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The metamorphosis of Reliance Industries

Anand Kalyanaraman | Updated on September 02, 2019 Published on September 01, 2019

From an energy-focussed giant to an energy-plus-consumer business play — the company has undergone a major transformation. We look at where RIL is headed

Stock charts often reveal the stories and journeys of companies. Sure enough, the chart of market behemoth Reliance Industries (RIL) over the past decade tells many a tale. From mid-2009 to early 2017 — nearly seven-and-a-half years — the RIL stock moved in and around a narrow range of ₹350-550 (adjusted for bonus issues).

Investors were understandably glum about this long hibernation, given the company’s reputation of rewarding shareholders. But then, the stock broke out — more than doubling over the past two-and-half years. Its moves over the past few months are also striking. After losing nearly 20 per cent since April due to concerns over high debt, the stock has made a comeback over the past few weeks, following RIL’s deal to sell 20 per cent of its oil-to-chemicals business to Saudi Aramco.

These long-term and short-term stock movements have many inter-connected threads. They reflect the company’s metamorphosis over the past decade from an energy-focused giant to an energy-plus-consumer business play, investor concerns about the mammoth investments and debt that have accompanied this huge DNA change, and how the company has sought to address these issues. They also offer glimpses into where the RIL juggernaut seems headed and the challenges ahead. But first, let’s cut back to a slice from the past, a crucial turning point in RIL’s evolution.

 

 

Turning point

In May 2010, Mukesh Ambani’s RIL scored a landmark legal victory in the Supreme Court over his brother Anil Ambani’s RNRL in their bitter dispute over gas from the Krishna Godavari (KG) basin. This set into motion a chain of events that, in a few years, sent waves of disruption and upended the telecom industry.

Soon after the Supreme Court verdict, the Ambani brothers scrapped the non-compete agreement they had entered into in January 2006 as part of the family arrangement to divvy up various businesses; Mukesh had retained the core energy business while Anil got telecom, financial services, infrastructure and power.

With the non-compete clause out of the way, Mukesh lost no time in clawing his way back into telecom in which he was the original price warrior with the erstwhile Reliance Infocomm. In June 2010, Infotel Broadband, a relatively unknown entity, emerged as the sole nationwide player in the wireless broadband auction. Soon, RIL acquired 95 per cent stake in Infotel Broadband and marked its re-entry into the telecom business. RIL was already betting big on high-end data services and the wireless broadband segment. Data, as it would turn out, would be the new oil.

It helped RIL that in 2013, the new unified licence regime allowed companies with broadband spectrum to also offer voice services after paying a relatively low cost.

Telecom redux, digital drive

Competitors cried foul but this move paved the way for RIL to launch its full-fledged telecom operations under the RJio banner in September 2016. RJio announced in February 2017 that it would start its tariff plans from April 2017.

 

With worries about commercialisation of the service easing, the RIL stock took off.

Since its launch, the intense competitive pressure exerted by RJio with cheap tariffs and aggressive expansion has pushed most incumbents, including Anil Ambani’s Reliance Communications, out of business. The number of telecom players in the country has shrunk from about a dozen to three major ones — RJio, Bharti Airtel and Vodafone-Idea.

RJio has risen rapidly to pole position with about 330 million subscribers — a market share of over a third and growing; it targets 500 million subscribers. Even as the remaining players have been struggling with declining profits and losses, RJio has been reporting strong growth in its financial metrics — its operating revenue increased to ₹46,506 crore in FY 2019 from ₹599 crore in FY 2017, and its operating profit (EBIT) is ₹8,784 crore in FY 2019 from a loss of ₹52 crore in FY 2017.

RIL’s successful return into telecom is a game-changer for the company, primarily because RJio is the fulcrum around the company’s strategy to increasingly focus on its major consumer-facing businesses — digital and organised retail.

This September 5, RJio plans to launch its Jio Fibre service, comprising broadband, TV and landline. With proposed attractive pricing and offers, and an underpenetrated market, this too has the potential to be a big revenue driver for the company. It could disrupt the business of direct-to-home operators among other players. Also, the proposed ‘First-Day-First-Show’ to premium JioFiber customers could shake up the business of cinema operators.

Over the years, RIL has, through what resembles a ‘string of pearls’ approach, made a host of acquisitions to build a comprehensive ecosystem and integration in the digital, media and entertainment business. Besides the telecom business, the acquisitions and investments in various media, entertainment and online channels such as Network 18, Colours, Viacom and Moneycontrol, content providers such as Balaji Telefilms, and in multi-service operators and cable broadband service providers such as Hathway Cables, Den Networks and Datacom give RIL the advantages of medium, content and last-mile connectivity. While the media and entertainment business does not contribute to the bottom-line (loss of ₹52 crore in FY 2019), it gives RIL the power of content and influence. Going forward, RJio plans to set up data centres and provide various technology-based solutions to enterprises in collaboration with Microsoft.

