Rs 61,490 cr cash burns hole in RIL's pocket, profitability dips

Mukesh Ambani’s Reliance Industries hasn’t had the best of quarters. In the second quarter ended 30 September 2011, it posted lower than expected net profit of Rs 5,703 crore against market expectations of Rs 5,750 crore. A drop in production from its oil and gas fields and lower than expected refining and petrochemical margins resulted in the poor performance (see table) .

But having sold a 30% share in these fields to BP for $7.2 billion, Reliance is sitting on loads of cash. As on 30 September, the company had cash or cash equivalents of Rs 61,490 crore - or Rs 187 per share - and this cash is earning more cash.

[caption id=“attachment_108773” align=“alignleft” width=“380” caption=“India’s Reliance Industries KG-D6’s floating production storage and offloading (FPSO) vessel is seen off the Bay of Bengal in this undated handout photo. Reuters”] [/caption]

For every Rs 8 of gross profits, Re 1 comes from its cash hoard. This cash will continue to burn a hole in its pocket by earning low returns (around 7% currently) unless it is more profitably deployed. Possibly through acquisitions of oil and gas assets or something else.

The company posted a turnover of Rs 80,790 crore for the September quarter of 2011 as compared to Rs 59,962 crore during the same period in the previous year. Operating profit (profit after providing for all operational cost) was at Rs 10,946 crore as against Rs 10,068 crore.

In other words, though the company’s turnover increased by Rs 20,828 crore, its operating profit increased by only Rs 878 crore. A sharp rise in raw material cost of 48% and fuel and power expenses of 17% resulted in the lower operating profit growth.

Other income, which is increasingly becoming a major contributor to the company’s profit, increased from Rs 672 crore to Rs 1,102 crore. In other words, an incremental Rs 430 crore to the company’s growth in profit before tax came from other income. Reliance posted a profit before tax of Rs 7,317 crore as compared to Rs 6,149 crore, a difference of Rs 1,168 crore. Thus 37% of the incremental jump in the company’s profit came from its investing activity rather than its operations.

Reliance’s Rs 61,490 crore holdings in cash and cash equivalents, on which it has generated Rs 1,102 crore as income, yields a7% annualised return. Much lower than what it earns in refining or petrochemicals.

On the operational front, crude oil production dropped by 42.1% while gas production fell by 20.3% for the September quarter on a year on year basis. As a result the contribution of this segment to the company’s profit fell from 28% to 21%. Higher brent prices of $112 per barrel as compared to $77 per barrel helped the division post better results despite the sharp drop in its volume.

The other negative surprise was the drop in gross refining margin (GRM) which was at $10.1 barrel as compared to market expectation of $10.5 per barrel. The refining division recorded a GRM of $10.35 per barrel in the June quarter of 2011. As a result of lower GRM, the refining division posted a lower profit as compared to the previous quarter. Segment profit for the company was at Rs 3,075 crore as compared to Rs 3,199 crore in the previous quarter.

The petrochemical division continued with its mediocre performance with a sharp drop in operating margins which fell from 14.2% in the second quarter of 2011 to 11.5%in the second quarter of the current fiscal. The division’s topline grew by 39.5% while it earning before interest and tax increased by only 10.2%.

Reliance shares have seen a sharp move in the previous week in anticipation of the result. The company has, to some extent, disappointed with its numbers. Further, there is no visibility on the use of its cash of Rs 61,490 crore, which are generating a meager 7%. No signs of an improvement in its oil and gas production coupled with the ongoing litigation regarding the expense allocation of its KG Basin will act as headwinds to the share price movement.