A sharp jump in crude oil and natural gas prices as economic activity opens up has improved demand prospects for the oil and gas sector after the second wave of the pandemic. Strong oil demand has boosted the outlook for refining margins, and receipts from allied products such as petrochemicals (Petchem) may see an increase.
All this means that the earnings outlook for Reliance Industries Limited (RIL) has improved. This optimism is visible in the nearly 24% increase in share prices from July’s lows. The firm’s oil-to-chemicals (O2C) business has been hit by soft refining margins and weak petchem demand over the past few quarters.
“O2C profitability is improving with the potential to upgrade to consensus estimates, assuming no fresh shock from Covid,” analysts at Jefferies India Pvt Ltd said in their note.
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The benchmark Singapore gross refining margin (GRM) currently stands at around $5.3 a barrel, which is much better than the average of $2.1 a barrel seen in the June quarter and $1.8 a barrel in the March quarter. Analysts expect RIL’s GRM to rise to $8-10 per barrel, given that the company commands a significant premium over the benchmark.
Domestic volume recovery in the Petchem segment is likely to be bullish. Besides, strong festive season demand has pushed up the premium of domestic prices over imported polymers since August. Consequently, Jefferies expects RIL’s petchem volumes to recover to FY22 levels by the end of FY19. They also expect RIL’s GRM to improve by $2.4 since the end of FY12 based on improvement in underlying product spread.
Meanwhile, the O2C segment contributed approximately 47% to the consolidated segment Ebidta during Q1. The improved earnings outlook is expected to lead to higher valuations for this segment. In addition, the framework of the Saudi Aramco transaction (expected in Q3) will determine any potential jump in the value of the business, analysts said.
The impact of the pandemic on the business and the weak environment delayed the stake sale proceedings to Aramco. The induction of Aramco’s chairman on RIL’s board is perhaps a sign that the process of stake sale is picking up again.
But more than its mainstream petrochemical business, RIL’s investors have recently focused on its fastest-growing retail and digital services segment. The retail segment is expected to rebound during the June quarter due to the lifting of COVID-related restrictions. In the digital services business, Reliance Jio has maintained its leadership in mobile broadband by adding 6.5 million users during July, according to Nomura’s September 23 note. It recorded the highest net growth in wireless subscribers for the sixth month in a row and reached 37.3% market share. As a result, Jio’s growth could strengthen the company’s valuation.
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