Weak refining margins to put pressure on RIL shares: IIFL

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Weak refining margins to put pressure on RIL shares: IIFL

Prayesh Jain of IIFL gave his take on Reliance’s results on CNBC-TV18. He says that the stock is likely to underperform in the near-term, given its earnings estimates have high leverage to gross refining margins (GRM) and GRMs may not recover as fast as expected.

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Excerpts from Markets Midday on CNBC-TV18 Watch the full show » ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets Reliance BSE | NSE 24/05/12 Are Mutual Funds betting on Reliance?

Prayesh Jain of IIFL gave his take on Reliance 's results on CNBC-TV18. He says that the stock is likely to underperform in the near-term, given its earnings estimates have high leverage to gross refining margins (GRM) and GRMs may not recover as fast as expected.

Below is the edited transcript of the interview. Also watch the accompanying video.

Q: Would you say that the bad news in terms of margins, performance, FX losses, GRMs... all that is sufficiently priced, and Reliance is unlikely to dip further?

A: We feel that post the results, the stock will continue to underperform in the near-term, considering that there are still lingering concerns over Europe and the demand outlook is not that great. GRMs might not recover as fast as we were earlier expecting and Reliance's earnings estimates have very high leverage to GRMs. In that sense, the earnings risk is pretty high in the near-term. So I think that the stock will underperform in the near-term.

Q: A whole host of brokerages like Goldman Sachs, CLSA, even Religare, told us earlier in the morning that perhaps this is the worst that Reliance has seen on GRM front at USD 6.8 a barrel. Purely on this parameter where are you now, do you expect more weakening of the GRMs from here?

A: Looking at the overall scenario, Reliance for the first time has reported GRM less than Singapore GRM. What I am talking about is weakness in GRMs is at the global level. If GRMs are going to decline at the global level, and if it is led by spreads like the gasoline spreads or the naphtha spreads, then definitely Reliance GRMs could see some more weakness. The risk towards that is pretty high considering that petrochemical demand has been on the lower side and with global economy not recovering at a decent pace, the demand is likely to remain weak. Further, low-cost gas-based capacities have been added in Middle East and that has created much more impact. So in that regard, weakness might continue at least for the next one or two quarters.

Q: There is FX loss of about Rs 3,500 crore. While nobody could have really bought protection for a 20% or a 17% fall in the rupee, things will perhaps even out by March. So do you think that March quarter could spring surprises purely because you have a better balanced forex and perhaps some of the losses will be written back? By March, would you call a buy because of certain other trimmings?

A: By March definitely things might improve for some aspects of the businesses, but when you talk about Reliance's refining segment which contributes more than 70% of the top-line, we are going to see a shutdown for around two to three weeks which might impact some secondary units as well. So that might create an offsetting impact and that might add to the concerns in terms of earnings for Q4.

Q: What is your target price on the Reliance and secondly, if we do assume that the whole amount of Rs 10,400 crore is spent on the buyback, what does this do to the EPS?

A: We although have a target price of close to Rs 900 for the stock, but what we feel is the stock will underperform in the near term because of the concerns that I mentioned and possibly you might get a good entry price at some time ahead in the next six months. We would prefer to buy at those levels rather than at current levels. With respect to buyback, a complete buyback if they do, you might see positive impact on EPS of around 2%- around 50 bps on ROEs.

Q: On the E&P front where are you because the company seemed a little more hopeful about the KG-D6 prospects from hereon? In terms of a timeline according to your assessment, when do you think the ramp-up in production may happen?

A: That's very difficult to say considering that capex is under arbitration with the government. Unless that is resolved, it's very difficult for the company to incur any capex or give any guidance in terms of production. That is a critical thing and that would take anywhere between six months to twelve months before the arbitration is over or possibly even beyond that. So unless the arbitration is out of the way, I don't think that the ramp-up would happen. So we might see another one year of flat kind of production levels for KG-D6.

Q: What are you factoring in by way of GRMs in the current quarter and maybe in the next as well, what kind of lows are you expecting? You are saying that target price is Rs 900 but there will be more attractive levels to buy. So is it a sub Rs 700 level that you will look at?

A: If the stock moves below Rs 700 levels, we will definitely be buyer of the stock and in terms of GRMs, it is too early in this quarter to comment on, but what we are factoring is around USD 7 per barrel which is flat levels as compared to what they reported in Q3. Next year, we are expecting it to be in the range of USD 7.5 per barrel.

Q: Petchem EBIT, would that also improve in the current quarter?

A: Petchem EBIT I think so be at a flattish levels sequentially considering that there have been gains in terms of dollar to some extent in this quarter, but if that reverses and the rupee strengthens in this quarter then you might see some gains getting offset.