BRIGHTER DAYS AHEAD?

Only an upturn in its core biz can lift RIL Stock May Benefit Long-Term Investors, Say Analysts

WITH a market capitalisation in excess of 3,00,000 crore, or $64 billion, Reliance Industries is a company one may hate or love, but surely can’t ignore. However, this poster boy of the India Inc has not been doing well of late. Its conspicuous absence from the recent market rally — and a downright fall through August — therefore, came as a big surprise to retail as well as institutional investors.

However, there is still no certainty if and when the stock will realign itself with the overall market. Last year, the company commissioned two mega projects and their ramping up process throughout the year provided positive growth triggers for the stock to sustain price-to-earnings multiple (P/E) above 20 — highest among its peers globally and higher than the Sensex. As both these projects — the new refinery and KG basin gas — reached their peak outputs, the company failed to introduce any new growth driver. Its core petroleum refining and petrochemicals businesses have come under pressure due to cyclical downturn and little help came from its diversification efforts. Its high valuation, therefore, appeared unjustified.

After its entry into the retail business four years ago, the company has now decided to invest in shale gas in the US, broadband wireless and power industries domestically while recently picking up a stake in East India Hotels. Some of these investment decisions have not gone down well with some analysts. “Unfortunately, investments such as the broadband venture, and now EIH, don’t help the growth thesis. These instead raise questions on whether RIL would have been better off returning that cash to shareholders, rather than making investment decisions outside its core operations. It may also indicate lack of core oil and gas growth opportunities, which, if it persists, can cause further lacklustre stock performance,” mentioned a Credit Suisse report on the company dated August 30.

While the new businesses won’t contribute much in the short run, an improvement in its core industries is what experts are betting on. However, opinions are divided on when the upturn will begin. Kotak Securities, for example, maintains a ‘reduce’ rating on the company citing concerns over the continuing weakness in chemical and refining margins. A few others believe the worst is already past for the company. “After a 15% year-to-date underperformance v/s the market, we believe the unexciting refining and petrochemicals outlook is largely priced in,” mentioned a Citigroup report dated August 23. A more recent report by Merrill Lynch estimated RIL’s September 2010 quarter refining margin at $8.0-8.6/bbl, “which would be its highest in six quarters”. Both these foreign brokerage houses retain their ‘Buy’ ratings on the company. However, most others, including Edelweiss, HSBC and Motilal Oswal, continue to carry a ‘hold’, ‘accumulate’ or ‘neutral’ rating on the scrip. Going forward, the company is expected to end FY11 with earning per share between 58 and 67, according to various analyst estimates. The current market price trades at 13.8 to 15.8 times its FY11 forward earnings. The company may appear inexpensive at these levels. However, the question remains whether it can justify any higher valuation when its growth appears stagnated.

As things stand, the scrip appears to have undergone a de-rating and not expected to cross the 4-digit level again in a hurry unless a sustainable upturn begins in its core industries. Having said that, a technical pull-back in the short run cannot be ruled out. India Infoline, for example, had given a ‘Buy’ on the company on August 30 when the scrip traded at 947 assuming it had fallen too much. “It is already trading into an oversold territory and appearance of positive divergence certainly supports argument for reversal in the short term,” it mentioned, giving a target of `1,020. Conventional wisdom suggests the best time to invest in a cyclical industry is when the cycle is at its bottom, which appears the case with refining and petrochemicals industries. As the long-term prospects for the company remain bright, investors willing to wait for 2-3 years could consider accumulating the scrip now.