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Reliance likely to show a decent recovery in Q2: Probal Sen, Centrum Broking

Gasoline and LPG doing well in pockets. Broadly speaking, downstream prospects are better.

ET Now|
Oct 07, 2019, 02.05 PM IST
Probal Sen-1200
As far as refining industry is concerned, for the next six to nine months, one is likely to see some more traction in product spreads, specifically in diesel, says Probal Sen, Senior VP-Research, Centrum Broking. Excerpts from an interview with ETNOW.

Indian OMCs seem to be getting re-rated. The government divestment plans are in; Asian GRMs have seen a decent recovery. What is the view on the overall landscape?
The impact that a private player coming in can have on the Indian downstream refining space, is a structural positive. Suddenly about 13% of India’s refining capacity and about 24-25% of India’s marketing capacity potentially being in the hands of private players, opens up a completely new era as far as Indian oil and gas downstream is concerned.

From that aspect, given the fact that fuel pricing would no longer see any sort of interference -- explicit or implicit -- as a result of this transaction, then obviously that is the kind of rerating people are ascribing specifically to the marketing business. As far as refining is concerned, for the next six to nine months, one is likely to see some more traction in product spreads, specifically in diesel, given the fact that the IMO regulations are coming nearer.

We saw some signs of recovery already in September, but one would expect that diesel spreads could potentially see another dollar or two of strength and FO spreads might see a little bit more of a contraction as we get closer to IMO implementation. So overall refining is likely to do a little bit better marketing.

While fuel consumption growth does remain disappointing in line with probably a broader economic activity, we are seeing that fuel consumption growth has slowed down so one would probably have to wait for a little while to see a sharp pick up in all the products. Gasoline is still doing well, LPG is doing well but that is in pockets but barring that, broadly speaking downstream prospects are a bit better.

The valuation multiples that people would ascribe to these businesses will obviously go up if these transactions see a successful closure and sees any interest from global buyers.

What about Reliance Industries? GRMs have remained subdued for a very long time. When do you see some meaningful recovery, now that we have seen the Asian refining margins as well having seen a good bounce back?
In Q2 itself, the movement of key product spreads show that Reliance is likely to show a decent recovery at least on a QoQ basis. What hampers the recovery at least in the immediate quarter is that they had a shutdown of one of the refineries in July which obviously would have hampered the product yield for this quarter.

Despite that, our expectations is that they would still do somewhere between $9.3 and $9.5, which is about $1.2 to 1.4 higher than what they reported in the first quarter. Going forward, given the recovery that is happening and with the shutdowns now out of the way, in the second half, it is very likely that one will get back to a $4.5 kind of premium on benchmark Singapore margins. So our expectation is Singapore is unlikely to go much below $6 over the next six to nine months. If you were to take that as the benchmark, then even Reliance can comfortably do somewhere between $10 and $10.5 which I is a pretty reasonable level given the kind of environment.

What is really hampering a more structural recovery is that global demand estimates for crude and products have consistently been seeing downgrades for the last six months. That cycle needs to stop for a more structural trend to emerge as far as all the products are concerned, not just diesel and gasoline which have been doing better anyways.

Until that happens, if Reliance is able to sustain a double digit margin, given the kind of momentum that is behind the other businesses, they have their earnings will continue to expand quite comfortably over the next six months.

What are you making of the kind of rerating that Indian OMCs have seen, especially in case of BPCL ever since the government announced its divestment plans?
There would be different opinions in terms of how one looks at a stock like BPCL in the current environment. There are two ways to really look at it; one is to look at it as a going concern and attribute your traditional EV/EBITDA multiples to a business and see what an investor would be willing to pay, given that they are getting an entry and getting a leading position in the Indian marketplace. If one looks at that metric frankly, at the current price of around Rs 520 odd, one would like to think that based on traditional valuation multiples, a lot of the rerating is probably in the price.

The other approach is that if one looks at it as a strategic asset and says that if an incoming investor looks at something like a replacement cost methodology, for example, then one would say that the upside could be even higher. You could probably have another Rs 100-150 of upside that is still there on the table. But our considered opinion is that at these prices, the news flow might continue to drive the price upwards.

If one really looks at the place that the businesses are in and the prospects of the specific business segments; refining at maybe around 6.5-7 times EV/EBITDA and marketing at a higher, even 8 times EV/EBIDTA, then you would struggle to get a price more than Rs 500 a share. From that aspect, at this level, at least for the near term, the story has topped out. Obviously, if an investor comes in or if the reserve price that is declared by the bankers is much higher, then one can see some more momentum that is left in the stock.

What kind of investors and global oil companies do you see getting interested in the Indian refining assets, should the government put it on the block?
I honestly would not want to comment on what kind of investor will come in. The government is pretty agnostic in terms of what kind of buyer as long as it is a serious buyer and he is willing to put up the money for the government’s stake. The important thing is that where the interest comes from will depend on what the policy direction is.

There was a bit of a hiccup in the fuel pricing deregulation story when the October 2018 announcements came and a Re 1 cut announced by the minister, rather than the companies themselves. Those kinds of hiccups make one nervous in a rising crude price environment. Currently, given that crude is at comfortable levels, that makes it far easier to keep the policy in place and drive home the direction. The government is telling us they are reforming the entire space and that they are open to private investment.

From that aspect, given where we see projection of crude prices for the next couple of years, it is a great time to introduce private competition and drive home the message that the government does not intend to be in these businesses. But as I said, prospective buyers will probably need to be sure that true deregulation is in force. If that is the case, marketing business will probably be the trigger for a buyer to come in. Just buying a standalone refining asset in India or anywhere else, may not be attractive, but when you couple that with the growing fuel consumption in the country, the package may prove to be very attractive for any potential buyer.

Also Read

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Expect muted quarter from Reliance as refining margins stay weak: Probal Sen, IDFC Securities

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