Reliance Industries: Refined prospects

The market mayhem has seen the stock of Reliance Industries (RIL) lose more than 10 per cent since the beginning of this calendar year. This is despite the company doing quite well over the past few quarters — consolidated profit grew nearly 40 per cent year-on-year in the recent December quarter and 18 per cent in the past nine months.

The stock fall presents a buying opportunity for investors with a long-term perspective and an appetite for risk. One, the valuation seems attractive. At ₹906, the RIL stock trades at about 10 times its trailing twelve month earnings, less than the average 11.5 times over the past three years. Next, the company’s growth prospects seem healthy. The benefits of the big-ticket capital expenditure in the refining and petrochemicals segments should kick in from 2016-17.

The oil and gas exploration business continues to be in trouble, but the segment doesn’t pull much weight overall. The retail business is profitable and growing at a steady pace. While the impending telecom foray is a wild card for now, the odds of success in the coming years seem good.

RIL is currently being powered by its refining and petrochemicals businesses. Refining contributed nearly two-third to the overall operating profit in the nine months ending December 2015, while petrochemicals accounted for almost 30 per cent. Gross refining margins (seven-year high of $11.5 a barrel in the December quarter) should remain strong in the coming quarters — with crude oil trading weak, demand for end products such as petrol and diesel expected to be healthy, and no big refinery capacity expansions globally. In the petrochemicals segment too, the company expects the pricing environment to remain favourable. That said, these are cyclical businesses; so, margins will oscillate between peaks and troughs over time.

What should hold RIL in good stead is the significant upgrade and expansion programmes (capex of about ₹1 lakh crore) in refining and petrochemicals, which have been under way for the past few years. Some of these have been completed and the others are in advanced stages. The benefits should start accruing from 2016-17. The petcoke gasification plant should give a leg-up to refining margins while the capacity increases in petrochemicals should add to scale, integration and profitability. So, profit in these segments can increase sharply in the coming years.

These should more than make up for the challenges in the exploration segment. Low prices and volumes have roiled both the domestic exploration business (primarily the KG-D6 field) and the international US shale ventures. The ongoing disputes with the government over a host of issues, including cost-recovery, have not helped. With the company cutting capex sharply, an improvement in performance seems unlikely, at least in the near term. But this should not have a big impact — the exploration business, having shrunk significantly over the years, accounted for less than 1.5 per cent of the overall operating profit in the nine months ending December 2015.

That’s lower than the contribution from the retail business, which is adding new stores and growing steadily across categories. Profit in the segment grew 20 per cent year-on-year in the nine months ending December 2015. The company continues to invest in the business and is working on launching its retail e-commerce initiative.

RIL’s next big bet — its telecom venture Jio — is expected to be commercially launched within the next few months. In a highly competitive market, the telecom venture may take a few years to break even and could be a drag on profit in the initial years. But with a pan-India licence, deep pockets facilitating huge investments (about ₹1 lakh crore so far), strategic tie-ups (such as the one with Reliance Communications for spectrum sharing), and a different delivery platform, RIL could again disrupt the industry like it did in the early part of the last decade. The telecom business looks promising and could become a key growth driver for the company in the future.

Despite the huge capex undertaken so far across businesses, RIL’s cash hoard is formidable at about ₹92,000 crore and its debt-to-equity ratio remains comfortable at less than 0.75 times. This gives its adequate room to fund investments and expansions.

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