Stock Review: Reliance Industries

WHEN the going gets tough, the tough gets going. And, when valuations shoot sky high, research analysts start digging deeper in search of value. Credit Suisse's recent report on Reliance Industries does exactly the same, trying to unearth value locked up deep within the behemoth's esoteric subsidiary structure. The researchers were no doubt helped by the fact that RIL published the annual reports of 82 subsidiaries and summary accounts of 12 subsidiaries for the first time.

    The report, however, concludes that although the subsidiaries hold potential to create earnings surprises, it is difficult to value them. "Other than holdings of treasury stock, it is however difficult to value these other investments firstly due to their small earnings (e.g., Reliance Retail) and secondly, due to the lack of details on land and real estate investments."

    While the market prices in the treasury stock holdings, other RIL investments in subsidiaries worth $7.5 billion are typically ignored, for lack of detail and lack of earnings. They are a fertile source of EPS surprises just waiting to happen. It's a pity, though, that they don't generate any regular income. "If the Rs 35,400-crore invested in RIL's subsidiaries was instead invested in commercial paper, earning 5% post tax, FY10 EPS would have been 11% higher," mentioned the CS report.

    RIL's 94 subsidiaries together hold a sizeable balance sheet of Rs 45,000 crore. A 21% of total subsidiary balance sheet is invested in RIL treasury stock, 23% in gross block and 16% in land/real estate. In terms of the sources of funds, between 41% to 56% of the total funding came from RIL itself. Almost one-quarter came from retained earnings and a mere 4% was contributed by external borrowings.

    Apart from the extraordinary gains of $1.9 billion from the sale of the treasury stock, RIL's subsidiaries generated $68 million net loss in FY10. Continuing losses at Reliance Retail and overseas E&P projects were more than the tiny profits made at Jamnagar SEZ and the African retail operations.

    The researchers also hit upon some extraordinary transactions within the subsidiaries that hold treasury shares of RIL. While the number of shares has come down by 1.65 crore, their overall balance sheet value appears intact. Sale of shares at book value and a partial repurchase at a higher price seems to be the only possible explanation. "We see this achieving an interesting result. The book value per share of the 1.65 crore shares now left with Reliance Universal Enterprises Limited is Rs 1200. If these shares are now sold at current market price, no profit will be generated; so, no taxes will have to be paid on them," noted the CS analysts.

    A company of RIL's stature can surely make investments for strategic purposes that don't generate income in the short run. At the moment, lack of clarity prevents from putting any value on these investments in subsidiaries, when one values the company as a whole. Investors mustn't expect any short-term benefits coming out of these investments.