Reliance's O2C jitters: A refining challenge that's crimping growth

IPO moves and new energy clarity: Key upside risks for the conglomerate

Weighed down by the oil-to-chemicals (O2C) business, Reliance Industries (RIL) results for the April-June quarter (Q1) of 2024-25 (FY25) missed Street estimates. A 14 per cent fall in the O2C segment’s operating profit compared to the year-ago quarter and a 22 per cent sequential decline pulled down the consolidated performance.

The O2C segment accounts for a third of the overall operating profit and about 60 per cent of the attributable consolidated profit.

The disappointment in Q1 performance was reflected in the company’s global depositary receipts, which ended 4.33 per cent lower on the London Stock Exchange.

Although the results were announced after market hours on Friday (the stock was down 1.9 per cent), it is expected to open lower in Monday’s trading. From its monthly lows, the stock has gained about 8 per cent.

Given the Q1 miss, the focus will shift to the recovery of the O2C business in the July-September quarter. The weak O2C performance was due to a dip in gross refining margins and weaker petrochemical deltas, driven by subdued global demand for petrochemicals. Transportation fuel cracks fell 5-30 per cent year-on-year (Y-o-Y), while petrochemical deltas were down 1-17 per cent Y-o-Y.

According to BOB Capital Markets, the business is well-positioned to maximise margins in a normalised environment. Analyst Kirtan Mehta states, “Margin normalisation was acute this quarter, bringing O2C operating profit (Rs 13,093 crore) to the lower end of the Rs 12,000-20,000 crore range over the past eight quarters, with unit margin at $89 per tonne reaching a 14-quarter low. While there are near-term challenges, RIL has demonstrated its ability to maximise margins with its highly flexible O2C configuration.”

The brokerage projects FY25 operating profit growth in the high single digits (9 per cent) due to the retail and O2C slowdown. However, it expects an 11 per cent annual growth in profits from 2023-24 (FY24) through 2026-27, led by a 22 per cent increase in consumer business profits.

Within the consumer businesses, digital services led the operating profit growth in Q1. The digital or telecommunications (telecom) business contributed the largest share to consolidated operating profit at 39 per cent, while the retail segment accounted for 13 per cent.

For Reliance Jio, notable was the addition of 7.9 million subscribers, marking robust growth for the ninth consecutive quarter. However, the Street was disappointed by the average revenue per user (Arpu), which remained flat sequentially at Rs 181.7, despite healthy data growth and an uptick in high-Arpu home broadband business. Brokerages expect Arpu to improve, given the 13-25 per cent increase in pricing effective July 3.

Key triggers for the digital segment, according to analysts Himanshu Shah and Yash Visharia of Dolat Capital, include the flow-through of the tariff hike, an increase in the 5G subscriber base, lower capital expenditure/robust free cash flows, and the potential listing of Jio.

Growth in retail services revenues by 8 per cent was primarily driven by a 19 per cent increase in footfall. The company expanded to larger format stores, increasing its retail area by 15 per cent to 81 million square feet, with a 2.6 per cent rise in store addition.

Streamlining operations helped improve the operating profit margin by 30 basis points to 8.5 per cent. However, muted discretionary spending impacted the performance of the fashion and lifestyle segment.

Elara Capital expects revenue and operating profit to grow by 14 per cent and 21 per cent, respectively, from FY24 through 2025-26 (FY26).

The brokerage has maintained its ‘accumulate’ rating. Analysts, led by Gagan Dixit, have raised their FY26 earnings per share estimates by 2 per cent as the benefit from higher telecom tariffs may be offset by weakness in O2C margins. Any announcement regarding initial public offering plans for the telecom/retail business and further clarity on the new energy segment are key upside risks.