RIL: Eye on the core

Analysts believe the company's investments in core businesses could double operating profit over 5 years

Reliance Industries (RIL) would like the market to believe that it has not taken its eyes off the core business. Over the last 12 months, the company has made investments in new businesses, while the core business has come under stress. Most analysts became sceptical as near-term triggers were missing. So when Chairman Mukesh Ambani announced at the annual general meeting that the company would double its profit to Rs 70,000 crore by FY17-18, the market did not react.

The reason has been lacklustre operating performance over recent quarters, as demand started slowing. The biggest concern most investors have is of falling gas production from its KG-D6 block. The run-ins with the Directorate General of Hydrocarbons on a variety of issues also made investors jittery. Over the past month, however, the negative perception around the company began to diminish. The upgrade cycle started after it got its capital expenditure budget of $1.06 billion for FY13 cleared.

To improve profitability, the company plans to cut costs and improve volumes. To achieve this, Goldman Sachs, in its recent report, says: “RIL is planning to reinvest its operating cash-flows over FY12-17, with 82 per cent of that going back into its core business, which would improve its long-term cash return on capital invested profile.” The company has planned to expand the capacity of its downstream business by 60 per cent. CLSA, which upgraded the stock to ‘Outperform’, says the $12-billion downstream expansion will boost petchem capacity by 60 per cent and bring much-needed volume expansion after a three-year hiatus.

The other long-term trigger for the stock is the petcoke gasification project, which will add $2.5/barrel to the refining margins. CLSA’s analysts are also enthused by the refinery off-gas cracker that will produce ethylene at one of the lowest costs ($400/t) in the world. “Full commissioning by FY16 will add $3.5 billion to FY17 Ebitda (earnings before interest, taxes, depreciation and amortisation), even on our mid-cycle margin assumptions,” the CLSA report explains.

Not all believe this theory. Analysts at Standard Chartered Securities have a cautious view on Asia’s refining sector outlook, as rising and cheap shale oil supply improve competitiveness of the US Gulf Coast refineries and potentially threaten exports from Asia. Accordingly, the brokerage has reduced the Singapore refining utilisation rate and margins to $5.5/barrel for calendar 2013 ($6.5/barrel) and cut RIL’s margins to $7.5/barrel for FY14/15 ($8.0/bbl).