RIL: Feeling the pinch

Discounts to downstream players dent RIL profit margins

Reliance Industries reported 28.2 per cent jump in revenues last quarter, but operating profit increased only 17.9 per cent owing to a drop in the profit margin of its key refining business. On a sequential basis, too, the company's operating margin has slipped 214 basis points.

EBIT (earnings before interest and tax) margin of the key refining business slipped 139 basis points to 8.23 per cent, which, according to analysts, is largely because of the $1.2 per barrel discount given by the company to downstream players. The company's discount to downstream players is estimated at Rs 300 crore in the September quarter.

There wasn't any such discount in either the year-ago September quarter, nor this fiscal's June quarter. Adjusted for this discount, the refining division would see a small improvement in profit margin, while the drop in overall operating margin would come down to 25 basis points from the reported level of 170 basis points.

Gross refining margin (pre-discount) of the company was estimated at $11.6 per barrel, compared with $11.4 per barrel in the June quarter.

Of course, post-discount, the refining margin dropped to $10.4 per barrel. So, despite a 15 per cent increase in revenues of its refining business, profit of the segment fell 14.27 per cent quarter-on-quarter.

Meanwhile, the company's petrochemical business has shown signs of revival in the September quarter, after a sluggish performance in the June quarter. The segment's profit has grown 22.86 per cent to Rs 1,279 crore, on the back of a 13.65 per cent growth in segment revenues.

On a sequential basis, segment profit of the petrochemicals business jumped by 45 per cent. The company's focus on higher value polymer products, coupled with a revival in demand from user industries seems to be paying off.

It was the improved performance of the petrochemical division that helped overall operating profit expand 17.09 per cent y-o-y to Rs 3,712 crore. Profit before tax rose at a faster pace, growing almost 37.3 per cent to Rs 2908 crore, thanks to a cut in interest cost and lower depreciation.

Going forward, the company's gross refining margins are expected to remain strong, partly due to large refining capacity in America which is still inoperative due to the recent hurricanes.

The Reliance stock currently gets a valuation of just about 4.3 times on an EV/EBITDA basis, but one needs to keep in mind that the current refining and petrochemical cycle is close to its peak, which means valuations are not really that cheap.

Bharti Tele: Forex swing blow

Bharti Tele-Ventures lost nearly Rs 5,000 crore of its market capitalisation, on news that its net profit rose just 2.2 per cent sequentially last quarter, much lower than the 11.1 per cent growth the company had managed in the June quarter.

On a year-on-year basis, too, growth in net profit fell sharply to 43 per cent last quarter, against 114 per cent in the June quarter. But the 8 per cent correction in Bharti's valuation seems looks like a case of overreaction.

Core earnings, or operating profit, rose by a healthy 8.6 per cent on a sequential basis, which, in fact, was much better than the 3.9 per cent growth recorded in the June quarter.

Growth in net profit was much lower mainly because of forex fluctuations, which led to an increase in the company's net interest expense. Adjusted for this, growth would be upwards of 8 per cent even at the net profit level.

The mainstay wireless (mobile) business, reported a 14.2 per cent jump in operating profit on the back of a 9.1 per cent increase in revenues.

The company had earlier reported a 15 per cent increase in its subscriber base compared with the June quarter, and the 9.1 per cent growth in revenues, therefore, came as a negative surprise.

ARPUs (average revenue per user), evidently, are falling at rates higher than what the markets had anticipated. Last quarter, they fell 3.1 per cent, mainly because pre-paid customers accounted for 90 per cent of the net additions last quarter.

Besides, a majority of the pre-paid additions were on account of the Rs 200 pre-paid recharge coupon, which has 30-day eligibility.

The ARPU of these subscribers, of about Rs 200 per month, is much lower than the company's average of Rs 476. It's interesting that Bharti managed 170 basis points increase in the operating margin of its wireless business despite lower ARPU, and the full impact of the reduction in roaming rates and inter-circle call rates in eight circles.

Overall operating profit growth was lower at 8.6 per cent because of a 18 per cent drop in profit of the fixed line and broadband business.

Again, this drop was only on account of losses in new circles where the company started fixed line and broadband services - profit was maintained in existing circles. Since operating profit growth continues to be healthy, and since net profit was hit by exceptional factors such as fluctuation in rupee-dollar rates, there's no cause for alarm.

One negative, however, is that capex continues to be aggressive. In fact, Bharti has raised its capex estimate for FY06 from $1 billion to $1.2 to $1.3 billion.

It also added that these capex levels may continue in FY07 given the high rates of growth in the industry. But even if the markets were to adjust for the $500 million or so increase in capex estimates for the next two years, the $1.1 billion (Rs 5000 crore) correction in Bharti's market cap seems overdone.