Reliance Industries

Despite its June quarter results being in line with expectations, the stock of Reliance Industries Ltd (RIL), India's largest private sector company, saw no respite from its weak run. The markets seem to be have been spooked by the temporary cap on gas output from the KG-D6 basin. This, combined with concerns over overcapacity in the petrochemicals business has resulted in RIL's lacklustre run at the bourses.



However, the concerns may be overdone. There has been a string of positive recent events — the shale gas interest acquisitions in North America, continuing hydrocarbon discoveries and a favourable outcome in the protracted gas supply dispute with RNRL (which has paved the way for RIL's diversification into telecom and power).

Also, the company continues to be a veritable cash generating machine (FY10 operating cash flows of around Rs 20,500 crore) giving it the ability to muscle into any sector it chooses. Characteristically aggressive expansion plans hold the potential to propel growth.

RIL, which has underperformed the market for quite some time now, presents an attractive buying opportunity for investors with a long-term perspective. At the current market price of Rs 1,000, the stock discounts its trailing twelve months earnings by around 19 times, lower than the Sensex multiple of 22.

Entrenched position

Over the last fiscal, RIL has strengthened its formidable position in the energy business, thanks to the KG-D6 production, and the new refinery in Jamnagar.

The oil and gas segment grew significantly with the KG wells ramping up gas production to around 60 mmscmd. This segment which generates the highest margins (in excess of 40 per cent), now accounts for almost 32 per cent of operating profits. The company's recent decision to cap gas production due to technical reasons and commence ramp-up to around 80 mmscmd only after two-to-four quarters is a short-term negative. Nevertheless, the long-term growth story looks intact.

RIL has enjoyed a traditional advantage in refining, its biggest revenue contributor (in excess of 70 per cent), with its high complexity refineries enabling processing of cheaper, heavier crude to earn superior gross refining margins (GRMs). With Reliance Petroleum's new SEZ refinery coming into its fold, RIL's capacity has almost doubled to around 1.24 mbpd. The segment reported low operating margins (4 per cent) in the June 2010 quarter. However, with GRMs expected to improve from last fiscal's lows, thanks to improving demand and widening differential between light crude and heavy crude, RIL could benefit.

The petrochemicals segment (accounting for around 20 per cent of revenues and 34 per cent of operating profits) is facing pressures due to overcapacity in the global market. However, feedstock synergies (in-house naphtha from the refining segment) and strong domestic demand outlook hedges the company to some extent. RIL is among the largest players globally in petrochemicals and has announced massive expansion plans in the segment. This could benefit the company significantly when the cycle turns.

Big-ticket expansion

The last quarter has seen RIL acquire stakes in significant shale gas acreages in North America. These ventures — with Atlas Energy, Pioneer Natural Resources, and Carrizo Oil and Gas — broaden RIL's upstream interests at a global level, and reduce the impact of cyclicality on the business. Shale gas is touted to be a game-changer in the natural gas business.

A key qualitative benefit for RIL is the access to technology, which may prove quite valuable in other potential markets. India plans to award shale-gas blocks by August 2011, by which time RIL's North American foray would have given it a formidable head-start.

Post the redrawing of the non-compete agreement with ADAG, RIL has re-entered the telecom sector by acquiring Infotel Broadband, the sole nationwide player in broadband wireless. The company has also announced ambitious plans in the power sector, and to scale up its retail business significantly. Besides, it is said to be in talks to acquire BP's fuel marketing assets in Africa. Reports also indicate a possible re-entry into fuel price retailing in India. Recent discoveries in the Cambay basin bode well. The company has also initiated steps to develop satellite fields on the East Coast and its other blocks in the country.

RIL's mammoth cash flows give rise to a problem of plenty. Favourable leverage ratios (net gearing of 24.2 per cent), huge cash balance (Rs 26,407 crore) and a formidable war chest in the form of treasury shares ensure that cash is not a constraint for expansion plans. While most of these projects are long-gestation in nature, they have the potential to catapult the company to the next growth cycle.

Financial performance

In FY 2010, high volumes in oil and gas, and refining saw the company grow consolidated net revenue by around 35 per cent to Rs 2,03,740 crore. However, a weak pricing environment resulted in profits growing at only around 4 per cent to Rs 15,898 crore and margins declining. GRMs declined sharply from $12.2 a barrel in FY 2009 to $6.6.

For the latest quarter, net revenue and profits at Rs 58,228 crore and Rs 4,851 crore respectively, were up 87 per cent and 32 per cent y-o-y driven by oil and gas, and refining segments. Margins however declined due to higher proportion of gas to oil, and higher depreciation costs. GRMs at $7.3 a barrel were down sequentially ($7.5) but higher than the year ago figure ($6.8). The performance was still good, given that the benchmark Singapore GRM had registered a steeper fall from the previous quarter. Return on equity is healthy at around 12 per cent.

Going forward, though growth may moderate in the near to medium term given the high base effect, expansion initiatives should see the company reporting strong numbers.

Risks

Sluggishness in demand due to uncertainties in the global economy could drag the company's performance, especially in the petrochemicals business. An unfavourable outcome in the ongoing gas supply dispute with NTPC will weigh negatively on the company.