The Hidden Growth Engines Starting To Purr Inside Reliance Industries Ltd

Reliance Industries Ltd is a classical case of the opportunity we ignore which is right in front of our eyes. Given its size, it is a share which is hard to ignore. Yet, if you ask anyone if they would consider putting it in their portfolio designed for growth, they would possibly just excuse your ignorance and not respond.

It is also not hard to understand why this is the typical response. The company has a complex holding structure. There is an air of secrecy around the company and a sense that they are not the most ethical people. To top it all, they seem to not be doing anything with the piles of cash in their books. The core business they are in is boring and commoditized. Not many understand the dynamics of exploration and refining. In a universe filled with exciting stories with dizzying growth prospects, this is often ignored.

This is a mistake. And this is why this is a mistake :

1. The core business is doing well. Reliance Industries has one of the most efficient and flexible refining capacities in the world. They are able to refine any grade of crude and in any mix and shift the processing rapidly between different mixes. This flexibility makes gives them the ability to leverage on higher margin products apart from inherent efficiency in refining.

They are now at the end of USD 16 billion capex plan. The effects of this will start kicking in by the second half of calendar year 2016. This is expected to add about USD 1.2 Billion to pre tax profits by 2018.

The story in the core business is strong. It is growing and becoming more efficient at what it does.

2. Reliance Retail is the largest retailer in the country today. Revenues stand somewhere around INR 17,000 crores and it is tracking to its guidance of INR 50,000 crores over the next few years. The earnings of this stream are not discounted at the same rate as stand alone retailers with less impressive numbers have been.

3. Reliance Jio

The entry of Reliance Jio into telecome will have the potential to trigger a consolidation of this industry. Mainstream media is waking up to this now. Consider just the fact that globally most markets have only four or maybe five telecom players. India is headed in that direction and Reliance Jio will potentially emerge with a meaningful market share of one of the largest telecom markets in the world. Other players will have a serious financial problem to match the speed and scale with which Reliance can deploy in the market place. Of course, the risk is that Reliance is not known for its ability in B2C businesses. But expect them to master this sector, because the stakes are too big. Mukesh Ambani has bet INR 70,000 crores so far in this game without seeing a penny in return so far. You can be reasonably sure he is focused on making it profitable and quickly. Also, keep in mind this is his son's coming out party just as the execution of the original refineries was his own coming out party. The heat is on and the coming calendar year will see serious action in this regard

Most interestingly, the company is quoting at a significant multiple discount compared to its 10 year average. Even if it continued on as AS IS basis, the overall efficiency and scale enhancement make the multiple low. Now, given the kind of multiples Telecom and retail enjoy, there is bound to be a rerating for this scrip. Even given the conglomerate discount, there is a lot going for this company now.

The story can be summed up as - Get ready for good growth driven both by earnings growth and multiples growth. This is a long term story and the full scale of impact will be seen not before three years at least. Which is why, the time to act is now. This elephant is going to dance.

 

Buddy I agree with you broadly. It was looking tempting at sub 800 levels and at 900 levels. I guess there could easily be a good 30% returns over the next 12-15 month that too with a strong margin of safety. Apart from the telecom Capex most of the investments have been in the Petro chemicals space. [Their Quarterly investor presentation shows that they are #1 or #2 across a lot of polymer and chemical derivatives globally]. This is a tremendously strong position for any conglomerate to be in. Hence completely agree with you. However I also have a fair bit of negative perceptions around they action over the last 2 years - i.e. From a strong position of 70K crore cash to a substantial debt position, unrelated investments, Low ROE/ROI projects and lack of significant growth drivers over the next 5 years.

My only challenge with the stock is: Over the last 3-4 years they haven't been able to find large 'Move the Needle' kind of opportunities. Honestly speaking their Retail investments are not throwing the kind of ROE one would have expected. Without any debt their Retail margins are at low single digits - This business will have to grow to something like 10,00,000 Crore (~$150 Bn) to contribute something meaningful in EBIT ('I am not talking profitability here, I am talking about the significance of EBIT contributions to the overall business to make a huge mark).

Their Hospitality investments and Media investments are again value drainers (One can argue that the TV 18 investments give them a content edge, but I sincerely believe that is too much of a cost to pay for content or to develop competitive differentiation)

Moving on to telecom, 70K Cr is massive investment and only Reliance has the capability to pull something off massive like this!. In the last 5 years, they have spent 90% of what company 'A' has spent over the last 15-20 years (commendable!). But I am not sure if they can create that kind a dent in the competitive telecom market. My best guess is that they will create a lot of value to consumers like us rather than themselves by bringing down data values. Till just last month Airtel, offered 40 GB @ 4 MBPS at 1249. RJIO was conducting field trials in our locality. Airtel called each customer in the apartment, upgraded my broadband connection to 80GB @ 8 MBPS for Rs 100 more. This is RJIO impact!.. .. I believe JIO will significantly shrink the revenue and profit pool for players in the telecom space.

