Investor's Eye: Update - Reliance Industries, Godrej Consumer Products

 

Investor's Eye [June 20, 2013]  Sharekhan www.sharekhan.com

Summary of Contents   STOCK UPDATE Reliance Industries  Recommendation: Buy Price target: Rs1,010 Current market price: Rs799 Refining margin to correct; petchem margin to improve in the quarter coming ahead Key points Singapore complex GRM corrected in April-June 2013: After witnessing an improvement in the gross refining margin (GRM) in the last three consecutive quarters (Q2,Q3,and Q4FY2013), the Singapore complex GRM corrected in the past couple of months (April-June 2013) by around $1.5-2/barrel as compared with the average GRM for Q4FY2013. The correction in GRM was largely on account of a weakness in the product cracks particularly gasoil (16%) and gasoline (~19%) compared with the average crack for Q4FY2013. In addition to the lower product cracks, the Arab light-heavy crude price differential, which was around $4.5/barrel, narrowed down to $4/barrel during April-June 2013. Reliance Industries Ltd (RIL) reported an impressive GRM of $10.1/barrel during Q4FY2013 but looking at the recent correction in the product cracks, we believe the company is expected to post a decline in the GRM in the coming quarter (Q1FY2014) on a sequential basis. However, the average GRM for Q1FY2014 is expected to remain higher as compared with the GRM of $7.6/barrel in Q1FY2013. We have factored GRM of $8.5 for FY2014 and FY2015. Petchem margin to improve with increase in product prices and decline in feedstock: On the positive side, the petrochemical (petchem) business is expected to witness an expansion in the margin. The expansion in the margin is on account of lower feedstock prices and an increase in the prices of most of the end products. During the past couple of months, the prices of feedstock have decreased in the range of 8-10% compared with the average price for Q4FY2013. On the other hand, the prices of most of the petchem products have increased, which resulted in a margin expansion. The margin of products like propylene, HDPE and LDPE witnessed an improvement of 10-30% whereas the products like MEG and PTA witnessed a margin pressure of 17% and 2% respectively. During Q4FY2013, the company posted an earnings before interest and tax (EBIT) margin of 8.6%, which we believe will improve in Q1FY2014 on account of a recent increase in the margin of most of the products and lower feedstock prices. KG-D6 gas output continues to decline; nod to develop satellite field and likely revision in gas prices augurs well: The natural gas output from the company's Krishna-Godavari (KG)-D6 block declined to an all-time low of 15 million standard cubic meters per day (mmscmd) at the end of May 2013. The continuous fall in the gas output was on account of water and sand ingress in the field that led to shutting down of more than one-thirds of the wells. However, on the positive front, RIL has got an approval for the development of KG-D6 satellite field and has submitted a development plan for KG-D6 R-Series and will soon submit the same for NEC-25 block in order to arrest the decline in the output from the main field. In addition to this, the likely increase in the gas prices from the current level of $4.2/mmbtu from March 2014 augurs well for the company and could support earnings of the exploration and production (E&P) division. We maintain our earnings estimates and may revise after Q1FY2014 results of the company: We highlight a couple of negative developments like correction in the GRM and continued declined in the gas output in the E&P division. However, an improvement in the petchem margin augurs well for the company and could partially offset the impact of recent correction in the GRM. Hence, we maintain our earnings estimates for FY2014 and FY2015 and may revise them after Q1FY2013 results of the company. Outlook Given the recent correction in the GRM, we believe the near-term business environment for its refining business remains challenging and the company could witness margin pressure on a sequential basis in the coming quarters. However, a recent improvement in its petchem margin, a healthy ramp-up in the US shale gas and a likely revision in the prices of gas from March 2014 are providing visibility of earnings growth going ahead. Further, any approval for further development of the KG-D6 block could be positive for RIL. Hence, we maintain our Buy recommendation on the stock with a price target of Rs1,010. Currently, the RIL stock is trading at price earnings (PE) of 12.5x and 10.9x for FY2014 and FY2015 estimated earnings respectively.   Godrej Consumer Products  Recommendation: Hold Price target: Rs845 Current market price: Rs761 Management interaction note Key points Maintain steady growth in the domestic market: With no signs of any slowdown in key categories in the domestic market, GCPL expects to achieve a steady revenue growth in the stand-alone business in the coming quarters. We expect GCPL's revenues at the stand-alone level to grow by around 20% in FY2014. Lower raw material prices to aid profitability: The palm oil prices have seen a significant correction in the recent past due to weakening of demand in the international markets. The Malaysian palm oil prices are down by 25% YoY and are currently trading at 2,327 MYR ringgit. Also, the linear alkyl benzene (LAB) and high-density polyethylene (HDPE) prices have stabilised on a year-on-year (Y-o-Y) basis. The company would gain benefits from the decline in the key input prices as it will help in improving the gross profit margin (GPM) in the coming quarters. However, if the rupee continues to remain weak against the dollar and there are any purchases of key inputs in dollar terms in the coming quarters, it would negate the impact of softening commodity prices to some extend. Overall, we would see improvement in the GPM in the coming quarters and the substantial part of gains at the GPM level would be invested in branding building and promotional activities.  International business likely to see margin improvement on Y-o-Y basis: Most of the key international regions have seen a dip in their margins due to one-off factors in most regions in Q4FY2013. However, the management believes the margin picture should improve in FY2014. The Indonesian business is expected to remain in the range of 18-20% in the coming quarters. The Latin American business won't see a substantial improvement in first two quarters of the fiscal, as it is an off-season for the business. We expect the Latin American margin to improve to high single digits in FY2014. The African business is expected to see a gradual improvement in the coming quarters. Overall, we believe the international business would see a Y-o-Y improvement in the operating profit margin (OPM) in FY2014.  Impact of rupee depreciation for GCPL: The rupee has depreciated by 10% and currently stands at ~Rs59.5 per dollar in comparison with Q4FY2013. GCPL currently has foreign currency debt of $370 million (~Rs2,050crore). The repayment of debt is scheduled at $15-20 million every quarter. The impact of rupee depreciation will be adjusted against the cash flow for the unhedged portion of repayment, which means your cash outgo for that quarter will increase and it will get adjusted against asset or goodwill on the balance sheet (as most of the dollar denominated loan is taken for the acquisitions made in the international market). The increase/decrease in debt due to the revaluation of remaining portion of dollar denominated debt will be recognised against the goodwill on the balance sheet at the end of the year. At the stand-alone level, the mark-to-market loss would be limited to any import payables (net of export receivables, if any) in Q1FY2014. There are inter-company loans that have been given by holding companies to operating subsidiaries. The mark-to-market foreign exchange (forex) impact would amortise over the tenure of the loan. Going ahead, if the rupee appreciates against the dollar, the impact would get reversed.  Outlook and valuation: We like GCPL on account of its strong focus on driving growth in the domestic and international markets (through new product launches and enhancing the distribution reach) by keeping the balance sheet lean to derive future inorganic growth initiatives. We believe the company has a strong potential to achieve top line and bottom line compounded annual growth rate (CAGR) growth of above 20% over the next two years. At the current market price, the stock is trading at 30.0x its FY2014E earnings per share (EPS) of Rs25.7 and 23.7x its FY2015E EPS of Rs32.5. We maintain our Hold recommendation on the stock with the price target of Rs845. Click here to read report: Investor's Eye     Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

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