Reliance 1QFY08 profits rose 28%YoY to Rs 32.64 billion. Ebitda came 2.5% below estimates with forex gains, lower depreciation and higher other income driving reported numbers 2.5% ahead of forecast. Reliance has achieved 30% of our FY08 full year estimate but we expect the rest of the year to be soft as GRMs moderate. FY09, though, will be transformational with oil and gas from KG-D6 and RPL (both projects on schedule) coming onstream and Reliance Retail gaining critical size. All businesses need to remain in extended sweet spots to support current valuations.

1QFY08 profits rise 28%YoY to Rs 32.64 billion

Reliance reported a 28%YoY rise in 1QFY08 profits to Rs 32.64bn. Ebitda (up 10%YoY) came 2.5% below estimates, though, on the back of lower than expected refining ebit (+26%YoY). This was partly offset by higher than estimated petchem ebit (+30%QoQ) with forex gains, lower than anticipated depreciation (Rs0.5bn) and higher other income (Rs0.5bn) driving reported numbers 2.5% ahead of our estimates.

Refining margin of $15.4/bbl below estimates

Reliance’s GRM of $15.4/bbl was its highest ever and rose $2.4/bbl QoQ (but we had expected this to be a $1.5/bbl higher due to (a) $2-6/bbl QoQ rise in benchmark spreads, (b) $0.3/bbl savings from the conversion to an EOU, (c) $0.5/bbl of translation impacts and (d) $0.7/bbl of inventory gains (which management contends is offset by hedging), offset by (e) $0.5/bbl higher marketing under-recoveries.

Petrochems profits rise 30%QoQ ahead of estimates

We were surprised by the strength in petchem ebit, though, which rose 30%YoY despite (a) flat production volumes, (b) lower $ benchmark spreads (22% increase in naphtha prices) and (c) a 6-7% stronger rupee. Even if we build in a more modest 8% reduction in unit netbacks for Reliance (better product mix, higher tariff protected domestic sales), it would still imply a surprisingly high 25%QoQ reduction in opex.

Forex gains, favourable base helps YoY growth

While Reliance capitalised in Rs3.8bn in forex gains on loans for fixed assets, reported numbers were boosted by Rs1.9-2.0bn in forex gains on w-cap loans and interest costs. Our estimates also indicate that it would have made an Rs1.8-2bn forex gain on its business operations (cf. a similar loss last year). In addition, management clarified that it paid an Rs2.9bn milestone royalty on its PX plant last year which created a favourable base. Adjusted for these, core PBT appears flat to marginally down YoY.

Relatively subdued exploration activity expected

The KG-D6 gas development remains on track for first-gas in mid-2008 with oil production from the block expected to be 30-35kbpd initially. With exploration activity expected to be relatively subdued over the near term due to lack of rigs and appraisal of new finds like Cauvery and Saurashtra expected to take 8-12 months, focus will start shifting on FY09 and upstream earnings. At 12x FY10 PE, the cyclical refining and petrochems also need to be in extended sweet spots to justify current valuations.