Reliance Industries - Time For Rerating?-VRK100-10Sep2011

Reliance Industries

Is It Time For Rerating?

“Strength is weakness,” so said George Orwell. This sums up the predicament of Reliance Industries’ stock price on the bourses in the last two years. Reliance Industries Limited (RIL) is India’s largest company by market capitalization and profits. RIL has grossly underperformed several other blue chips on the bourses during the period. The bad news for the company seems to be over for the time being. Analysts see the conclusion of the BP deal and toned-down version of final CAG report as positive for the long-term.  Is it time for the rerating of RIL’s stock?

Before answering the question, let us go back a little. The fall in RIL share price was more pronounced since the beginning of this calendar year following a flurry of negative news flow about the company. First, it was the reports of fall in production of gas in KG D6 well of the Krishna-Godavari Basin. Next a damning interim report by CAG in which it was alleged that RIL had escalated capital expenditure while developing oil blocks in KG Basin. Following the negative events, several brokerages had downgraded the stock to sell questioning RIL for its poor corporate governance practices. Even though the company had struck a $7.2-billion agreement with BP during February 2011, the stock price had continued to plummet till 26 August 2011 when it reached a multi-year low of Rs 714. The all-time high price for RIL stock was Rs 1,625 (price adjusted for 1:1 bonus in Nov.2009) on 15 January 2008.

What has changed for RIL now?

The mood about RIL was so pessimistic that when its share price reached a multi-year low of Rs 714, several analysts had predicted that the stock would fall another 10 per cent and reach a level of Rs 650. But, the stock bounced back from its depths and rallied up to Rs 850 before settling at Rs 826 on 9 September 2011. The positive factors that contributed to the bounce-back were the conclusion of the $7.2-billion deal with the British energy major BP and the diluted version of the final CAG report. Following the conclusion of the BP deal, it is now expected that RIL would be able to ramp up its gas production in KG Basin in the next few years. In its final report, CAG did not mention anything about the inflated costs by RIL, though the final CAG report criticized the company for certain violations of production sharing contracts (PSCs).  

Some analysts see the developments in the past one week as a respite for RIL stock which is reflected in the sharp reversal in stock price from the lows of Rs 720. The stock has taken strong support around Rs 720-750 levels. The overhang of CAG report seems to be over for the time being. However, it is expected that the Government will take some action in response to the final CAG report. Investors need to follow the news flow surrounding the stock closely in the next few months.

Heavy cash overhang

Another ‘albatross’ around the neck of RIL is its huge cash pile on the balance sheet. As on 30 June 2011, the total cash holding of RIL amounts to Rs 45,775 crore. There are concerns in the investors’ community about how the company will use its enormous cash. If the cash is not put to use productively, it can be a drag on the company’s financial ratios. For the past few years, the company is unable to deploy its cash and earn reasonable returns.  From a high of 28.8 per cent in 2007-08, the return on net worth has almost been halved to 15.5 per cent in 2010-11 and the return on capital employed is 13.2 per cent in 2010-11 versus 20.3 per cent in 2007-08. The cash on the balance sheet cannot earn more than 8 to 9 per cent per year overall depending on the prevailing interest rates.

Valuation

In the latest June 2011 quarter, exports accounted for more than 60 per cent of the total turnover. As such, in future, the sales growth will depend on the ability of the company to grow sales amidst fears of a slowing world economy. In the past one year, while the oil & gas segment disappointed with lower production, other business segments – oil refining and petrochemicals – have done well. The stock has strong support around Rs 750 level. At the current market price of Rs 826, the valuation appears to be reasonable for long-term investors with the stock’s price-earnings multiple at 12.8, and price-book value at around 1.8. The dividend yield is a little less than one per cent. The face value is Rs 10 and the market capitalization is Rs 2.70 lakh crore. Total cash & cash equivalents on the balance sheet are Rs 45,775 crore.

References: BSE, RIL

Abbreviations: CAG – Comptroller and Auditor General of India,

Disclaimer: The author’s views are personal. He has a vested interest in the stock markets and his views should be taken with a pinch of salt. He may change his views very fast without any notice depending on the market and economic conditions. His views should not be construed as investment recommendation. There is a risk of loss in equity investments. Investors need to consult their certified financial adviser before making any investment decisions.

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