Singapore Complex GRM corrects sharply: The gross refining margin (GRM) of the Singapore Complex has fallen sharply to around $2.4 per barrel from $5.6 per barrel at the end of Q3FY2012. The correction in the Singapore GRM was on account of contraction in the gasoil crack. Looking at the severe drop in the Singapore Complex' GRM we believe RIL may post a sequential drop in the GRM in its Q4FY2012 report card. We have factored GRMs of $7.5 and $8 par barrel for FY2012 and FY2013 respectively. With a drop of every $1 per barrel in the GRM, our earnings estimates for FY2012 and FY2013 carry a downside risk of 3-4% for RIL.
Gas output at KG basin falling continuously; likely to reach 27mmscmd by FY2013: The gas output at the Krishna Godavari (KG) D6 oil field has been declining for more than a year now and the field is currently producing 34.5 million standard cubic metre of gas per day (mmscmd) compared to 53-54mmscmd a year ago. According to the management guidance in the media reports, the gas output at the KG basin is further expected to slide to an all-time low of 27mmscmd by April-May this year due to issues with the reservoir and to about 22mmscmd by FY2014. In our estimates for FY2012 and FY2013 we have factored in gas output of around 40mmscmd. Hence with the likely drop in the gas output to around 27mmscmd in FY2013 there is a downside risk of around 3% to our FY2013 earnings estimate.
Petchem margin under pressure with increase in naphtha price: The petrochemical (petchem) business, which accounts for 20% of the revenue and over 35% of the EBIT, is facing severe margin pressure. For M9FY2012 the company has posted over 360-basis-point contraction in its EBIT margin from the petrochemical division. Further, with the increase in the naphtha price (up 18% in the past two months the margin pressure of the petrochemical division is likely to increase.
We maintain our earnings estimates and would revise them after Q4FY2012 results of RIL: A few negative developments like the fall in the GRM, the lower than expected output from the KG basin and the margin pressure in the petrochemical division could be downside risk to our earnings estimate for FY2012 and FY2013. However, we maintain our earnings estimates for FY2012 and FY2013 and would revise them after the announcement of the Q4FY2012 results of the company. Further, in this note we are also introducing our FY2014 estimates with the earnings per share (EPS) estimate at Rs71.4.
Outlooks In order to factor in the recent negative developments of falling GRM, lower than expected output from the KG basin and margin pressure in the petrochemical division, we are downgrading our valuation multiple in case of its refining and petrochemical businesses. We thus arrive at a revised price target of Rs890. However, we believe the ongoing buy-back programme to provide support to the stock price and any positive development in terms of an improvement in the GRM and the petrochemical margin could be positive triggers for the company. Currently, the RIL stock is trading at 12.8x and 11.6x of FY2012 and FY2013 estimated earnings respectively. We maintain our Buy rating on RIL with a revised price target of Rs890 (based on the sum-of-the-parts valuation method).
VIEWPOINT
Liberty Phosphate
Subsidy reduction not to hurt volume growth
We have interacted with the management of Liberty Phosphate to understand the impact of reduction in subsidy payout rates on non urea fertilisers and its fallout on the demand environment.
Subsidy cut may lead to increase in price of SSP: The government has decided to reduce subsidy payout on nutrients in complex fertilisers on the back of a decrease in the prices of raw materials in international markets. The government has decreased the subsidy on phosphorous by 32.6% to Rs21.8 while that on sulphur remains unchanged. Single Sulphur Phosphate (SSP) contains 16% phosphorous and 12% sulphur. So a decline in the subsidy on phosphorous will reduce the subsidy payout on SSP by 31.4% to Rs3,690 per tonne. A decrease in subsidy on SSP will restrict the company from decreasing the maximum retail price (MRP) from the current level of Rs5,000 per tonne. As per our interaction with the management, the price of SSP can be increased by Rs1,000 per tonne to Rs6,000 per tonne if the government reduces subsidy in the forthcoming budget.
Demand to remain intact for SSP even if price increases: We expect the demand for SSP to remain strong in spite of a likely price hike as it will find preference as a substitute to diammonium phosphate (DAP). The price of DAP has run up sharply in the last one year from Rs9,400 to Rs19,000 per tonne. Farmers, as a result, have been forced to look for a substitute. A special initiative taken by the government to use more of indigenously manufactured fertilisers in order to restrict subsidy will provide support to SSP manufacturing as a substitute to DAP in the long term. As stated earlier, the use of SSP in place of DAP may provide an additional growth opportunity to the company.
Margin may remain at current levels in spite of decrease in raw material prices: The prices of key raw materials have seen a declining trend on the back of lower demand in the international markets. The price of rock phosphate, after reaching a peak level of Rs10,000 per tonne during the current fiscal, has corrected to Rs8,000 per tonne. The same may further decline to Rs7,000 per tonne. In addition to this, the price of sulphuric acid has also corrected down and is presently quoting at Rs2,500 per tonne. The same may stabilise at the current levels. However the positive impact of decrease in the prices of raw materials will be offset by a decrease in subsidies and hence the margin is likely to remain at the current level.
Outlook and valuation: Liberty Phosphate is one of the largest SSP manufacturers which can grow by capitalising on its brand name and distribution network. Given the aggressive expansion of its manufacturing capacities the company can potentially grow at a compounded annual growth rate (CAGR) of around 28.6% over the next two years. In terms of valuation, the stock trades at around 1.7x FY2013 rough estimates. This makes it one of the cheapest stocks in the complex fertiliser space. Liberty Phosphate has appreciated by over 22% since we introduced the stock with a positive bias in the "viewpoint" section of our daily online publication "Investor's Eye" on September 7, 2011. We maintain our positive bias on the stock.
