RIL blockbuster numbers to continue into H2; stock to gain: Pros

With the Petrochemical major Reliance Industries beating street estimates with its second quarter performance, most market experts expect the stock to trade in the positive tomorrow.The standalone profit of the company rose 2 percent sequentially and 17.9 percent year-on-year to Rs 7,704 crore with gross refining margin coming in at USD 10.1 a barrel.Market experts SP Tulsian of sptulsian.com, Deven Choksey, Managing Director at KR Choksey Investment Managers, Prakash Diwan of prakashdiwan.in, Sudeep Anand, Analyst at IDBI Cap Mkts & Securities, Prayesh Jain, AVP-Research at IIFL are all upbeat on this better than expected performance of Reliance Industries and believe the good show will continue in near future.Tulsian believes the beat on the petchem EBIT margins has compensated for the fall in refining margins.The petchem segment will be the real kicker for the company to grow in H2 of FY17 because you will be seeing huge volume growth.Petrochemical business in Q2 registered a 7.3 percent growth YoY at Rs 21,293 crore with EBIT (earnings before interest and tax) growing 38 percent to Rs 3,464 crore and margin expansion of 370 basis points at 16.3 percent. While the gross refining margin came in at USD 10.10 a barrel during the quarter against USD 11.5 a barrel in preceding period and USD 10.6 a barrel in Q2FY16. It was ahead of estimates of USD 9.5 a barrel. While the petrochemical EBITDA margins stood at 16.3 percent for the quarter.Choksey believes the company has  managed to deliver both in terms of volumes and petchem margins. The gross refining margins too were in line with their estimates, says Choksey. "The company has shown better performance in terms of gross refining margins. Given the higher crude oil prices and given their ability to source at a lower price heavy duty crude, the GRM in the third and fourth quarter should remain high."According to Anand the overall numbers were in-line with their expectations.Echoing Anand, Jain too says the numbers beat their estimates on most fronts. While refining margins came in weaker than expected the low interest cost made up for that disappointment, says Jain. Below is the transcript of guests interview on CNBC-TV18 analizing RIL’s second quarter performance. Prashant: I have number of USD 3 billion in terms of incremental operating profits because of the 4 expansions in the petrochemical segment which Reliance is undertaking and which are very close to commissioning now. The incremental operating profit I have is from a Citi analyst, do you have any thoughts on this because this will meaningfully change the overall composition of Reliance earnings from FY18 onwards I am assuming?Tulsian:That is what I have been continuously stressing upon. If you see the capex again, capex in this Q2 has been seen lower at Rs 17210 crore which was at Rs 26690 crore in Q1 of FY17. That means the spillover will be taking place and I have been repeatedly saying that two of the biggest capacity addition will be of paraxylene of about 2 million tonne which we are likely to see getting operational maybe in Q3. I won't be able to quantify but it is definitely going to surpass the USD 4 billion. If you take the ballpark as I said Rs 26000 crore was the capex in Q1 which fell to Rs 17210 crore in Q2. So, I won't be surprised to see a major investment of that is going in the petchem segment. So, you don't have much in the refinery except maybe pet coke gasification plant and all sort of things. So, I won't be surprised and that is what I have been repeatedly stating that the petchem segment will be the real kicker for the company to grow in H2 of FY17 because you will be seeing huge volume growth. I felt that maybe 10 percent growth of the volume must have been seen in this quarter which has been infact exactly at about 5 percent. So, the major expansion benefit of petchem will be seen in H2, it will be difficult to crystallise how much will be in Q3 and how much will be in Q4 and FY18 will obviously be having the full effect of the petchem expansion.Varinder: What are your first thoughts on the Reliance Industries results?Choksey:I think the overall results have come much in-line with expectations as far as we are concerned. We had basically kept the gross refining margins (GRM) to remain at around USD 10.10 and above per barrel; I think it has just come in at about USD 10.1 per barrel so it is largely in-line with our expectations.Our larger premises of calculating the GRM I think before the result was that they have shifted to a very heavy duty crude from Basra crude and that has basically resulted in giving them a significant amount of advantage on the price even though in this quarter the crude oil prices have moved up. So that has got an advantage as far as they are concerned.We have also factored into account the higher amount of petrochemical contribution because though I don’t have the exact number of volume that they have produced, but going by the estimated volume of 7.1 million metric tonne, I would think they have basically scored largely on the volume front on the petchem side.So, both these business units have actually delivered, one of the margin side and one on the volume side along with the margin in the petchem. So, I think that is where we find that the company’s performance is largely satisfactory and probably has met the expectations.Varinder: What could be the stock reaction in the morning as per you?Choksey:The company has shown better performance in GRM. My reading says that given the higher crude oil prices and given their ability to source at a lower price heavy duty crude, the GRM in the third and fourth quarter should remain high.I think in the last quarter they should also have the reflection of the petcoke gasification project into the new capacity that they are commencing. So, certainly that could be a trigger point. I would rather think that the company will announce their commercial operations of the expanded capacity in the refining segment either in this quarter end or maybe I think beginning of the fourth quarter, I think they should be starting the new refining capacities. So, that is what I believe. I think the stock should react favourably according to me.

