Reliance’s refining business drags down profits

Reliance Industries chose to focus on margins rather than improve volumes during the June 2009 quarter. Its performance was affected by a mix of factors. Export volumes dipped during a period when the rupee depreciated, which would have normally added extra rupees to RIL’s bottom line. The Jamnagar refinery voluntarily gave up its export oriented tax status as it wanted to focus on the domestic market. Gas production from its KG basin started, contributing to sales and profits, but also upped its depreciation outgo. The merger of Reliance Petroleum with the company is awaiting statutory approvals, else that would have made some difference to its performance too.

RIL has given standalone results only. Comparison given over here is over the June 2008 quarter unless mentioned otherwise.

RIL’s net sales during the June 2009 quarter declined by 22.9% to Rs 32,055 crore, as realisations declined in its main business of refining. Since its refinery lost its EOU status, its excise burden as a percentage of sales has increased. Falling prices contributed to a 24.4% drop in revenues while rising volumes added 1.8%, contributing to a 22.6% increase in gross sales (including excise, that is).

Its exports fell by 38.5% to Rs 17,433 crore during the quarter.

While RIL’s size of business shrank, it kept its focus on improving margins, even at the cost of volume growth. Material consumption costs dropped by 25.4% to Rs 23,508 crore and total expenditure dropped 26.3%. RIL also cut down its employee costs during the quarter by 16% due to ‘cost optimisation’ efforts. Other expenditure also fell by 36.9% to Rs 2,080 crore due to lower conversion costs, foreign exchange gains and lower selling expenses.

The result was that the company’s operating profit margin increased by 375 basis points (1% = 100 basis points) to 18.5%.

Now, that meant it maintained the health of its business, in terms of profitability while choosing to sacrifice on the amount of business it did.

But it had no control over what happened next. Depreciation jumped 41%, partly due to the KG6 assets coming on stream. Interest costs too jumped by 17% due to higher levels of debt and lower level of capitalised interest (what is added to the cost of an asset, before it is used in the business.)

But other income came to its rescue, rising by 210% to Rs 702 crore aided by higher interest income.

As a result, its profit before tax declined by just 5% but a higher tax provision (since minimum alternate tax increased to 15% from 10%) led to its net profit falling by 11.5% to Rs 3,636 crore.

RIL had total debt of Rs 51,780 crore as of June 30, 2009 and it had cash and liquid instruments of Rs 21,827 crore. Its net debt to equity is 0.24 times.

Reliance Petroleum’s sales during the quarter was Rs 7,639 crore and it earned a net profit of Rs 105 crore, while its gross refining margin was $5.54 /bbl.

RIL’s future performance will hinge upon an improvement in its refining margins. However, supply from KG6 basin to its new customers will also add to its sales and profits, this is a high margin business, with a segment profit margin of over 50%. In addition, the Reliance Petroleum plant will stabilise, it is a SEZ plant enjoying several tax benefits. As this plant ramps up and output increases, it will contribute significant to RIL’s results. While this will reflect in its consolidated results even now, since it is not publishing it, investors will not be able to see the combined performance. Once the merger is effective, it will reflect in its refining business.

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