Reliance Industries: Building natural hedges...

Reliance Industries Ltd’s announcement of commencement of production from the KG-D6 block did not quite excite the stock market. Its share price did not flare up; on the contrary, it fell marginally by Rs 14.70, or 0.72%, to close at Rs 2,037 on the BSE.

The reason, reckon analysts, is that most of the good news had already been factored in and reflects in the market price: the stock has already gone up 15% from its annual low and has outperformed the market as well. Analysts are now looking at commercial production of gas from the D6 block. Reliance Industries management has clarified that it will initiate commercial production of gas between January to March next year.

Despite the fact that the oil margin ‘golden days’ are set to come down as prices ease, Reliance Industries’ earnings growth story is expected to hold on, and even better many others in the trade . The company will tend to outperform the benchmark Singapore margins, enabled by decline on middle distillates (diesel, ATF, kerosene), which will not be as significant as others like gasoline. This is because middle distillates account for 46.8% of Reliance Industries’ product portfolio, compared to a Singapore complex index weightage of just over 20%. This will allow for a lot of cushioning.

On the petrochemicals side too, the company has created advantages and natural hedges. Despite easing margins in most petrochemical products, Reliance will gain from the IPCL advantage of using a gas cracker. Incidentally, most product prices tend to move in the direction of crude prices. However, gas prices in India have hardly moved.

This makes IPCL at least 60% more cost-effective; it will be able to maintain the advantage going ahead as well. Also, IPCL is expected to gain from strong polyvinyl chloride (PVC) prices, which are at a three-year high and are expected to remain there.

Analysts expect that IPCL, which contributes around 30% to Reliance Industries’ earnings before interest and tax, will contribute more in the current fiscal. The depreciating rupee is an added advantage as the company’s products are largely priced on import parity basis.

Despite these factors, the market eagerly awaits commercial production details of the company. Many reckon that instead of starting commercial production in February, it would benefit if it does so in April 2009. “This will help make most of the 7-year income tax holiday, which is expected for gas production. This tax holiday is for seven fiscal years (April-March) and the full benefit will be available if gas production commences in April,” says a Merrill Lynch report.

Analysts are also closely watching the decline in petrochemical margins; a huge slide could impact earnings considerably. But then, as the business plan unfolds, they expect more built-in hedges to emerge and protect Reliance Industries from commodity price swings. Till then, they will keep looking at smaller developments.