Stock Review: Reliance Industries Ltd (RIL)

Reliance Industries Ltd (RIL) is the largest private player in the refining, petrochemical, and exploration and production (E&P) space in India. It enjoys global leadership in its business, being the largest polyester yarn and fibre producer in the world. It is also among the world's top five to 10 producers of major petrochemical products.

 

Strengths

High cash reserves: The company's balance sheet continues to get stronger. Despite deploying cash in several businesses and having invested Rs23,229 crore (as on March 31, 2010), RIL still possesses a hefty cash and bank balance of Rs13,463 crore. Its cash and bank balance has grown over the last five years at a compounded annual growth rate (CAGR) of 30 per cent. Free cash flow, a measure of a company's ability to generate cash over and above its capital expenditures, has also risen significantly over the last five years at a CAGR of nearly 59 per cent.

Good nine-month numbers: During the nine-month period ending December 31, 2010, the refining and marketing segment's revenue increased by 36.4 per cent over 9MFY10. Increase in volume accounted for 15.3 per cent growth and higher prices accounted for 21.1 per cent of the growth in revenue.
The exploration and production business registered a growth of 57.8 per cent during this period. The company's net profit grew at 29.4 per cent during the same period.

Significant JVs: In 2010, RIL completed three transactions for acquiring shale-gas assets. These shale joint ventures (JVs) are expected to add significantly to the company's valuation. Through JVs with Atlas Energy in Marcellus, it has 3,43,000 acres; with Pioneer Natural Resources in Eagle Ford, it has 2,63,000 acres; and with Carrizo Oil & Gas in Marcellus, it has 1,04,400 acres of shale-gas assets.

RIL and SIBUR, Russia's leading petrochemical company, signed a memorandum of understanding (MoU) for setting up a JV in India. This new venture will produce butyl rubber at Reliance's integrated petrochemical site in Jamnagar.

Growth in organised retail: In the last quarter, Reliance Retail continued to expand the presence of its speciality formats.

Reliance Brands signed an exclusive long-term licence agreement with Quiksilver Holding S.à.r.l., a fully-owned subsidiary of Quiksilver Inc., the world's leading outdoor sports lifestyle company, for the launch of its core brands 'Quiksilver' and 'Roxy'.

A recent report by Edelweiss Securities sums up RIL's strengths well. It says that RIL's strength lies in its ability to build businesses of global size and scale, and execute complex, time-critical, and capital-intensive projects. These competencies, it says, will prove advantageous in its huge plans in the E&P sector, organised retailing and SEZ infrastructure.

 

Concerns

Dip in gas production: RIL is struggling to maintain its natural gas production at its guidance level of 60 million metric standard cubic metres per day (mmscmd). RIL's natural gas output has fallen to the level of 50-54 mmscmd in recent times from over 60 mmscmd in mid-2010. This has occurred owning to the complexities that have arisen within the reservoir.

New capacity: A lot of new capacity has been commissioned in the Middle East and production has been ramped up gradually. In future, with increased utilisation, these low-cost Middle East producers may marginally dampen petrochemical margins.

In Q2FY11, as incremental supply from Middle East crackers started making its presence felt, demand for naphtha reduced considerably and naphtha cracks turned negative in Asia and Europe. However, new crackers in Saudi Arabia ran short of advantaged feed, leading to increased demand for naphtha. This led to improved naphtha cracks in Q3FY11 which turned positive during the period.

Stock's underperformance: The recent stock performance of RIL, which has the highest weightage in the Sensex (11.69 per cent), has been disappointing. In the last one year (ending January 19, 2011) it has given a return of (-)9.5 per cent. The benchmark index, on the other hand, has delivered a growth of 8.5 per cent during this period.

 

Opportunities

Higher natural gas production: According to a report submitted by the Directorate General of Hydrocarbons (DGH) to the Oil Ministry, "RIL's Dhirubhai-1 and 3 fields, also known as D-1 and D-3 gas fields, off the East Coast, are likely to touch an output of 80 mmscmd for six years from 2012-13 to 2017-18. Together with gas output from the MA field in the same block, KG-D6 production in 2012-13 is slated to touch 88.5 mmscmd."

Foray into other segments: The cancellation of the non-compete agreement with the Anil Dhirubhai Ambani Group is expected to provide enhanced operational and financial flexibility to RIL, enabling it to enter and participate in the high-growth sectors of the Indian economy. RIL's refining and petrochemical segments have been contributing around 90 per cent of its total revenue, but this is expected to change as the company scales up its E&P business (it is set to emerge as an integrated E&P player).

Significant cash pile and treasury stocks could see RIL venturing into new sectors for inorganic growth. The company has decided to foray into the cement sector. It entered into an MoU with the government of Gujarat on the sidelines of the Vibrant Gujarat summit.

 

Valuations

The stock is currently trading at a price-to-earnings (P/E) ratio of 17.3. This is below its five-year median P/E of 18.19.

Over the last five years, the stock's earning per share has grown at a CAGR of 11.4 per cent. This gives it a price-earnings to growth (PEG) ratio of 1.5 times.
According to the Edelweiss Securities report mentioned above, global refining and petrochemical margins are expected to remain strong over the next two years. RIL, being a cyclical company with 65 per cent of its FY12E EBITDA coming from cyclical businesses (39 per cent from refining and 26 per cent from chemicals), will benefit from this.

Although the recent correction in the stock price offers investors the opportunity to participate in the refining and petrochemical up-cycle, they also need to watch out how the company fares in its broadband wireless access foray. They should also keep an eye on margins within the refining and petrochemical sector. Also, watch closely the results of reservoir studies at KG-D6 and the guidance provided by the company regarding volumes. Only if you are satisfied on these counts should you invest in the stock with at least a three-year horizon.