Bank of America-Merrill Lynch upgrades Reliance Industries

As outlook for refining margins improves the target price for the stock is increased by 9 percent to Rs 893.

The research house that had downgraded Reliance Industries to 'under-performer' in Jun'12 amid concerns over refining margin (GRM) outlook and a sharp cut in KG-D6 reserves has now upgraded it to "neutral". The move was made in the backdrop of improving refining outlook.

Reliance’s GRM have improved in previous two quarters and the analyst believes the strength is sustainable. Its earnings growth is also likely to recover in FY14E-15E to 8-13% year-on-year as estimates for long-term GRM have been raised by $1 a barrel.

Analysts owe the improvement in outlook for GRM’s to continuing refining capacity closures and recovering oil demand. Contrary to earlier expectations, incremental demand has exceeded net refining capacity additions even in 2012. In fact, the demand has now exceeded supply for three consecutive years observes Vidyadhar Ginde, analyst at Bank of America-Merrill Lynch.

Reuters' Singapore GRM in Feb’13 is at the highest level in 69 months. RIL’s Q2-Q3 FY13 GRM is also up 25-40% from the Q3FY12-1Q FY13 level of $6.8-7.6 a barrel. The analyst, thereby, expects strong GRM even in Q4 and feels the weakening of GRM’s in subsequent quarter to the levels seen in Q3 FY12-1Q1FY13 appears unlikely.

The analyst, however, believes that for re-rating the stock to BUY, stronger GRM’s than $9.5-9.6/bbl assumed in FY14-15 leading to EPS upgrades and/or a re-rating of its exploration and production business is needed. Its recent GRM, despite staging a recovery, is well below  FY07-09 level of US$11.7-15 a barrel hit by negative nap.