Robust O2C margin environment to drive near-term gains for Reliance

Footfall recovery pace, net subscriber count key to its consumer biz

A steady fourth quarter (Q4), a favourable outlook for Reliance Industries’ (RIL’s) key businesses, and growth triggers in the New Energy vertical are expected to keep the stock momentum and valuations of India’s most valuable company at elevated levels. The stock has been a stark outperformer, with gains of 29 per cent since August last year, compared with 4 per cent returns of the benchmark Sensex. 

The reason for the optimism is the expectation of a robust earnings growth.

Probal Sen and Sanjesh Jain of ICICI Securities expect the company to report annual earnings growth of 29 per cent over 2021-22 (FY22) through to 2023-24 (FY24) on the back of robust oil-to-chemicals (O2C) margin environment, steady growth in digital services, and strong momentum in its retail segment. Add meaningful strides being made in green energy-linked gigafactories and a reinvigorated upstream segment after a tepid four/five years and there is a recipe for strong growth over the next 24-36 months, they add.

Within the O2C segment, while the refining business is expected to see traction, with the Asian benchmark gross refining margin (GRM) trending higher than the historical levels, the petrochemical (petchem) business profitability is likely to be a drag. This was reflected in the Q4FY22 results as well.

The segment operating profit (O2C) improved nearly 25 per cent, led by multi-quarter high transportation fuel cracks. It was partially offset by lower polymer and intermediates margins and a higher energy cost.

Downstream product margins were impacted by weak naphtha cracking economics and supply overhang in fibre intermediates, pointed out the company.

The O2C segment accounted for 45 per cent of the company’s consolidated operating profit and around 70 per cent of the bottom line. 

Jal Irani and Iqbal Khan of Edelweiss Research have increased their earnings and target price estimates, upgrading the stock to ‘buy’.

“We are raising 2022-23 (FY23)/FY24 O2C operating profit by 26 per cent and 23 per cent, respectively, amid a strong O2C outlook, and the target from 9.5x FY23 estimates to 12.5x (global average: 8–8.5x), noting the New Energy synergies with O2C,” they said.

The pressure on petchem margins, however, has prompted Jefferies to cut the company’s FY23/24 operating profit.

Said Bhaskar Chakraborty and Pratik Chaudhuri of the firm, “We lowered the O2C operating profit for FY23 and FY24 by 11 per cent and 12 per cent, respectively, on weakness in petchem margins 

in the current financial year on weak China demand. Strong GRMs could normalise by the September quarter and not compensate for the petchem weakness.” 

On the consumer businesses of telecommunications (telecom) and retail, brokerages have a bullish view, although Q4 quarter results were a mixed bag.

In the telecom business, its 8 per cent sequential growth was led by a 10.5 per cent rise in average revenue per user (ARPU) to Rs 167.6. The rise in ARPU was a combination of tariff hike and improving subscriber mix. 

However, the gains were offset by a third consecutive quarter of decline in net subscribers. Its customer base saw a fall of around 3-4 per cent, compared with the year ago period, as well on a sequential basis to 410 million users.

Analysts believe the subscriber loss is temporary and should reverse as subscriber churn at Vodafone Idea will help market leaders. While the company indicated that the trend of subscriber identity module consolidation is abating, whether the trend will hold will be key to evaluating the impact/acceptance of tariff hikes. 

Motilal Oswal Research expects revenue and operating profit for the vertical to grow 15-20 per cent annually over the FY22-24 period, with focus on wireline segments, coupled with digital avenues, tariff hikes, and market-share gains driving growth. 

The key disappointment was on the retail front. The operating profit growth of 16 per cent was slower than expected as was the 23 per cent revenue growth. Even as store additions continue to be aggressive, the performance was impacted by Omicron during the early part of the quarter, reducing footfall. The metric, however, has recovered to pre-Covid levels towards the end of the quarter.

Edelweiss Research has highlighted that operational leverage seems to have plateaued as operating profit margin remained flat at 7 per cent quarter-on-quarter (down 40 basis points year-on-year). 

Aided by accelerated store additions across segments, aggressive foray into digital and new commerce, as well as recovery from the pandemic, the revenue and operating profit growth for the business is likely to be 36-50 per cent each, according to Motilal Oswal Research. 

While the New Energy business is expected to provide the next leg of growth, given the large investments (Rs 70,000 crore in four gigafactories), uncertainty about the roll-out, and full valuations, investors should await better buying opportunities for a slice of RIL.