 

 

Retail push

Along with telecom, RIL has also expanded its organised retail business by leaps and bounds over the past few years. Reliance Retail started operations in 2006 and achieved cash break-even in FY2013. While the sector witnessed significant consolidation, Reliance Retail expanded rapidly to become the country’s largest retailer; it is now much bigger in revenue terms than the next five players combined. With store additions across product categories and store formats, Reliance Retail’s store count increased to 10,415 as of March 2019 from 2,621 as of March 2015. The company’s revenue grew to ₹1,30,566 crore in FY 2019 from ₹14,556 crore in FY2014, while operating profit increased to ₹5,546 crore from ₹118 crore in this period.

In addition to continuing to expand its physical store presence, Reliance Retail now plans to enter e-commerce in a big way — a space currently dominated by Amazon and Flipkart (Walmart). This, it plans to do through the online-to-offline model, in which customers search for products or services online and buy it through offline channels. Besides using its own vast network of stores, Reliance Retail plans to tie up with other local merchants for this. RIL plans to provide various technology-based services and solutions to merchants and kirana shop-owners, and sees big potential in this opportunity that it calls ‘new commerce’.

The stricter rules announced by the Government earlier this year for online marketplaces with foreign direct investment — restrictions on keeping own inventory, exclusive deals with brands and deep discounts — could end up helping Reliance Retail’s online retail foray.

That said, both Amazon and Flipkart are formidable global players with deep pockets and the early-mover advantage. They continue to invest big in the high-potential Indian online retail market. Also, they are stitching up alliances (Amazon – Future Retail, for instance) to prepare for the big fight ahead. For RIL to be as disruptive a force here, as it was in the telecom market, will not be easy.

Diversifying, hedging

The massive ramp-up over the past few years in the digital and retail segments has helped RIL diversify its offerings and hedge its business model to a good extent, by reducing dependence on the core hydrocarbon segments — refining and petrochemicals. In the June 2019 quarter, the consumer-facing segments contributed 32 per cent of the consolidated segment EBITDA, compared with single-digit contribution a few years back. This is in line with the long-term plan of the consumer businesses contributing equally to overall earnings as the core hydrocarbon business.

This hedged business model approach has stood RIL in good stead. For instance, in what was a difficult June 2019 quarter for the core hydrocarbon business, the retail and digital businesses saved the day for RIL. The move helps the company reduce its dependence on the oil and gas business, at a time when globally, and in India, the shift towards electric vehicles is picking pace.

Refining and petrochemicals grow

Even as RIL’s large bets in the consumer-facing businesses were under way, the company invested big money in the mainstay refining and petrochemical businesses over the years. Among other initiatives, the petrochemicals capacity was nearly doubled, and the company set up its refinery off-gas cracker (ROGC) complex and petcoke gasifiers as part of the facilities’ upgradation. This led to improvement in the company’s product basket, reduced dependence on imported gas and improved the gross refining margin to double-digits. RIL’s refineries and petrochemicals plants are among the world’s largest and most integrated facilities, strengthened by the paraxylene and ROGC plants.

 

The benefits of these expansions and upgrades started reflecting between FY2016 and FY2019. The operating profit of the refining business rose from ₹15,827 crore in FY2015 to ₹19,868 crore in FY2019, while that of the petrochemicals business shot up from ₹8,291 crore in FY2015 to ₹32,173 crore in FY2019. While both refining and petrochemicals are cyclical businesses, better volumes and margins have helped improve their performance over the years.

The refining and petrochemicals businesses are also major cash generators; this helped supplement the funding for the major expansion across businesses. Going forward, RIL is working on a strategy that will reconfigure its refineries to produce only jet fuel (ATF) and petrochemicals. This will hedge it against the risk of expected lower demand for transport fuels such as petrol and diesel with the advent of electric vehicles. The demand for petrochemicals is expected to continue growing at a good pace, especially in India. RIL, as the biggest domestic player and also among the largest globally, seems well-positioned.

In the wake of the deal with Saudi Aramco to sell 20 per cent of the refining and petrochemicals business, there is some speculation that the promoters will eventually exit the hydrocarbons business. While their stake (about 47 per cent currently in RIL) will come down post the deal, the promoters would still retain substantial holding and their full exit seems unlikely given the high growth potential and profitability of the businesses.

