Stock Review: RIL

 

   In spite of a healthy profit growth, huge cash flows, great investment plans and most brokerages recommending 'Buy', the stock of Reliance Industries (RIL) has underperformed the markets for the past three years. Although the company has achieved an extremely large size and sports a healthy balance sheet, it is facing headwinds in terms of incremental profit growth. On the other hand, the deal with BP supports the valuation of its exploration assets, which limit the scrip's downside. For investors with buy-and-hold strategy, the scrip may not be able to outperform the market.

WHAT'S AILING

RIL's natural gas production was supposed to stay at 60 million cubic meters per day (mmscmd) with a possible increase to 80 mmscmd. However, after touching the plateau level, production fell and has stabilised around 45 mmscmd. The resultant fall in profits will prove a drag on the company's numbers in the coming quarters, as this business contributed over one-fourth of RIL's profits.

   Its other major businesses of refining and petrochemicals too are facing headwinds and may, at best, maintain their profits on a sequential basis going forward.

   RIL has also lost on a key opportunity in the petroleum value chain, which could have boosted its earnings, when it sold its subsidiary, RGTIL, licensed to lay the East-West Pipeline to the promoter group for a paltry sum. Had the business remained under RIL, it would have added around $1 billion in annual revenues, of which 40-50% would reflect in its net profit.

   The capital market watchdog Sebi's proceedings against RIL over violation of insider trading and creeping acquisition norms — and RIL's consent pleas which have been repeatedly rejected — appear to have further stained the company's image as a valuecreator for retail investors.

INVESTMENT PLANS

The company has diversified into telecom with an acquisition of a 95% stake in Infotel Broadband Services, which won a pan-India licence to roll out broadband wireless access. It recently tied up with DE Shaw Group to enter financial services. Through three distinct deals, the company has acquired a considerable stake in shale gas assets in the US.

   However, all these businesses are mostly in the primary phases and would need huge investments and several years to become profitable. An example is the company's foray into retailing which remains loss-making even after five years of operations.

FINANCIALS

Despite heavy annual investments, the company has had two consecutive years of operating cashflows exceeding its capex. This trend, plus the $9 billion it is set to get from BP for the stake sale, is likely to ensure that the company is cash-rich and debt-free within the next couple of years.

   After stagnating at a net profit level for the past three years FY08-FY10, the company managed a 27% growth in FY11 net profit to 20211 crore. In the past five years, the company increased its gross block at an annual average of 22%. However, with profit growth not keeping pace with asset creation, the return on employed capital (ROCE) fell to 12.3% from 18.8% of FY06.

VALUATIONS

Various brokerages use sum-of-the-part method to value RIL shares at somewhere between 1,000 and 1,200 depending on different assumptions. On the simple valuation metric of price-to-earnings multiple (P/E), it is trading at 15.3 times its consolidated net profit for FY11. This is still higher compared to its global peers, such as Exxon Mobil, Chevron, Royal Dutch Shell, PetroChina, China Petroleum, which are all are trading between a P/E of 7 and 12.