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Equity Research: Reliance Industry Ltd
RIL is among the few large companies in India with a positive earnings revision cycle ahead, given the strong refining and gas environment. RIL has a huge upside potential of 25% from its current market price.
RIL is among the few large companies in India with a positive earnings revision cycle ahead, given the strong refining and gas environment. Reliance Industries Limited is engaged in refining, including manufacturing of refined petroleum products, and petrochemicals, including manufacturing of basic chemicals, fertilizers and nitrogen compounds, plastic, and synthetic rubber in primary forms. The company's segments include refining, petrochemicals, oil and gas, organized retail, and others. The Refining segment include production and marketing operations of the petroleum products. The Petrochemicals segment include production and marketing operations of petrochemical products, including polyethylene, polypropylene, polyvinyl chloride, poly butadiene rubber, butadiene, acrylonitrile, caustic soda, and polyethylene terephthalate. The oil and gas segment include exploration, development and production of crude oil and natural gas. The organized retail segment includes organized retail business in India. The ‘others’ segment include textile, special economic zone (SEZ) development, telecom or broadband business and media. We expect RIL’s outperformance to continue (RIL has outperformed the NIFTY by 21% YTD), given the upside risk to consensus earnings estimates.
Earnings estimates imply a sharp pullback in diesel and gasoline cracks from current record level, but RIL remains among the best positioned refiners globally, given: a) ability to buy and process arbitrage barrels; b) diesel heavy slate; and, c) export focus. RIL’s upstream business should benefit from rising domestic gas prices and higher volumes. While RIL's product hedging means there is unlikely to be a complete pass-through of spot cracks, overall we see the O2C business reporting improving profits for the next few quarters. While PE spreads remain weak, strong PX should result in steady Petrochem profits.
RIL underperformed the NIFTY in 2021 (RIL+19% v/s NIFTY+24%). While higher Oil and GRMs are a positive, we had earlier expected the global Tech sell-off to impact RIL’s consumer valuations negatively (Jio, Retail) and cancel out the near- term earnings upside. RIL's consumer valuations have held up well and with likely higher ARPU’s and further ramp-up of Retail footprint, combined with Renewables business optionality, the Non Energy Business valuations should hold up going forward even as Consolidated reported earnings (and hence cash flows) should improve materially from here on Refining and E&P. AGM expectations continue to center on potential de-merger/IPO of Consumer businesses: RIL’s AGM tends to be announcement-heavy and expectations run high in the run-up to the AGM and this year (like the last 3) centers on concrete timelines being announced for IPOs of the Consumer business. We do not expect any concrete timelines from this year’s AGM on the Consumer businesses IPOs (Jio, Retail), even though media reports (BL) have talked about IPOs of these businesses.
In our view, RIL is among the best positioned refiners globally in the current environment of strong product cracks. RIL’s refining strength comes from:
Underlying supply-demand pressures are leading to another rise in road fuel prices: Inventories of middle distillates—which include diesel, heating oil and jet fuel— across the developed economies of the OECD nations are at their lowest levels in more than 12 years. On the US east coast, stocks of diesel have fallen to levels not previously seen in data going back to 1981. Gasoline stockpiles in the same region are at their lowest levels since 2014. This shortage has pushed refining margins to record highs of $50/bbl in the Atlantic Basin, more than $65/bbl on the US west coast, and as much as $40/bbl in Asia (though Asia cracks have retreated to about $33/bbl since reaching record levels in late April when Japan diesel stocks began building from lows).
With margins at record levels, refiners have the kind of opportunity they have waited for: Unfortunately for consumers, many refiners in Europe and the US had already given up before this moment arrived. Even before the onset of COVID pandemic, major Western integrated oil companies had been selling or closing refineries, or converting them to biofuel processing or storage terminals. By 2019, as a result of the explosive growth in China’s independent oil refining capacity, the nation has gone from being a net fuel importer to one of the world's top ten refined product exporters. Its total gasoline, gasoil and jet fuel exports rose to 1.34 mbd in 2019, up 175% from 0.5 in 2012 and, in 2021, China officially surpassed the US as the world's largest oil refiner. Refiners in India and the Gulf had also forged ahead with capacity expansions. In total, almost 10 mbd of new capacity was due to come online by 2025 in India, China and the Gulf.
