RELIANCE INDUSTRIES: Consumer businesses drive the quarter; Debt & Capex moderating

Reliance Industries (RIL) reported in-line standalone revenue of INR871.4b (-9% YoY, flat QoQ) in 2QFY20. EBITDA came in at INR136.7b (-8% YoY, flat QoQ) versus our estimate of INR136.4b owing to the lower-than-expected refinery throughput of 16.7mmt, despite a better GRM of USD9.4/bbl (flat YoY, +16% QoQ). Lower depreciation, combined with higher other income and higher interest cost, resulted in a beat of 9% in standalone PAT of INR97.0b (+10% YoY, +7% QoQ).

The company recognized the entire MAT cut in the quarter with an effective tax rate of 20.8% versus 25.4% in 1QFY20.

At the consolidated level, RIL reported EBITDA of INR221.5b (our estimate: INR213.2b; +5% YoY, +4% QoQ), primarily led by the better-than-expected performance of the digital and retail segments. Higher other income led to consol. PAT of INR113.5b (+19% YoY, +12% QoQ; our estimate: INR107.8b). In 2QFY20, the tax rate on a consolidated basis stood at 24.7% versus 29.5% in the previous quarter, as the company maintained an effective tax rate of ~35% for retail and Jio.

In 1HFY20, standalone EBITDA was down 9.1% YoY to INR273.1b, while PAT was up 6% YoY at INR187.4b, led by a lower tax rate of ~12% YoY. Consolidated EBITDA increased 4.1% YoY to INR434.7b, while PAT was up 12.9% YoY to INR214.9b.

Better-than-expected GRM negated by lower throughput: Refining EBIT stood at INR49.2b (-5% YoY, +11% QoQ).

–          The premium to SGRM reduced to USD2.9/bbl (v/s USD3.4 in 2QFY19 and USD4.6 in 1QFY20) as the company had a lower gasoline and FO yield, which primarily drove the improvement in SGRM. Also, the increase in prices of heavy crude had an adverse impact.

–          GRM stood at USD9.4/bbl (our estimate: USD8.7/bbl), as against USD9.5/bbl in 2QFY19 and USD8.1/bbl in 1QFY20. Throughput was at 16.7mmt (our estimate: 17.0mmt; -6% YoY, -5% QoQ).

Petrochem volumes improved to 4.0mmt from 3.3mmt in 2QFY19 and 2.9mmt in 1QFY20. Petrochemical EBIT stood at INR75b (-6% YoY, flat QoQ), led by pressure on product spreads due to the global supply glut (largely from the US and China).

–          Implied EBITDA (USD/mt) was lower at USD317 (-22% YoY, -27% QoQ) due to a sequential contraction in most petrochem margins: PE (-9%), PP (-44%), PX (-13%) and PTA (-16%).

Domestic E&P continues downtrend: Oil & Gas EBIT came in at INR0.6b (-132% YoY, -49% QoQ), led by lower realizations and the continued negative impact from the Eagle Ford midstream commitment.

–          Gas production from KG D6 stood at 1.68mmscmd in the quarter, down from 1.76mmscmd in 1QFY20. CBM production stood at 0.93mmscmd.

–          US shale production stood at 19.9bcfe (-6% YoY, +12% QoQ) with increased production from new wells (6 in Marcellus and 8 in Eagle Ford). However, blended realization for US shale was down 33% YoY and 17% QoQ.

RJio’s growth momentum continues: RJio maintained its healthy subscriber growth momentum, driving strong earnings growth. Revenue grew 6% QoQ (in line) to INR123.5b, while EBITDA increased 10% QoQ to INR51.4b (in line).

–          Capex of INR137b in 1HFY20 reduced from INR326b/INR681b in 1HFY19/FY19. RJio’s gross debt stood at INR1.6t (as of Sep’19) and PAT increased 11% QoQ to INR9.9b (our estimate: INR11.2b).

–          Net subscriber adds of 23.9m were steady, while ARPU continued trending down (-2% QoQ to INR120). Monthly subscriber churn stabilized to 0.74% versus 0.97% in 1QFY20.

Reliance Retail maintains strong performance in a slowing economy

–          Reliance Retail’s 2QFY20 revenue/EBITDA grew strongly by 27%/31% YoY to INR412b/23b on the back of strong SSSG across store formats and improving efficiencies – margins were at a 10-quarter high of 5.6% – at a time when consumer spending is slowing down.

–          Core retail EBITDA grew by 68% YoY to INR19.2b, with the EBITDA margin at 8.8%, contributing 83% of total retail EBITDA. 1HFY20 revenue/EBITDA grew 36%/68% to INR794b/INR44b.

–          Reliance Retail added 337 stores during the quarter. Total stores now stand at 10,901 with total retail area at 25m sq. ft.

Valuation and view

–          Consolidated net debt stood at INR1,570b at end-1HFY20. Consol. gross debt was at INR2,920b (RIL standalone – INR1,460b, Jio – INR840b, E&P – INR35b, Retail – INR157b). Consolidated cash stood at INR1,350b at end-1HFY20.

–          Capex intensity lowered during the quarter with a total investment of INR190b (v/s INR226b in 1QFY20 and INR1,345b in FY19), of which Jio accounted for INR50b, RIL standalone for INR90b and retail for INR20b. There was no specific guidance on capex.

–          Petcoke gasifiers appear to have been fully commissioned, which should reduce capex, at least in the standalone business.

–          SG refining margin shot up in Sep’19, primarily due to supply disruption risks, which led to a shortage in supply of heavy crude. This led to a huge jump in FO cracks, along with an improvement in gasoline cracks led by increased seasonal demand. However, over the past few days, it has come down to ~USD4/bbl and even hit lows of ~USD2/bbl at times.
We believe that the SG refining margins will likely stabilize at USD5-6/bbl over the medium term as demand recovers slowly and a few high-cost refiners take shut downs amid poor GRMs.

–          Petrochem margins are expected to be weak in light of continued US-China trade concerns, the weak economic outlook and the strong additional supply globally over the next 2-3 years (RIL expects petchem market to balance out by 2021-22).

–          Domestic polymer demand growth, however, was 5% YoY, supported by packaging and water management projects. It is expected to be seasonally healthy in 3Q, driven by agriculture and consumer packaging.

–          We value RIL using SOTP. We revise the valuation multiple for the core segment of refining and petrochem to 8.5x (from 7.5x earlier) FY21E EV/EBITDA to factor in the enhanced delayed coker capacity, the widening of crude blend window for maximizing distillate yields prior to IMO and the revival in petchem margins for the company under its flexible feedstock utilization. The company expects to utilize the full economics of petcoke gasifier by 4QFY20.

RJio’s TP raised to INR280: Our DCF-based TP of INR280 (v/s INR250 earlier) ascribes 10.5% WACC and 4.0% terminal growth with implied EV/EBITDA of 16/11x on FY20/21E. This is partly attributed to the likely temporary increase in 3QFY20 ARPU and strong earnings growth momentum beyond FY21. While net debt including fiber assets stands at INR2,053b as of FY20E, management indicated that fiber asset sale would be announced soon which could reduce debt by INR460b.

–          The stock trades at 17.5x FY21E EPS of INR80.9 and 11.4x FY21E EV/EBIDTA. RIL (standalone business) is expected to be FCF positive in FY20, with FCF/share of INR108. We reiterate our Buy rating on the company with a revised TP of INR1,630.