CONSUMER BUSINESS TO OFFSET REFINING WOES: RIL

Deleveraging, profit upside from digital initiatives are major earnings drivers

Reliance Industries’ performance for the September quarter was a mixed bag, with its numbers missing the estimates of most brokerages. The Street, however, is not worried as digital services and retail segments are growing at a scorching pace. Though the consolidated revenue and operating profit growth were in single digits, the new businesses registered a revenue growth of 27-43 per cent while profit growth was 49-67 per cent.

The company is banking on this pace of growth to help it scale up the two businesses to account for half of the overall operating profit as compared to a 33 per cent at the end of Q2FY20. The two businesses contributed a tad over 20 per cent a year ago. In fact, one of the reasons for brokerages such as Bank of America Merrill Lynch and SBICAP Securities to upgrade the stock price is the digital and new commerce initiatives that are expected to be medium-term growth drivers.

BOFA-ML believes that if the company can execute its plans for the key segments, its market cap could potentially leapfrog by 64 per cent to $200 billion over the next two years.

So far, the execution in digital and retail seems to be spot on. The firm has been able to grow its market share both in the organised retail space as well as in wireless services. Even as its rivals are struggling to maintain their share, Jio added 24 million customers for the second quarter in a row, taking its total subscriber base to over 355 million. Given the recent introduction of the interconnect usage charge of 6 paise per minute coupled with expectations of a tariff uptick, the decline in average revenue per user (ARPU) is expected to stabilise if not reverse. With the company expected to on board subscribers to paid fixed line broadband services, revenue and subscriber momentum should see an uptick in the coming quarters. At the current run rate, subscriber target of 500 million should be reached in a year from now.

Retail, the other growth engine, too, has been gaining share. This is on the back of a double-digit growth in samestore sales and new store additions in smaller towns and cities. Operating profit margins have improved by 150 basis points year-on-year to 6.3 per cent as higher scale, improvement in product mix and store productivity rubbed off on profitability. The increasing share of private labels (currently 14 per cent of grocery) also bodes well for margins. While online e-commerce is also well placed to grow, the near to medium term trigger is the kirana (unorganised retail) digitisation.

The performance of the retail and digital did offset the disappointment of the legacy businesses of refining and petrochemicals. While crude oil price continued to trend down and, thus, was expected to impact revenues of the refining segment, refining margins improved. This was due to the impact of the International Maritime Organization’s new rules related to sulphur content that have started to reflect on gross refining margins (GRMS).

The premium over Singapore complex margins declined, as strength in fuel oil cracks supported Singapore margins, said the company. This was the reason that reported GRMS missed estimates of brokerages. Analysts feel that downstream margin outlook remains muted as global capacity additions may exceed growth. While prospects for gasoline cracks remains subdued, weakness in GRM premiums may be offset by boost from IMO regulations and, hence, RIL is well placed to mitigate the segment headwinds.

Any miss in refining segment was, however, made up by better-than-expected petrochemical segment’s growth. The segment saw revenues grow 2.5 per cent sequentially and operating profits by 1.3 per cent sequentially. Analysts were expecting a decline in the petchem segment’s operating profits, with decline in product margins. However, the weaker petrochemical product margins were offset by record petrochemical production and cost optimisation through light-feed cracking. While petchem margins are likely to remain weak on the back of higher supplies, commercialisation of the petcoke gasification project (under stabilisation phase) should help from the second half of FY20.

With major capex behind the company, RIL is now looking at deleveraging with a target to become a zero net debt company by March 2021. Avishek Datta of Prabhudas Lilladher has hiked the target price for the company to factor in the lower intensity of capex.

Meanwhile, Saudi Aramco’s potential 20 per cent stake sale (based upon an enterprise value of $75 billion for the oil to chemical division) could hasten the deleveraging process.