01 September 2008

Buy RIL stock when it falls, Investors Guide from ET

Buy RIL's stock when it falls

Beta: 0.37
Institutional Holding: 25.98%
Dividend Yield: 0.6%
P/E: 15.6
M-Cap: Rs 3,10,444 cr
CMP: Rs 2,136

Reliance Industries (RIL) ranks among the country’s largest companies in the private sector on various parameters. It is on the verge of commissioning two of its biggest projects in September ’08.

At full utilisation levels, these projects are expected to add nearly Rs 80,000 crore to RIL’s consolidated revenues, further strengthening its numero uno position in India Inc. Its current market valuation appears to have taken into account the immediate gains from these two projects.

However, going forward, the stock may witness stagnation as its future outlook is getting cloudy due to the build-up of several negative factors. Nevertheless, there remains a possibility that given its strong cash flows, presence across industries and forward and backward linkages, RIL can spring positive surprises. Long-term investors can accumulate the stock at dips.

RIL has invested nearly $8.8 billion in its Krishna-Godavari (KG) basin gas fields since their discovery in ’02. Production from these fields is expected to start by the end of September at the rate of 25 million cubic metres a day (mcmd), which will be gradually scaled up to 80 mcmd.

The second mega-project, which will commence operations this month, is Reliance Petroleum’s 29 million tonne per annum (mtpa) high-complexity petroleum refinery in Jamnagar special economic zone (SEZ).

Latest media reports and comments from government quarters suggest that RIL will be able to stick to its initial schedule of completion by September ’08 and commence commercial production by December ’08. This Jamnagar plant will make RIL not just India’s largest petroleum refiner, but also the world’s largest single location refiner.

However, RIL is facing some imminent woes. The natural gas project is embroiled in two major lawsuits with Reliance Natural Resources (RNRL) and NTPC, both of which are claiming a huge chunk of gas supply at low prices.

This has disabled the company from selling gas to any third party. Any adverse outcome of these court cases can have a major impact on RIL’s future profitability, as well as its return on capital.

Similarly, the RPL refinery project, which was conceived when globally refinery margins were on the rise, is getting commissioned just when the rally has waned. The benchmark Singapore refining margins have fallen sharply to around $4 per barrel as of end August ’08 from $12 at the start of July ’08.

In view of several other refineries coming up in West Asia and China, the refining industry is expected to remain in a downward trend for the next 3-4 years. Over the past couple of years, RIL has aggressively entered the organised retail sector, opening around 735 stores across 13 states. This is another industry which is witnessing the entry of too many players, putting a big question mark on its profitability.

Initially, RIL’s valuation had got a boost from the potential growth prospects of its two mega projects. However, as the problems became more apparent, valuations plummeted. The scrip’s price-to-earnings (P/E) multiple, which had crossed 31 in January ’08, has halved to around 15.5 now, as the stock price fell from Rs 3,200 to Rs 2,150.

Still, the company commands one of the highest valuations among global peers such as Exxon Mobil, Royal Dutch Shell or PetroChina. And since current valuations have already factored in higher profitability of the new businesses, there is every reason that the valuations can weaken further.

Despite all these negatives, there are a few positive factors, which will help add some shine to the company’s performance. Being fully integrated in the petroleum value chain, the lower profitability of its refining business can be compensated to a certain extent by future improvement in profits of its petrochemicals business.

Secondly, the recent weakening of the rupee bodes well for RIL, which is increasingly focusing on exports, while its domestic revenues are also linked to the rupee-dollar exchange rate.

RIL operates in a capital-intensive commodity business, which is subject to business cycles. Against this background, it is creditable for the company to have maintained a return on capital above 18% over the past five years. But this has necessitated the company to plough back most of its profits into the business and pay just around 10% as dividends.

This will continue in future too and RIL’s dividend payouts, as well as dividend yields will remain very low. In the long term, several other projects that RIL is pursuing should help boost its growth momentum. The company is developing special economic zones in Haryana, Gujarat and Maharashtra.

It is also investing in exploration blocks in India, as well as abroad, and has bagged coal-bed methane (CBM) blocks. The potential hydrocarbon reserves from these blocks will also add value to the company. Hence, long-term investors can buy into the scrip when it falls, but they should not expect much upside in the near term from the commissioning of RIL’s two mega projects.

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Source:Economic Times, Business Standard.

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