Inventory gains boosted RIL's refining margins: Experts

Petrochemical major Reliance Industries' first quarter earnings beat analysts' expectations on Friday with the standalone profit growing 4.4 percent to Rs 7,548 crore compared with preceding period. Revenue increased 7 percent to Rs 53,496 crore during the quarter from Rs 49,957 crore in preceding period. Gross refining margin surged to USD 11.50 a barrel for the quarter ended June 2016 from USD 10.8 a barrel in March quarter.Market experts Prakash Diwan, SP Tulsian, Deven Choksey and Sudip Bandopadhyay weighed in on the results.It is a spectacular performance, said Diwan. Inventory management has been part of the company's efficiency, he said, adding that the company has managed to offset the higher interest costs by cash on books. Petrochemical business can grow further, he said. Delayed launch of Reliance Jio is an overhang on the stock, he said. "I don't think the stock will get re-rated majorly."Choksey of KR Choksey Investment Management said the numbers are impressive. The gross refining margins have beaten all expectations, he said. The company's sourcing contract which has been secured at a lower price has given it an upside in margin, he said. Going forward, capacity expansion will play a larger role, he said. 

SP Tulsian stressed how major losses for the company came from its global operations. GRM's huge increase has come from inventory gains, he said, adding that the company has had a good show in the first quarter.

Agreeing with others, Bandopadhyay said the numbers are excellent. "Inventory gains are a contributor," he said. The company has efficienty managed its inventory well, he said, but it won't be able to repeat the inventory gains from one quarter to the next. The overseas assets have been a burden on the company, he said, adding that the company should get rid of those assets so that bleeding stops. "The game-changer will be Reliance Jio, he said.Disclosure: Reliance Industries owns Network 18 that publishes Moneycontrol.com. Below is the verbatim transcript of the discussion with CNBC-TV18.Anuj: Rs 7,546 crore standalone net profit, how do you look at it? Diwan: It is outstanding, no doubt, and it seems that expectations were too muted given the fact that it is way off the expected number. This is at the backdrop of the fact that we were expecting gross refining margins (GRMs) to be fairly lower compared to last quarter’s 10.8. So, I would definitely be very curious more than anything else to figure out where the magic has come from. Anuj: Refining is Rs 6,581 crore versus Rs 6,362 crore. The expectation was Rs 6,000 crore and they have delivered Rs 6,581 crore. So this is where the beat is coming from.Diwan: This is where the magic is. This seems to become a trend now, every time we expect GRMs to be tepid, there is a lid that has been put on to the GRMs and they say this is the best you can do and they still manage to outsmart the expectations. Primarily again this is going to be better inventory management and product mix and especially the heavy distillates is what ends up contributing very abnormally and the lopsidedness comes because of that particular product mix. As we get into the discussion and see the breakup that will get validated, but, Rs 6,000 crore and Rs 6,500 crore on just refining alone is a huge beat. Not only that, last quarter when Rs 6,300 crore was reported, we were rejoicing of sorts and this seems to be definitely something which will need to be explained on the positive side. Anuj: Two things, one is your view on inventory management and the fact that some part of the gains would have come because of inventory and second, the stock has not done much despite coming out with good numbers for last two or three quarters, do, you expect things to change Monday morning?Diwan: Let me first clarify the view on the bullishness that I demonstrated on the numbers. The reason is inventory management is also part of the company’s efficiency. At the end of the day, it is not like they have been so lucky that they ended up having Rs 47,000 crore worth inventory. Singapore GRMs at USD 5 per barrel plus and this at USD 11 per barrel is a huge chasm of management on their efficiencies. That speaks volumes given the kind of strength that company has always enjoyed at a scale like this. I agree with the fact that other income is not something that people would love to see so that is going to be a little bit of a questionable thing. However, again they have managed to offset the interest, the higher interest cost with the treasury that they manage because you have interest because you have borrowings, at the same time you have cash on your books and somewhere that is going to kind of balance out. The point is that the petchem business would still be the one that has headroom for growth whereas exploration has always been a little bit of question mark and that is kind of as Tulsian pointed out the losses are deepening out there. In the overall scheme of things, it is not something very significant as yet. So, my sense is the stock probably continues to be as robust as it has been but whether the market reads into these numbers as a thumbs up and looks forward to a better quarter going forward is what it is going to decide the stock price and to that Reliance Jio thing comes as a overhang. So, the whole point is till those things are clear on the basis of sheer core business efficiency, I don’t think the stock gets rerated very majorly but at least people won’t get disillusioned with these numbers on Monday morning and start wanting to get out of it.Anuj: I am sure you would have looked at the numbers. Your first comments. I am still scratching my head on where this refining performance is coming from?Tulsian: Let me just make the analysis I have been able to gather if you see the refinery has shown an earnings before interest, taxes (EBIT) of Rs 6,593 with a refining margin of 11.5. I wish to draw the attention here if you see on March 31 this is spoke in the afternoon also on March 31, 2016 company had an inventory of Rs 47,000 crore. Now inventory is largely comprising of crude and petrochemical segments.As I said that in this first quarter we have seen crude rising by 30-31 percent and if you take that 31 percent increase practically