Not only are refining capacities lower in Europe and the US, feedstock mismatches reduce effective capacity even further: Sanctions on Iran and now Russia crimp the availability of diesel-rich, medium-gravity crude oils. Furthermore, the US ban on imports from Venezuela and Russia has tightened supplies of low-sulfur vacuum gasoil (VGO) and other residual oils which serve as supplemental feedstocks for more complex refiners. And although the light, tight oil produced in the US is in relatively abundant supply—even more so in 2H22 as US production growth accelerates—US refiners are optimized to run heavier crudes with higher sulfur content. Refiners can easily shift middle distillate yields to produce more diesel and less jet fuel, but, as air travel continues its post-COVID rebound over the rest of this year and the next, jet fuel demand will continue to tighten the global diesel balance and increasing total middle distillate yields can come at the expense of the output of gasoline. With both gasoline and diesel in short supply, refiners will be left with one option to produce enough fuel to meet demand: run more. But capacity utilization at operating US refiners is now running at 91.3%, its highest seasonally since 1998, and it is hard to see that utilization can increase much.
Without the spare capacity to process more crude into products in the US or in Europe, Western consumers will need to turn east: Before the invasion, Russia was the world's second largest exporter of oil products, shipping more than 2.9 mbd— including 1.1 mbd of diesel exports—more than half of it to Europe where half the cars run on diesel. While Russia has been successful in marketing its deeply-discounted crude, it has been having difficulties selling its refined products, with exports reduced by about 0.5-0.7 mbd. A decline in product exports combined with a 200 kbd drop in Russian domestic oil demand has resulted in Russian refiners cutting runs. Russia's idle primary oil refining capacity has more than doubled since March, rising to 1.4 mbd in April—almost 0.6 mbd above usual April maintenance— and is likely to stay at around these levels through the end of 2022. As a result, Europe’s diesel shortage has become a worldwide problem as shipments get rerouted. China, the second-largest refiner worldwide, has cut its refineries' export quotas by more than half this year in line with its plan to eliminate exports of transportation fuels by 2025 to achieve its net-zero goals. China’s refined oil product exports for the first four months of the year plunged 28% vs 2021 and were down 44% yoy in April.
Overall, It is projected that the oil demand will increase from 2.6 mbd yoy in 2022 to 100.2 mbd, 300 kbd below 2019 demand. Jet fuel still leads 2022 demand growth, increasing 1.32 mbd vs 2021 as travelers return to the skies, but gasoline is a major contributor as well at +0.57 mbd yoy (+0.24 mbd yoy in the US alone). Jet demand is likely to stay inelastic relative to price with downside risks limited to a resumption in COVID lockdowns outside of China, but, with driving demand elasticity climbing along with prices, risks to our global gasoline demand outlook are skewed to the downside as prices at the pump continue to set new records over the coming months. Even if US refiners run at max rates and cut fuel exports to minimums, cutting exports will further tighten fuel supplies in Latin America, keeping fuel prices on both sides of the Atlantic at these record-high levels and pushing them even higher. And even that scenario assumes we don’t lose any more refinery capacity. Not only is it possible that any refinery could go down unexpectedly for weeks at any time, 1 June marks the beginning of hurricane season. The NOAA is calling for a very active hurricane season of 19 named storms, 9 hurricanes, and 4 major hurricanes. If that assessment is correct, we should expect tropical storm activity similar to that we saw last year when Hurricane Ida knocked out as many as a dozen US Gulf Coast refineries and damaged the Phillips 66 Alliance refinery so badly that Phillips decided to convert it into an export facility rather than reopen it. With gasoline and diesel inventories at the levels we expect, any outage of this nature would send fuel prices to new highs.
Historical Financial:
Estimated Financials:
Source: Ace Analyser
Conclusion:
I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Stocx Research Club). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI Registered individual/entity and the above research article is only for educational purpose and is never intended as trading/investment advice.
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