Reliance Industries: Is this a Buying Opportunity?

• "The best things in life are free, but sooner or later the government will find a way to tax them." ~ Anonymous

On 1 July, the markets were taken aback by the government's decision to levy a windfall tax on domestic crude oil producers.

Further, new duties were imposed on the export of petrol, diesel and aviation turbine fuel in a bid to curb windfall gains to private refiners and boost domestic supply.

This policy action is also seen as an effort by the government to reduce pressure on the rupee, rein in the current account deficit and increase the domestic supply of petroleum products.

This is why Reliance share price is falling for the past couple of days. Shares of Reliance Industries Ltd tanked over 9% during market hours on Friday before recovering but still closed with losses of close to 7%.

Note that Reliance is a top renewable energy company with focus on green hydrogen as well as other renewable sources.

There is still a lot of uncertainty over how much of an impact these new duties will have on the margins of Reliance and other companies like ONGC and Indian Oil Corporation.

ONGC share price is also falling owing to the same reasons.

As analysts and investors scramble to assess the repercussions of these taxes, let us try and understand what are these duties, how they may affect Reliance and if this could be an opportunity to accumulate shares of the company.

Lead-up to the Taxes

After Russia invaded Ukraine, Indian oil refiners made a killing by snapping up Russian crude at a deep discount and shipping it to Europe and US.

Further, domestic producers have been selling crude oil to domestic refineries at international parity prices, thus making windfall gains.

Recently, domestic gasoline supplies at gas stations have run out in states like Rajasthan, Gujarat and Madhya Pradesh as oil refining companies preferred to sell fuel abroad.

On the other hand, ONGC and Oil Corporation of India reported bumper profits in the March quarter when international prices soared to US$139 per barrel.

With that backdrop, it was only a matter of time before the government would intervene and curtail this imbalance by imposing duties and taxes.

Windfall tax is a higher tax rate on sudden big profits levied on a particular company or industry.

A duty of Rs 6 per litre on the export of petrol, Rs 13 per litre on diesel exports and Rs 1 per litre on Aviation Turbine Fuel will be levied, along with an additional Rs 23,250 per tonne tax on domestically produced crude oil.

Italy and the United Kingdom are two key economies that had levied windfall tax in May this year on oil & gas and energy companies.

Finance Minister justified the Modi led government's move saying, "phenomenal profits" made by some oil refiners on exporting fuel at the expense of domestic supplies had prompted the government to introduce an export tax on petrol, diesel, and ATF.

The move will help ease shortages as India has been forced to increase imports of fuels, with imports rising to 13,000 barrels a day in the first half of June, a seven-month high.

Reliance: How Does this Affect the Company

Some analysts believe that shares of Reliance Industries may continue to remain under pressure over the next few days as the market may further discount on this government move.

Other analysts feel that companies like ONGC will be more adversely impacted and even though refining margins for Reliance will be hit, they remain optimistic on the stock and have reiterated their 'buy' calls.

It is too early to calculate the actual impact on the price of shares of the company but it is important to note that Reliance's Jamnagar refinery was accorded Export-Oriented Unit status and was set up as an SEZ, which should provide relief for the company and possibly tax exemptions.

However, let us look at the implication on the company more objectively.

Due to the Russia Ukraine war, the company's refining margins are reportedly much higher at record levels of US$25-$26 per barrel against just US$9.8 per barrel in financial year 2021-22.

Hence, even with the imposition of taxes, these super abnormal margins of US$25 could reduce to about US$15 - US$18 per barrel. It is unlikely that it can reduce any further with the current supply situation.

Even a US$15 per barrel margin would still be higher than the average margins over the last ten years.

According to the new taxes, exports of petrol will be taxed at Rs 6 per litre and diesel at Rs 13 per litre.

The large export tax on diesel is negative for Reliance and effectively the refining surge in profits would now get capped. However, the management is very agile and can easily move their product basket in order to reduce their tax incidence and according to what is more profitable.

Reliance: A Good Buying Opportunity?

Since the announcement of windfall tax, the share price of Reliance is down by 6.9% and has stabilised at levels above Rs 2,400.

Technical analysts feel that the share price has strong support at Rs 2,350 levels and a very strong support at levels of Rs 2,050.

Fundamentally, the company has been on a strong growth trajectory since March 2021. It's a fundamentally strong company.

With a total refining capacity of 70 MMTPA, the company is expected to continue exploiting tight market conditions by purchasing Russian crude at a discount.

Further, its retail store expansion, scaling up of Jio platform along with expected tariff hikes and clean energy business will all contribute to growth over the next few years.

A recent report by Bernstein Research expects the oil-to-chemicals business of Reliance to deliver record earnings before interest, taxes, depreciation and amortisation (EBITDA) of Rs 84,500 crore - 25% higher than what consensus estimates predict.

Bernstein raised the target price by 17.7% to Rs 3,360 from its earlier target of Rs 2,830.

Windfall taxes on oil producers are a global trend and highlight the tightening energy market outlook. However, long term investors should look beyond it.

Companies like Reliance have been making abnormally massive profits out of an exceptional situation, and it is only fair that a part of that profit is taxed by the government.

Even after paying this tax, it is important to note that the net margins are still much higher than normal.

With or without taxes, Reliance's growth story is intact and if investors are able to purchase shares at a lower price, they could look at it as an opportunity and consider buying for the long term..

Investors could use this opportunity to get the stock at a cheaper price, like taking advantage of a sale to purchase something you have always wanted.

After all, when like gives you lemons, you take them, because they are free!

 

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.