major portion of that will get enjoyed by the company on all the products. You just cannot say that maybe if you take a conservative estimates also at least Rs 30,000 crore of inventory of petchem and crude must be held by the company and even if you take that five percent also of that the extra gain which we get to see has come largely on that account because while calculating 9.8 as GRM for this quarter I have factored in USD 1 on account of the inventory gain.So, whatever the extra USD 2 or maybe about USD 1.5 has come this has come purely on account of the inventory gain. I am not prepared to accept that this is the result of efficiency but yes, the results on account on the refinery segment is really very good.Now, coming quickly on the interest if you see the interest expenses have risen to Rs 1,200 crore. For this quarter Rs 1,206 crore against Rs 855 crore for Q4. So, that means the major portion of capacity expansion may have been capitalised in this quarter and because of that the interest expenses have risen. And this is an alarming situation going forward that you will see the capital expenditure getting booked now by the company going here on and that will keep on increasing the interest burden.So, a straight jump of Rs 350 crore on account of interest. Now, that has got offset by the interest income incrase as well and other unallocated income of Rs 575 crore which must have come from the treasury operations because company book the major gain as a mutual fund investment or maybe other fund investment. So, that is Rs 500 crore must have come extra on that account. So, if you see the profit after tax (PAT) at Rs 7,077 crore I am referring mind it on a consolidated basis. While I had estimated it at Rs 7,075 crore. So, the PAT has exactly come where I have estimated it to be, Rs 7,075 crore and it has come at Rs 7,077 crore.So, overall excellent performance on GRM is largely on account of inventory gain which maybe to the extent of about USD 2.5 and I don\\'t think that we can extrapolate the same kind of performance. Though the margins have started improving slightly on the Singapore front by about USD 0.25 but I don\\'t think you can take this as a trend going forward for Q2 also but increase of the interest expenses, extraordinary huge income on account of other income or to the extent of Rs 500 crore I don\\'t think that will get liked by the market to a great extent.So, let us not go purely on the bottom-line and GRM, you need to individually analyse each and every item and in the afternoon as I said I am expecting the oil and gas exploration front to post net loss for the first time and I estimated a loss of Rs 110 crore on EBIT level on oil and gas. It has posted Rs 312 crore. That is also seen quite negative, because on a consolidated basis the major losses has come on account of the global operations, the US shale gas operations and all that. So, these are the concern, high other income of Rs 500 crore and losses of Rs 300 crore on oil and gas and on the exploration front and GRM huge increase which we have been seeing on GRM to the extent of Rs 6,600 crore has come largely on account of inventory gain.Anuj: The petchem number is absolutely in line with your expectations. Rs 2,900 crore, you were expecting Rs 2,910 crore. As a trigger for your company it is not done much over the last two quarters?Tulsian: Let me touch on petchem also. In fact there is a disappointment because first let us come on the topline. Topline in Q4 was Rs 20,915 crore and as I have said all the crude and crude derivative products have shown an increase in the realisation. So, obviously the topline should have been increased for the petchem segments which has in fact seen a de-growth of about Rs 200 crore on the turnover.Now, come on the petchem margin front the EBIT margin again I am referring it on a consolidated basis in Q4 it was 13 percent and in this quarter it has risen by 13.55. that means just 55 bps. And mind it one has to look to that there has been huge capacity addition on the petchem front and because of that the interest and depreciation expenses have increased because we have not seen any kind of capitalisation having taken place on Reliance Jio.So, whatever additions have happened or capex have happened on the petchem account and that benefit has not seen getting reflected. So, I would say that maybe petchem is flat to mild disappointment because the estimates of Rs 2,910 which was made by me, I am not saying my estimates should be adhered to, but that has not shown any kind of growth just as seen by 55 bps.And my point which I am repeatedly harping is of the increase in the crude prices by about 30-31 percent in this quarter. I am referring to the point which Prakash has made that this is an efficiency, this is wrong. When you are comparing the Singapore benchmark which was at 5.20 you are not factoring in the inventory gain, you don\\'t know what company will be having what kind of inventory. So, it is the question of calculation of inventory gain which no analysts will be going to get that figure.So, it has to be presumed that when you are having a chunk of inventory of Rs 47,000 crore on March 31, 2016 it is a given, it is known fact if crude has risen by 32 percent a large chunk of that which has got added into the GRM.Second point, coming on Deven\\'s point that they are procuring crude at lower price so that ought to have increased the GRM further by about USD 1.5. so, I don\\'t think that is also seen getting reflected. So, this is purely the magic, the surprise has come only on the GRM, only on the refinery and that has happened largely because of the inventory gain.Q: We have USD 11.5 on gross refining margin (GRM) and we have segmental performance refining earnings before income tax (EBIT) of Rs 6,518 crore. How are you looking at these numbers?Choksey: At the outset definitely the numbers are very impressive and the GRMs have probably beaten all expectations. In fact, yesterday with my analyst when I was in dialogue, I was referring to him on the same subject that the kind of crude the Iraq crude that they are buying at a lower value, I guess I think the refining margins would be spectacularly high and probably I think that’s what is proving the point. Of course, I am yet to see the full numbers and