Reliance Industries: FACING A HOST OF WOES

After commissioning two mega-projects, Reliance Industries has hit a few roadblocks which could affect its profitability

Although Reliance Industries (RIL) finally succeeded in commissioning its megaprojects — natural gas production from KG basin and Reliance Petroleum refinery — they both seem to have run into a stormy weather. A large chunk of the KG basin gas continues to remain embroiled in legal hassles, while the RIL-RPL merger may get delayed due to shareholder objections. The recent Union Budget carried some bad news for the company, the global outlook for its business remains weak and its other businesses — Retail and SEZ — are going nowhere. The scrip has already lost a sixth of its value over last one month, but in view of these recent developments the valuations still appear rich and long-term investors should consider buying it only on dips.

RECENT EVENTS
Over last three months, RIL has commissioned his two mega projects – RPL refinery and KG basin gas – involving investments of around $18 billion. However, since then the things have progressed adversely for the energy giant. The Mumbai High Court granted an unfavourable verdict to RIL in its row against RNRL over the supply of 28 million cubic meters per day (MCMD) of natural gas at a price 44% lower to its current price. The matter is now being debated in the Supreme Court. The company is also fighting a similar court battle against the power major NTPC over another 12 MCMD of gas. At the same time, the company’s proposed merger with Reliance Petroleum is getting delayed following objections raised by some shareholders. The Union Budget for FY2010 introduced income tax exemption on production of natural gas, however, restricted it to blocks awarded under the 8th round of NELP. This deprived all earlier blocks — including RIL’s KG-D6 block — of tax exemption. To add to the woes, the Budget also proposed an increase in the Minimum Alternative Tax (MAT) to 15% from earlier 10%. And while the company is battling these odds, the business environment for refining as well as petchem continues to weaken. RIL’s only solace is thatRNRL’s power plants are not yet ready, which would allow it to sell natural gas at current prices for next 2-3 years.

BUSINESS
The company currently operates 33 million tonne per annum (MTPA) refinery at Jamnagar and has recently commissioned another 29 MTPA refinery under Reliance Petroleum. With both the refineries running concurrently, they now represent world’s largest single location petroleum refining complex. As the new refinery is set up in SEZ, the company has surrendered its status as an Export Oriented Unit (EOU) from April 2009. Over last few years RIL has entered aggressively in organized retail opening around 900 stores across 80 cities - an industry, which is witnessing entry of too many players and low profitability. The company is developing special economic zones in Haryana and Gujarat –another line of business, which has fallen out of favour.

GROWTH DRIVERS
The only hope for incremental growth comes from the company’s portfolio of E&P blocks. It is investing in exploration blocks in India as well as abroad and has also bagged a coal-bed methane (CBM) block. The potential hydrocarbon discoveries from these blocks will add value to the company. The newly constructed refinery, being more complex compared to the first refinery, will help command a better margin for the company. The company’s full integration from petrochemicals to refining to E&P will allow it to perform better in the times of uncertainty.

FINANCIALS
For the year ended Mar 09, the company reported a net profit of Rs 15607 crore marginally better than previous year afte.r removing the extraordinary items. The company’s operating profit margins weakened reflecting the weak economic conditions. The capacity utilisation at the company’s refinery too came down in the second half of the year with weakening gross refining margins. The company, which reported $15 a barrel GRM in FY08, could post only $12.2 in FY09. Similarly, the production of polymers too was 9% lower in FY09 at 3.07 million tonne.

VALUATION
At the current market price of Rs 1934, the scrip is trading at 19.4 times its earnings for the year ended March 2009. However, its per share earnings (EPS) is set to jump to Rs 130 for FY10, which discounts the current market price by 14.9 times.