Reliance Industries rating – Buy: Refining profits to improve in Q4

Despite tight inventories, diesel cracks have come off sharply from the past week. RIL’s refining profit could surprise positively in Q4FY22e but should normalise in FY23e. Petchem margins are near 10-yr lows and China’s lockdowns paint a weak outlook for CY22 in our view. We see an 8% potential downside risk to our FY23E O2C Ebitda est as a result. Earnings growth should remain healthy in FY23e on the back of Retail and Jio. Retain Buy.

Diesel inventories at multi-year lows: Global inventories of diesel have fallen to their lowest level since 2008. Diesel demand remains stable across Asia and the US with some panic buying reported in the EU. China’s NDRC has asked local refiners to suspend export of gasoline and diesel in April that could support diesel margin in the near-term. However, Covid restrictions in China is dampening demand. As it remains steadfast in its Zero-Covid policy, demand for auto fuels is likely to soften in the near term in our view.

Diesel margins have come off sharply: Despite the inventory tightness, diesel cracks have corrected from $36 to $12 while Jet kero cracks have corrected from $28 to $13 in recent days.

Refining profits will improve q-o-q: With diesel accounting for 48% of its product slate and diesel margin up c50% q-o-q despite the correction, we expect RIL’s refining margin to improve $2 q-o-q. Refining profits will be aided by inventory gains on inflation in product prices. We are building in an improvement in RIL’s GRM to $10.5 in FY23e (from $9 in FY22e).

Petrochemical margins at multi-year lows: Prices of key petrochemicals – PE, PP and PET – have not seen the steep rally witnessed in feedstock naphtha price in the last month. As a result, margins have collapsed to multi-year lows. However, RIL’s integrated operations will see lower impact as it captures the naphtha spreads. China’s Zero-Covid policy and property sector curbs were already weighing on petrochemical margins. The recent spike in Covid cases in the mainland has led to renewed restrictions that will further weaken downstream demand and likely keep margins weak over most of CY2022 in our view.

Petchem weakness could offset refining strength over CY22e: Assuming some normalisation of margins from current levels, the fall in petchem profitability could offset the refining improvement over Q4FY22-H1FY23e. We see 8% downside risk to our FY23e O2C Ebitda est at a 5% lower petchem margin y-o-y.

Integrated ops lower earnings impact, maintain Buy: The downside to O2C Ebitda translates to 3% downside to JEFe consol FY23e Ebitda. RIL is the largest buyer of its own gas, hence higher realisation is unlikely to compensate the shortfall. Rapid expansion in Retail and strong growth in Jio should lead to c20% y-o-y EPS growth in FY23e. Any weakness in the stock would be an opportunity to accumulate.