Moody's: Inventory loss and lower refining margins dampen RIL's Q3 results

Moody's Investors Service says that Reliance Industries (RIL, Local Currency Issuer Rating: Baa2 positive, Foreign Currency Senior Unsecured Debt Rating: Baa2 stable) results for the quarter ended December 2014 (Q3) were weaker compared to the preceding quarter following a decline in contributions from its refining and petrochemical segments. The company's ratings, however, remain well supported, particularly from the prospect of strengthening credit metrics over the medium term, and therefore are unaffected.

Although throughput for the refining segment increased marginally to 17.7 million tons as compared to 17.3 million tons in the previous quarter, the gross refining margins declined to $7.3 per barrel from $8.3 per barrel. The decline in refining margins came at a time when the Singapore complex refining benchmark improved to $6.3 per barrel as compared to $4.8 per barrel in the previous quarter resulting in a decline in RIL's premium over Singapore complex. The decline in RIL's refining margins was largely driven by weakness in naphtha spreads, lower light -heavy differentials and inventory valuation losses.

"We expect contributions from RIL's refining segment to improve over the next 2 years as the company completes it petcoke gasification project, that will replace the high cost liquefied natural gas as refinery fuel," says Vikas Halan, a Vice President and Senior Credit Officer at Moody's.

RIL also reported weak results for its petrochemicals segment. Although most of the petrochemical crack spreads improved in the quarter, paraxylene spreads continued to decline. RIL also produced lower volumes of 5.3 million tons in the quarter against 5.7 million tons in the previous quarter.

"We also expect earnings from the petrochemical segment to improve over the next 2 years as the company completes its petrochemical capacity expansion and refinery offgas cracker projects," says Halan.

RIL's upstream oil & gas segment also recorded a decline in earnings from both domestic and shale gas operations. The gas production at the company's largest production field - KG-D6 - continued to decline to average 11.8 million standard cubic meters of gas per day (mmscmd).

From 1 November 2014, the government revised the domestic natural gas price formula to $5.6 per million British thermal units (mmbtu) from the previous price of $4.20/mmbtu.

Although the MA1 block in the KG-D6 field is receiving higher price/cash flow, the incremental cash flow for the D1/D3 block in the field is retained in an escrow account, which RIL will receive once it resolves its ongoing arbitration with the government regarding the production shortfall and cost recovery.

On the international front, RIL's US shale segment reported a decline in revenue and EBITDA owing to sharp reduction in crude oil and natural gas prices. However, operations continued to remain strong with production increasing to 52.1 billion cubic feet equivalent during Q3 as compared to 49.8 billion cubic feet equivalent in the previous quarter.

RIL's reported net borrowings also increased by INR127 billion to INR 713 billion as compared to September 2014 as company continues to invest in its ongoing projects in its energy and telecom businesses.

"We expect RIL's credit metrics to weaken for the fiscal year ending March 2015 as earnings weaken and borrowings increase. However, we expect improvements in credit metrics as new projects result in margin improvements over the next 2 years," says Halan.

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