Varinder: What are your first comments on the Reliance Industries numbers? Sudeep: If we look at the broader numbers, revenue is ahead of our expectation of Rs 561 billion. So revenue is definitely ahead of expectation.  EBITDA is in-line with expectation. Our expectation was around Rs 107 billion and they have reported Rs 106 billion. If you look at the petrochemical side, we had assumed a 15.2 percent of EBIT margins while they delivered about 16.3 percent. So, even on an absolute number, we had assumption of Rs 33 billion for petrochemical EBIT while they had delivered about Rs 34.6 billion. We will have to check for the gross refining margin (GRM) and all. Varinder: GRM is at USD 10.10 per barrel. Sudeep: Our expectation was USD 10.4 per barrel so slightly below expectation. However, on EBIT front we had expectation on Rs 59 billion which was around 10 percent fall quarter-on-quarter (QoQ) basis.

Prashant: What are your first thoughts on Reliance Industries numbers? Jain: The numbers are definitely a beat on our estimates. We were expecting the PAT to be around Rs 7,420 crore; they have delivered Rs 7,700 crore. The main beat has come from the petrochemical segment where we were expecting the EBIT to be in the order of around Rs 3,000-3,100 crore odd and they have delivered Rs 3,464 crore. So, definitely there is a beat. Refining, slightly weaker than what we were expecting but the lower interest cost has made up for that disappointment. So, overall, net-net a good set of performance yet again by Reliance.Prashant: What is the sensitivity to oil prices themselves for Reliance’s refining segment? I remember late 2014 when oil prices started falling, actually they collapsed from that point, many thought that the margins also will come under pressure but they did not. FY16 turned out to be pretty good. We have the opposite situation now, oil prices are on the uptrend.Jain: We have to see as to what was the reason why the crude oil prices collapsed and now why the crude oil prices are rising back. It is all supply driven. The demand side of the equation is not changing materially. The demand is not dwindling at a very sharp pace or is not growing at a very alarming pace. The demand side equation is not changing.So, if the crude oil price rises from here there is a possibility that the GRMs might come under pressure for a player like Reliance as well because the petroleum products demand is not changing materially. Varinder: How do you see Reliance Industries reacting in the morning after these numbers?Diwan: Couple of things that very clearly seem to be -- if you see the stock, for the last 15 days, ever since we saw beginning of this series, there was a little bit of a firmness that started off. As we got closer to the result date, there was a little bit of a tapering off or softness that came in because the numbers were expected to be fairly soft especially on the frontline gross refining margin (GRM) numbers. However, these numbers very clearly will make sure that the stock again gets back into a little bit of firmness given that there is no disappointment.The petchem is just the beginning of a huge change that we will start seeing in the next 8-12 months and it is just going to improve. Now my only concern there is that there is a statement by the chairman saying Reliance Jio might also extend the free services period because of the issues that subscribers are facing on connectivity due to interconnection problems which means that, that side of the business will continue to be a little bit of a pull. So, people will want to see clarity on that segment which should not become a drag for too long.Visibly that was suppose to be beginning on January 1 but if that were to extend, it kind of makes sure that the benefits from petchem improvement, improvement in refining margins in quarters coming ahead will probably be negated. So, my sense is the stock will probably see a sentimental resumption of that move which we saw, not dramatic, but it will definitely be positive. Prashant: Do you suppose these results and some of the talk around the core business expansions etc will move the conversation on Reliance and how people view Reliance as a stock away from Jio etc because one complaint has been cash usage policy, Jio etc. We are hear talking about