Absence of immediate drivers puts Reliance Industries stock in back seat

While Q3 performance beat Street estimates, O2C is key to sustaining growth this year

Although the October-December quarter (third quarter, or Q3) performance of Reliance Industries (RIL) came ahead of Street expectations and the stock has been an underperformer, sharp upsides are unlikely, given the lack of immediate triggers.

The RIL stock is down 5 per cent over the past month and has underperformed the benchmarks, given portfolio shifts by foreign institutional investors from India to China.

Analysts, led by Jal Irani, of Nuvama Research cut their 2023-24 (FY24) operating profit estimates by 2 per cent, given a weak near-term outlook. The brokerage believes that the windfall tax on high-speed diesel/aviation turbine fuel (ATF) exports could drag earnings in the near term. The analysts have a ‘buy’ rating on the stock and believe RIL’s New Energy roll-out could unleash its next leg of growth, besides aiding conventional businesses.

IIFL Securities has also cut back its 2022-23 and FY24 earnings estimates by 3-4 per cent to reflect delays in telecommunication (telecom) tariff hikes and higher depreciation. The brokerage expects the stock to react positively to news flow on tariff hikes in telecom, the demerger of Jio Financial Services, and the green energy business.

JPMorgan’s Pinakin Parekh and Sarfraz Bhimani expect the oil-to-chemicals (O2C) business, which includes refining, petrochemical (petchem), and exploration and production segments, to remain crucial earnings drivers in Calendar 2023 as consumer business growth turns sluggish.

It was the O2C business that had accounted for half of the incremental operating profit improvement in Q3 on a sequential basis. The segment’s operating profits were up 16 per cent on a sequential basis, given robust middle distillate cracks (diesel, ATF). The company indicated that middle distillate cracks will continue to remain firm on lower inventories, seasonal demand, and the impending loss of Russian supply.

What impacted segment performance was the downstream chemical margin as demand stayed muted and supply was in excess. The company indicated that polymer margins should improve with a revival in demand from China, the European Union, and the US.

The oil and gas segment saw a 91 per cent increase in its operating profit on the back of price hikes. The momentum is expected to sustain on volume ramp-up.

Revenues and operating profit for Reliance Jio came in below estimates. While subscriber additions remained healthy, what dented revenue was a marginal increase in average revenue per user (ARPU).

Cleaning up of its customer base led to a disappointing ARPU, with the marginal gains coming from an upgrade to higher-priced plans and increased data consumption. In addition to weak APRUs, higher depreciation impacted the telecom segment’s bottom line.

Given that the company is aggressively rolling out its 5G network, further gains on the ARPU front are expected to come from the migration to the 5G platform, as well as tariff hikes. The latter has a larger impact on the operating metrics and financials of the telecom segment.

On the retail front, strong store additions and record customer footfall led to a 19 per cent growth in net revenue. Store count at 17,225 was up over a fifth, compared to the year-ago quarter. Over the past three years, the company has scaled up its retail count by 1.5x.

While most formats posted strong traction and there was a 30 per cent increase in transactions (at 265 million), the company indicated that customer sentiment remained cautiously optimistic and discretionary spends were impacted in the aftermath of the festival season.

Higher operating leverage and increased efficiency aided the improvement on the operational front. Margins were up 40 basis points over the year-ago quarter at 7.9 per cent. The trajectory of revenue and margin performance will depend on increased volumes, scale efficiencies, and product mix.

Analysts, led by Bharat Chhoda, of ICICIdirect expect RIL’s consumer business to be a growth catalyst. While tariff hikes undertaken by Jio would be a key monitorable, the O2C segment is likely to improve as higher middle distillate cracks help strengthen gross refining margins, along with a rebound in petchem demand.

In addition to the performance of key businesses, the Street will also keep an eye out for the debt trajectory. Net debt in the quarter increased 18 per cent on a sequential basis to Rs 1.1 trillion.

While RIL’s consolidated dues and borrowing are up sharply over the past year, JPMorgan believes this is mostly driven by a surge in deferred payment liabilities after the spectrum acquisition in Jio and underlying borrowings staying well below the fourth quarter of the 2019-20 peak.