Reliance Industries, or RIL's, second-quarter earnings exceeded our expectations, thanks to improving product margins, particularly gasoline and petrochemicals, which offset the weaker exploration earnings.
Adjusted earnings per share grew by 9% to Rs 22.1 versus the prior year, beating our 2% growth estimate. Over the longer term, the market will likely soften, owing to increasing supply from the growing refining and petrochemical capacity in Asia. However, continued low crude prices are likely to underpin demand growth in Asia and offer margin support in the near term.
As such, we expect refining market conditions to remain favourable this year, which (along with the pact with Indian Railways to supply high-speed diesel) should provide higher product yields for RIL. We have raised our 2016 earnings forecast by 5% to Rs 77 per share, but this is not material enough to change our fair value estimate of Rs 950 per share.
We retain our no-moat rating.
Refining operating income (64% of group) jumped by 42% versus last year, up to Rs 55 billion, on lower costs and higher gross margins ($10.60 per barrel, versus $8.30 last year). The margin jump stemmed from the higher discount per barrel for sour crude and the narrowing of the light and heavy Arab differential, which increased the margin per barrel for African sweet crude relative to Brent crude. Gasoline market strength persisted for another quarter, with demand responding to low prices. Petrochemical operating income (30% of group) increased by 7% versus the prior year, up to Rs 25 billion, but we are not enthused by this, as it entirely stemmed from an 8% capacity increase.
At current prices, RIL is close to fairly valued. The next catalyst for the stock would be gas-price deregulation and visibility regarding returns on invested capital for the new businesses, such as telecom, consumer retail and e-commerce, in the second half of this year. We would also appreciate asset disposals in the oil and gas segment.
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