Why it's not a good time to be a Reliance shareholder

Reliance Industries had shocked the market when it announced its December 2011 results. Two main reasons were cited for the drop in profit, the first being a drop in gas output, while the second one was a fall in gross refining margins (the difference between prices of crude oil and finished products).

The March 2012 results are expected to be worse than that of the previous quarter. Gas production has already fallen to levels never seen before. And they are expected to get worse before they get any better. The gross refining margin (GRM), according to a report by Bank of America Merill Lynch, has touched a 15-week low and has halved over the last seven weeks to $5.1 per barrel. For the December quarter, Reliance posted an average GRM of $6.8 per barrel, which was $3.3 per barrel lower than that of the September 2011 quarter. The March 2012 quarter GRM will be the lowest since December 2009.

[caption id=“attachment_255941” align=“alignleft” width=“380” caption=“Reliance is diverting its cargo to the Western markets as it finds lower prices and demand in Asian markets. Reuters”]  [/caption]

A report in the The Economic Times quoting a report by JM Financial says that Reliance is diverting its cargo to the Western markets as it finds lower prices and demand in Asian markets. Nearly 70 percent of its products are shipped to the shores of Europe and US.

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Reliance’s GRM has generally been trading at a premium to Singapore’s GRM. However, since December 2011, the company’s GRM is in discount. This is because there is a sharp spike in demand for fuel oil from Japan, which is increasingly using it to produce power compared to nuclear fuel powered plants. Reliance does not produce fuel oil.

The premium enjoyed by products in the US over that of Singapore has also come down sharply over the last three years. The fact that Reliance is still selling products in the US is probably because demand is lower in Asia, especially from China.

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In the worst case scenario, Merrill Lynch expects Reliance to post a net profit of Rs 3,740 crore as compared to Rs 4,440 crore for December 2011. The best case is Rs 4,310 crore.

In any case, it is unlikely that Reliance will better its December number in March 2012. A number of analysts had termed the December 2011 numbers as the worst expected in the near future and had built in higher profits in the future in their valuation sheets.

After announcing a buyback and backed by optimistic projections, Reliance Industries moved higher and touched a high of Rs 864.70 in February 2012. As lower production of gas was announced and markets got a whiff of refining margins slipping further, the stock lost ground and presently trades at Rs 732.

For Reliance, neither is gas production increasing in a hurry nor is Asia’s fuel demand rising to push up GRMs. If crude prices rise further, demand might slow down, in which case GRMs can slip lower. Not a good time to be a Reliance shareholder.