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Sunday, Jun 19, 2005

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Reliance Industries: Buy

AN investment may be considered in the stock of Reliance Industries, as there could upside potential over a one-year period.

The nuts and bolts of the arrangement between the Ambani brothers may be settled over such a period and complete clarity is likely to emerge on the business structure.

Institutional investors who have remained on the sidelines waiting for the `ownership issues' to be settled may scale up exposures in the stock now.

There is also the possibility that shareholders of Reliance may get to participate in telecom business' value that may be unlocked as part of the restructuring exercise.

Though the profitability of the telecom business and its valuation is likely to be inferior to that of Bharti Tele-Ventures, the structuring may be done in a manner that ensures gains. (Shareholders will, however, have to wait for the IPO and a listing of Reliance Infocomm).

The buyback programme at a maximum price of Rs 600 cushions the downside risk in the stock. We also expect the company to support the stock in the market through the buyback, if needed.

This is likely, as the Mukesh Ambani group would be interested in ensuring that there is no slippage in the market capitalisation of Reliance. This would be crucial to financing its business plans that entail substantial investments over the next few years.

In this backdrop, we take a positive view on the stock despite concerns over the quality of corporate governance. As far as this aspect is concerned, we expect improvement, as this would be a key aspect that will be closely tracked. If this does not fructify, it could affect investor interest in the stock.

Growth prospects for its oil and petrochemicals business appear to be bright despite the possibility of lacklustre earnings growth in the latter in FY 06. Higher refining margins are likely to more than compensate for the rising crude prices.

A merger of IPCL with Reliance Industries, which appears more likely, now, could also act as a trigger for valuation gains.

The telecom business has acted as a drag on profitability and returns have not been commensurate with resources and risks. As this business is vested in a separate company, Reliance would be valued as a pure energy sector play.

In much the same way as the Larsen & Toubro stock enjoyed a re-rating after it listed as a pure engineering and construction sector play, the valuation of the Reliance Industries stock may also be marked up. The magnitude of gains is, however, likely to be moderate and not on a plane that is comparable to the three-fold rise in the L&T stock.

The principal risk to our recommendation is a petro-product pricing arrangement that will require Reliance to indirectly share the burden of subsidy on kerosene, LPG and diesel. Shareholders of IPCL, Reliance Energy, Reliance Capital and Reliance Industrial Infrastructure could retain their holdings.

S. Vaidya Nathan

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