RIL: Co will Continue to Face Pressure on Earnings

Mukesh Ambani’s speech at the 37th annual general meeting of Reliance Industries (RIL) was more of a review of the year gone by, but fell short in terms of providing clarity on the future. The projects he listed at the AGM will come up only down the line except in the petrochemical segment.
The pressure on earnings will continue for India’s largest private company, especially in refining and oil & gas segments. Mukesh Ambani’s statement that the company will be debtfree in FY12 comes hardly as a surprise. More than a year ago, Goldman Sachs had projected that this would happen by FY14, but the $7.2-billion deal with BP earlier this year will help the company become debt-free sooner than expected. In FY10 and FY11, the company’s operations generated more cash than its annual capital expenditure – a trend likely to continue in the future.
Being cash-rich may be construed as lacking in investment options and diluting return on equity. However, given the economic recovery is yet to gather pace and investment gurus like Mark Mobius predicting another financial crisis ahead, being debt-free can be a virtue.
In other words, the cash pile may be an indication of muted growth but signals better stability. For investors, this may mean a limited upside in stock prices and low downside risks. The challenge now relates to utilisation of the huge cash pile. One option could be to go in for a special dividend or a buyback.
The other alternative is to hoard it for future acquisitions. The second option makes more sense given there could be exciting opportunities for acquiring distressed assets in the backdrop of a muted economic growth in the West.
The company appears more gung-ho about its petrochemicals division compared to the refining segment, which has always been its highest revenue earner.
While referring to the petrochemicals division, Mukesh Ambani had said, “As we diversify our portfolio from commodities to specialities, we will accomplish in the next five years what we have achieved in the past thirty years in terms of earnings from this segment.” In FY11, the company’s earnings from this segment stood at . 9,540 crore and will need to grow at 15% every year to achieve the feat of doubling in five years.
In case of the refining business, Mr Ambani made the point that in FY11, the company had done well. “Our refineries had the best refining margins in the world,” he said. Ambani had also said that Reliance is best positioned to capture top quartile margins, citing its crude sourcing strategies, low operating cost and production of cleanest fuels. However, being the numero uno is not the same as being in the top 25, and hints at some weakness in earnings from the refining business going ahead. Even in the case of its thirdlargest earnings contributor — oil & gas segment — there was hardly any clarity on how and when the decline in production from the Krishna-Godavari basin block (KG D6) would be arrested.
With two of its three main business segments likely to stagnate, RIL will find it very tough to show incremental earnings. Reliance Retail, which, according to Mr Ambani, is now at the inflection point of a new paradigm, is still to break-even and at least a couple of years from making any sizeable impact on the company’s overall earnings. All these could lead to the stock’s continued under-performance for months.