 per cent.  

 The firm is pursuing a programme to aggressively deleverage its balance sheet and emerge a zero-debt entity in the next 18 months. Analysts expect a re-rating after this move, with other triggers including retail and digital services business growth over the next few years.