RIL refining margin to reach $11/bbl ahead: JM Financial

Reliance Industries will announce its fourth quarter earnings today.

Mehul Thanawala, VP, Research-Oil & Gas, JM Financial expects the oil and gas major to report flat Q4 gross refining margins (GRMs) at USD 9.5 per barrel versus USD 9.6 per barrel in the previous quarter. "In the long run one can expect refining margin to be at USD 11 per barrel. We are valuing RIL at a fair value of Rs 848, almost close to Rs 850 per share. Thus, valuation looks attractive," he said in an interview to CNBC-TV18. Also read: RIL to do better in Q4, bullish on Tata Power: Tulsian Below is the verbatim transcript of his interview to CNBC-TV18 Q: What do you expect RIL's gross refining margin (GRM) to look like this quarter? A: We are expecting RIL to report flattish GRMs. We are actually building in USD 9.5 vis-à-vis USD 9.6 in the previous quarter. The primary reason is that during this quarter RIL had taken a shutdown for almost four weeks in one of the crude distillation units (CDU) out of the four that they have and also some associated downstream units. This would have tweaked the output slate compared to their normal output slate and also would have resulted into slightly lower operating rate compared to the historical rate that we have been seeing. Based on it, we are building in slightly lower, while the refining margins in general were stronger. Particularly for petrol we saw spreads going as high as USD 18-19 vis-à-vis about USD 10-11 that is historically there. What we saw during that quarter was a sudden spike to about USD 18-19, but that is because of the slate we are building in slightly lower at USD 9.5 as we mentioned. That slate had tweaked and petrol anyway is about 10 percent for RIL. So, it does not impact refining margins fully. Based on these two we are building in USD 9.5 as the refining margins for the quarter. Q: What about the petrochemical side of the business, what are the expectations there? A: Petchem historically has been one of the cash cows for the company. Broadly the EBITDA has been between Rs 10,000 to 15,000 crore over last 6-7 years since Indian Petrochemicals Corporation Limited (IPCL) was integrated. So, overall for petchem we would see a flattish kind of quarter again. We expect that they will be able to report almost similar levels of EBITDA as the previous quarter. I do not see a surprise over there. That is because of the change in gasoline and refining margins. There would be some tweaking with the petchem margins but broadly stable again over there. Q: How are you positioned on the stock itself? Are there any potential triggers either in the form of today’s earnings or the impending gas price hike etc; that could take the stock back to that Rs 920 level that we saw at the start of the year? A: We continue to believe that valuations for Reliance should be based on mid cycle margins, which is about USD 9 GRM. Also similar level of EBITDA that we have seen currently that is about Rs 12000-13000 crore of annual EBITDA from petchem and give a multiple based on the peers. Now based on that we are valuing RIL at a fair value of Rs 848 almost close to Rs 850 per share, which is where the stock is currently at 10 percent lower. So, valuations are attractive. However, in the near term if we see triggers as far as gas price is concerned gas price is not going to have an immediate benefit on RILs earnings. Reason being, 1) it is a very small part now relative to the entire business refining and petchem. 2) The USD 4.2 even if it moves up to USD 5.6-5.7, the earnings multiple, government share does go up in future. So, gas price hike does not impact RILs valuations materially. May be 1-2 percent plus minus, but broadly what it also does is that it leaves scope for higher future production. When the gas prices increase the recovery rate from the same block can be increased. Therefore, if we see in a longer term the gas price hike will be positive for RIL. We don't know how much of the impact will be there on the recovery rate because we still don't know the price. However, yes street is building in 1-2 percent kind of benefit, which can come in if gas price hike goes. We are very positive on RIL with a slightly longer term view because of their petchem expansion and refining margins. Last time also we had been mentioning that we continue to value Reliance based on USD 9 GRM as the mid cycle refining margins. If we look at their petcoke gasification unit, they are going to convert petcoke to gas and use it to replace LNG and other more expensive fuels. They are also simultaneously going to extract ethane and butane, which is there in the flare gas and is set for power generation. They are going to use that to convert it into petchem. Both these will be very beneficial for RIL in the long-term. We are expecting that with petchem capacities being doubled and the cost being lower based on the waste gas etc, their petchem EBITDA will more than double. The mid cycle EBITDA would be somewhere around Rs 12000-13000 crore. So we are expecting that to more than double over a three year time line. Similarly, because of the petcoke gasification there will be a sharp increase in the refining margins by USD 1.5-2. The USD 9 mid cycle refining margins that we are talking about currently will get re-rated to about USD 11. That is where one will see the benefit of the current valuation attractiveness coming in. We are recommending it to investors with a slightly longer term view. Valuations are certainly attractive, but we don't expect that there will be an overnight jump.