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Monday, April 26, 2010

Reliance Industries: acquisitions could drive valuations higher

Shares of Reliance Industries Ltd (RIL) have underperformed the market by a wide margin in the past one year. But things have been slightly better since early March this year, as the markets have been enthused about the recovery in refining margins and the prospects of its oil and gas exploration and production business. RIL shares have risen by 10% since 9 March, compared with a 4% rise in the Nifty.

Against that backdrop, the company’s results for the March quarter, announced last Friday, are a bit disappointing. For the December quarter, RIL had reported a gross refining margin (GRM) of $5.90 (Rs262.55) per barrel, at a premium of $4 to Singapore refining margins. While the average refining margins in the Asian region rose sharply, RIL’s premium narrowed to $2.60 per barrel last quarter.

Due to the lower-than-expected GRM, profit from the refining business is considerably lower than analysts’ estimates. Analysts at Motilal Oswal Securities Ltd and Prabhudas Lilladher Pvt. Ltd provide segment-wise profit forecasts and they had estimated profit of the refining segment at Rs2,300 crore and Rs2,635 crore, respectively. RIL reported a profit of Rs1,986 crore for the segment, around 20% lower than the median of the two estimates given above.

The firm did slightly better than estimates in its petrochemicals business and profit at its oil and gas business was marginally lower than the estimates of the two brokerage. On an aggregate basis, operating profit was around 4% lower than estimates.

The divergence between estimates and reported profit was greater at the net profit level due to higher depreciation charges, which rose 21.4% sequentially to Rs3,392 crore last quarter. According to an analyst, with production levels in the oil and gas business increasing, the depletion of these assets is now happening at a faster rate. The net result was that reported net profit of Rs4,710 crore was around 8% short of consensus estimates.

As pointed out earlier, the street is likely to be disappointed and this is likely to reflect in RIL’s shares when markets resume trading on Monday. Of course, this will affect sentiment only in the immediate term and in the medium term, the stock’s performance would depend to a large extent on the performance of the exploration business.

The firm’s recent acquisition of a stake in Marcellus shale assets has enthused investors. With the company’s existing operations expected to throw up a lot more cash from this year, there could be more acquisitions and this could drive valuations going forward.

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