probably workout on the entire margin and numbers.Considering the fact that I think one of the module of refinery was under maintenance like it was said in the last year’s first quarter also. I think the numbers have probably come up very decent. I need to look at the volume processed exactly, but it appears that the numbers on the refining margin front are definitely are more than satisfactory and that could possibly show the way forward that if they end up procuring the heavy crude at a lower values, they could possibly the winners in this entire region as far as the refining margins are concerned. The fact that the Singapore GRMs have been at around average USD 5, I guess this is a respective number that one has seen in this quarter from refining side.Q: Does that change things a bit because large part of this is because of inventory gains. How do you expect the stock to react Monday morning?Choksey: I think I do agree gains on the inventory side, but when you refinery going under the maintenance and you are increasing the throughput in a given period of time, I think some amount of inventory carrying is a natural thing, because this situation was not different even the last year that is the first point which I would like to put up, but the main important point which I was driving home is kind of heavy crude that they are procuring particularly from the Iraq front, I think the crude that they procured they have gain certainly significant amount of margin on that front and that’s what my point is that I think if you have a sourcing contract at a lower price probably higher crude oil wouldn’t deter much as far as your ability to produce higher amount, so I am of the view here that I think as long as the company can procure the heavy crude at a lower price probably you would continue to see better performance on the margin front compare to Singapore GRM even in future contract also.Q: On face of it, it looks like a really good set of numbers. However SP Tulsian has raised red flags on inventory gains and higher other income, what is your prima facie take on the numbers?Bandopadhyay: The numbers are excellent, nobody expected these kind of GRM number. They have beaten all possible estimates on the GRM front and it is quite commendable the way they have managed. I take SP Tulsian\\'s point, I think definitely inventory gains is a significant contributor. I think we will see this inventory gain issue being played out in case of lot of upstream and downstream companies in these quarters results. While these companies had taken a inventory loss in the earlier quarters they will have a gain in this quarter. Reliance is definitely a beneficiary of that considering the amount of throughput they have.I think one point which is relevant is that we should not always compare Reliance GRM with Singapore because inherently Reliance has a capacity to refine different grades and inferior grades of crude. That definitely gives them an edge over most other refineries across the world and their GRM will most probably always be higher than the standard which is provided by Singapore or other benchmarks available. While USD 11.5 definitely has a significant inventory component, I won\\'t write it off or I won\\'t say that this still has got problem or they have just got lucky and that is how they got this. It is an efficient management of their inventory. The question whether they will be able to repeat it quarter on quarter? Definitely not. Inventory gains depends on how the markets are moving, so next quarter what happens one cannot comment on that right now.On a fundamental note there are couple of other red flags which one has to worry about. The overseas assets have been a millstone around their neck for a long time, I think the management realises that, they have been disposing of on a piecemeal basis. However they need to do more, they need to get rid of those assets or do something about it so that they start contributing or at least the bleeding stops on that account.Also if you see the Reliance Jio thing, I think the whole world is probably waiting for the launch and related facts and figures. One has to see when that happens and the management commentary around it. Of course it is a matter of huge concern Rs 1,50,000 crore is the amount deployed and that will get capitalised and somewhere the precisions will start will start getting reflected. How they take that forward, how they handle the business is going to be of great concern and the future of Reliance share to a great extent will depend on how Reliance Jio performs going forward.Petchem by and large slightly lower than expectations but by and large it is there. I agree to what Prakash Diwan was mentioning, there is a significant potential for generating higher profit margins from that business. So, that will definitely get played out over the next few quarters. I think the game changer will be Reliance Jio one way or the other. Q: How do you expect the stock to react Monday morning and in the near term do you think the underperformance continues?Bandopadhyay: Monday morning I don\\'t think the stock will get too much of a reaction either negative or positive. It did beat the expectations but there are certain negatives. So, on the balance I think stock will keep hovering around the same range. However if you talk about the medium to long term to a great extent it will depend upon how the Reliance Jio launch happens.If the Reliance Jio launch is successful, Reliance should be in for good time as far as the stock market is concerned. It will be perceived as a huge success, not only perceived I think it will add also significantly to Reliance\\'s bottomline and the overall weight in the market.So, to a great extent Reliance Jio launch will determine the future trajectory of Reliance shares as well. Other businesses barring the oil and gas and overseas assets are by and large doing well. There are things to be done on the petchem side, may be inventory has given them a huge benefit in this quarter in refining, that may not be there in next quarter but overall these are all stable businesses, improvement scope is there but they will not be able to produce miracles from hereon.It will be Reliance Jio which is a huge chunk and that will set the trajectory for Reliance in the future.