PAYBACK TIME FOR RELIANCE

Market cap touches ~5 lakh crore; earnings growth to spurt in FY19

Reliance Industries’ (RIL’s) market capitalisation touched ~5 lakh crore, becoming the first listed stock to do so after Tata Consultancy Services (TCS) scaled that peak three years ago. The RIL stock, which has been hitting its multi-year highs consistently within recent times and is in touching distance of its all-time high levels of ~1,625, has gained 50 per cent over the past six months.

The bullish sentiment rests on expectations that its investments both in its telecom venture (Reliance Jio) as well refining and petrochemicals will start delivering. With some of these projects being commissioned in FY17 and some to be rolled out in FY18, earnings growth will jump sharply in FY19.

Analysts say it is payback time for the mega entity. And analysts at JP Morgan say that de-leveraging will kick in as large project spending ($48 billion) across refining, petchem and telecom comes to an end, with the company entering a free flow generation period. They say that de-leveraging from here would depend heavily on the revenue build-up of Reliance Jio. Moreover, the gasifier and refinery off-gas cracker (ROGC), which relates to the core refining and petchem business, are important, given the spend ($18 billion on core projects) for operating profit improvement from FY18 on.

Though the telecom venture is still witnessing high operating costs and interest costs, investors are keen to understand the timeline for the venture achieving breakeven. Its regular progress on subscriber additions and retention thus would be a key area to watch out for. Nevertheless, it is the core businesses expansions in petchem that remain more important in the interim. Analysts at Motilal Oswal Securities say that the company’s new refining/petchem projects are likely to add to earnings from the second half of FY18 and FY19, but the telecom business would be a drag on profitability.

In the refining business, the installation and mechanical completion of the gasification project, linked to the company’s domestic tariff area refinery at Jamnagar and the pre-commissioning activities, is going on. The petcoke gasification initiative is aimed at reducing the energy cost for the Jamnagar complex on a sustainable basis. The initiative is expected to boost the company’s refining margins. In FY17, RIL’s gross refining margins outperformed the Singapore complex margins by $5.2 a barrel, the highest premium achieved in the last eight years. Abhijeet Bora at Sharekhan says that with $20 billion capex in petrochemical and refining largely completed and the project nearing the commissioning stage, he expects RIL’s consolidated operating profit to grow strongly at an annual rate of 21 per cent during FY17-19. This portends well for profitability.

Among major expansions, all eyes are on the company’s refinery off-gas cracker (ROGC) commissioning at Jamnagar. In a letter to shareholders, company chairman Mukesh Ambani said that “we are in the process of starting up the ROGC in the world along with related downstream capacities. This is a pioneering initiative and a unique opportunity available at Jamnagar due to the scale of our refinery operations”. The cracker is tightly integrated with the company’s refineries and will use refinery off-gases as feedstock. This cracker will be among the lowest-cost operations globally. The benefits to profitability clearly will be strong.

Bora expects ROGC, petcoke gasification, and ethane projects to add $1.7 billion (~11,660 crore, assuming a rupee-dollar rate of ~67) to operating profit in FY19. This is substantial given the fact that RIL had clocked operating profit of ~46,194 crore in FY17.

In addition there are other downstream expansions too taking place. With oil and gas reforms such as petrol and diesel decontrol already in place, the company is ramping up its fuel retail stations. At the end of FY17, 1,221 fuel outlets were made operational.

Analysts at Kotak Institutional Equities recently raised sum-of-theparts based target price to ~1,500 from ~1,420, ascribing higher EV/Ebitda multiple of 7x for refining and petchem segments compared to 6.5x earlier given rising comfort on imminent commissioning of projects and possible upside from strength in downstream business. Most analysts, however, will be reviewing their target prices after the June quarter results.