Oil and gas (E&P) slips

The only major business that did not click for RIL over the past decade is oil & gas (exploration and production). Its major bets — both in the domestic market (KG fields) and in the international market (US shale gas) — did not live up to expectations. A variety of problems, from pricing disputes to production declines, has seen the segment languish for many years now. In FY 2019, the business posted an operating loss of ₹1,379 crore on revenue of ₹5,005 crore. Even so, RIL, along with its partner BP (30 per cent stake), plans to invest $5 billion in the development of three projects in the KG D6 block, with the first project expected to go onstream in 2020.

Investments, pay-off, deleveraging

Over the past five years, RIL has made massive investments of ₹5.4-lakh crore in its various businesses, a chunk of it (about ₹3.5 lakh crore) in telecom. This has started paying off well, with net profit rising from ₹23,566 crore in FY2015 to ₹39,588 crore in FY2019, a growth of nearly 70 per cent. The smart jump in profits in FY2017 and FY2018, coupled with the commercialisation of RJio’s services in early 2017, seems to have assuaged investor’s worries, and the RIL stock has rallied handsomely.

Yet, the heavy debt taken to finance the growth has increased the strain on the balance-sheet and raised some concerns. A recent report from brokerage Credit Suisse had said that RIL’s financing liabilities had increased from $19 billion in FY2015 to $65 billion in FY2019; its net debt had risen from $2.7 billion to $12.4 billion in this period and additional debt in the consolidated balance-sheet rose from $9.4 billion to $20.6 billion. This had led to an increase in interest cost from $1.2 billion in FY2015 to $4 billion in FY2019. The report had said that RIL had been free cash-flow negative for six years, and that its interest cost amounted to a high 44 per cent of operating profit (EBIT). Concerns about high debt levels, along with a muted June 2019 quarter and market weakness, saw the RIL stock slip about 20 per cent since April this year.

So, the announcement made three weeks back about the RIL-Saudi Aramco deal saw the stock take wing again. RIL’s agreement with Aramco, subject to approvals, to sell a 20 per cent stake in its oil-to-chemicals business at an enterprise value of $75 billion has many positives for RIL. One, the valuation is quite attractive. Two, the deal should fetch RIL about $15 billion (about ₹1-lakh crore) and help the company deleverage significantly. Next, it should bolster its crude oil sourcing capability, given that a key oil supplier will also become an investor in the business. Besides, it fits in with RIL’s strategy to increase the share of the consumer-facing segments to overall profits. The deal with Aramco covers RIL’s refining and petrochemicals assets as well as RIL’s 51 per cent stake in the proposed fuel retailing business joint venture with BP.

In recent times, RIL has also entered into other deals that should help reduce its debt levels. The fuel retailing joint venture with BP should fetch RIL about ₹7,000 crore, and asset manager Brookfield has agreed to invest about ₹25,000 crore in RIL’s telecom tower assets. Besides, RIL is looking at value-unlocking options from its real estate and financial investments. Seen together, all this fits in well with Mukesh Ambani’s announcement to make RIL a zero net-debt company in 18 months. As of March 2019, the company’s net debt (debt less cash and marketable investments) was about ₹1.54 lakh crore.

Historically, RIL’s philosophy has been to build businesses on equity capital and rely less on debt. The Aramco deal is in line with this approach. RIL’s debt-to-equity ratio at a consolidated level (0.74 as of March 2019) has stayed reasonable at under one time, despite the huge capex over the past few years, and recent deals should help bring it down further.

Positive for investors

The good growth prospects for the company’s main businesses — oil-to-chemicals, digital and retail — bode well for investors. So do the proposed deleveraging plans. Besides, the planned move to list Reliance Retail and RJio within the next five years could result in value-unlocking for RIL’s investors. Also, Mukesh Ambani’s assurance of rewarding shareholders through higher dividends, periodic bonus issues and other means should keep interest in the stock ticking.

In the near term, the troubles in the global and domestic economy could affect RIL’s businesses — especially the cyclical refining and petrochemicals segments. But the company has the muscle to weather the tide. Once the proposed deals with Aramco and BP are completed, there will be a dip in RIL’s revenue due to reduced stake. But this should be more than offset by lower interest cost. At about ₹1,250, the stock trades at a reasonable 13.5 times FY2021 estimated earnings as per Bloomberg consensus estimates, just a tad higher than the three-year average of about 12.5 times.

There are some external risks though. Over the years, RIL’s, especially RJio’s, breakneck growth has invited allegations from the competition, even if sotto voce, of partisan policy benefits and regulatory capture.

From many players, the telecom sector in the country has now become an oligopoly and runs the risk of becoming a duopoly or even a monopoly in the coming years. This could eventually see the competition law kick in and bring about curbs.

Published on September 01, 2019
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