refining, petchem the old core businesses of Reliance?Tulsian: I don't think that the cash usage is being talked now. I have been maintaining this for last maybe 6 months that where is the cash with the company. They have Rs 1,89,000 crore as debt and cash equivalent of Rs 82000 crore as on September 30 2016. So, that means the company has a net debt of Rs 1,07,000 crore. So, it is futile and senseless to talk that company has surplus cash and why should we talk of the cash usage policy though the company is making good money by deploying the money. In fact I have never agreed with this kind of concept that on one hand you have Rs 2,00,000 crore borrowing and on the other hand you have Rs 1,00,000 crore as surplus. So, I don't think that the discussion or the debate point of cash usage will continue to be there.Secondly, Reliance Jio will definitely be a big hangover because if you have seen the statement of Mukesh Ambani, he has said that Rs 2.5 lakh crore will be the investment. We have all along been estimating an investment of about Rs 1.5 lakh crore and a major reflection of that will be seen in FY18 because I don't know what treatment of the interest, the amount capitalisation will be given in Q4. Logically that should be booked in Q4 where we will be seeing the huge interest and depreciation on that Rs 1.5 lakh crore also getting booked in Q4 while it will not be having the matching margin or the Reliance Jio business.So, if you take whole of FY18 I estimate that Reliance Jio business can give them a topline of Rs 70000 crore and even if I take 30 percent as the margin which is very ambitious, they will be having Rs 21000 crore as the EBIT. On that if you knock off the interest and depreciation, Reliance Jio will definitely be a hangover. I don't think that that will really be contributing any significantly to the bottomline. So, in that situation petchem - the old core business will keep driving the Reliance at least for FY18 and maybe even in FY19 because I don't see any clarity from the Reliance Jio business adding to the bottomline significantly for next couple of years. They will keep contributing to the topline but topline doesn't have any meaning if your bottomline remains stagnant or that gets contributed from your core business of petchem and refining on which I continue to keep the very bullish and positive view. Varinder: Do you also share the same thoughts that for the next two years at least Reliance Jio will not generate any cash in terms of profitability for Reliance?Diwan: It will start generating cash hopefully from January 1 but as Mukesh Ambani mentioned sometime back that they also expect that business to throw up margins in the mid teens; if we recall that is what he mentioned, of course no timelines were indicated but as SP Tulsian is saying, the interest burden will not make it profitable though it would start generating that kind of cash and we are talking about that 100 million subscriber base that is critically the mass that you would need to reach that size of revenue.So, I would probably start seeing that clarity come mid FY18 and that is maybe same time next calendar year, that is when your visibility would start improving and people would want to give it some sort of a discounting positive or negative. However, at this point, the petchem business is probably undervalued in the stock if you ask me; that is what is coming out very clearly. If refining were to improve and if its correlated to crude firming up which is happening as a trend towards the latter half of this quarter, very clearly going forward if crude supplies at higher levels were to come into and with this kind of throughput which is almost 120 percent of capacity, you are talking about better margins or at least retention of the same kind of margins and improved petchem volumes and pricing.So, there you have a very clear underrated stock from the core businesses. Reliance Jio remains an enigma for some more time. It has been an enigma for the last one year; it will continue to be another 1-2 years. So, I don’t think people will get so worried about it at this point in time but the stock is undervalued from the petchem expansion potential. Disclosure: Reliance Industries, which owns Reliance Jio, also owns Network18, which publishes Moneycontrol.com.