Shale was supposed to be the biggest growth driver after gas in KG basin. If I remember correctly, RIL invested close to 7-8 Bn here and ongoing capex across three fileds is about 200 Mn every quarter. I believe at current prices even these projects are below cost of Equity for RIL. Honestly apart from Petro Chemicals I don't see silver lining for Reliance. Post the JIO launch, RIL would need large sums of money to create the 4G ecosystem (Handsets, developer community, software investments, infrastructure, customer service etc). As a strong player, it took Bharti quite a long time to break-even, I am assuming in such competitive times it would take JIO substantial amount of time to break-even and contribute to the bottom-line.

But then, Big daddy is always big daddy. You have very few entities in the world that spew $1 Bn in cash every quarter [Not withstanding JIO investments] . Honestly that is very close to also what Facebook generated last quarter!

Just my thoughts.... I love this forum for the kind of discussions that we can have!.

 

You have touched upon the crux of it - Industry level impact of jio entry.
Phase 1 will lead to severe price and margin pressure ( RJIO effect as you put it) leading to possible shrinking of profit pool. This will trigger phase 2 in which industry consolidation will happen. The weaker ones will fold in. The big boys namely : Bharti, JIO , Vodafone will slug it out in a more condidated industry. Which of these has the deepest pockets? Granted, that alone won't win the war. Their past initiatives have a dismal track. But this could be the potential game changer also because this has always been close to Mukesh Ambanis heart. As far as retail is concerned, I would be careful using ROE measures at this stage because end game could be demerger.

To the extent that there is lots of execution risk I agree with you. But this is the most sustained effort yet which has come from the house Dirubhai built.

 

Where do these musings lead to? If business model of the company is so complex and in so unrelated sectors , will it not be difficult for an average investor like me to comprehend and appreciate all the details of different unrelated business verticals ? Will it not be very long wait for investors to sell at significat upside in future ? Can Mukesh Ambani management deliver what is being expected ? These are my worries.

 

Check the stock performance for the last six years. zero or negative return. RIL is a Good Story but keep fails in reality.
Oil Business - ONGC is cheaper than RIL
Retail Business - Not great. failed in south india. not sure how it is doing in rest of the country. i feel this model will not work in india for another 10 years. 70% population goes to small store.
Reliance Jio - Huge Investment, Heavy competition,low margin. (i can not pay even 15% more to get 4G from 3G, hope not be another RCOM 525 to 45)

My personal call - RIL is not a wealth creator.

 

@Mr Abhilash Padival&@ Mr Fun_Da_Mentalist. Kindly take notice of to day's article on RJ.

 

RIL has been a significant under performer for the longest time. The point is that there is a widening gap between stock market underperformance and company performance. Therin lies the opportunity. But I realise this is a stock which gets intense reactions. Given strong core performance, If they execute half decently on telecom and retail the upsides are not insignificant. That is the thrust of what I am saying. Keep in mind it is quoting to a discount to long term PE. Of course the flip side argument is : if there is a discount there is surely a reason for it. This is why markets are fascinating anyway.

 

@ M/S Fun-Da-Mentalist,Abhilash Padival,

This is the general big picture perception of the market & perception determines the price level. In my view market does not trust management"s execution capabilities in future as market determine the valutions on future probabilities.

 

you are right in that they have voted on him by lowering pe multiples over time. let me put it this way : downside from sub 900 levels are minimal.

 

In my view Inflection point is yet to be reached if one applies Theory of Relexivity as per my comprehension.Please, don't get me wrong.! I am not biased but, like you,I dont getconvinced easily .I like when BUFFETT says " .......really successful people say no to ALMOST EVERYTHING "

 

That is a good good thing to keep in mind. No to almost everything. The 20 punches rule.

 

Retail - Bharti Walmart shut shop,Subhiksha, Pyramid, Spinach, a lot of others that went retailing, Biyani exiting some businesses, you could name a few that went boom & bust riding the retail/organised retail theme, it is only because of the free cash flows and the equity that RIL enjoys that has allowed them to pump in cash into this business which is yet to yield any significant returns. The market is changing dynamically for retail, now CAIT - Confederation of All India Traders is going online with the help of HDFC Bank https://e-lala.biz/ and don't forget the startups. Reliance Retail has shut shops (a lot of Reliance Fresh) and discontinued its Delight stores (fresh & frozen meat) to appease the Jain/Gujarati shareholders.

Telecom - Good for the consumers, as an investor - nothing to add there.

The major value addition/wealth creation was done when it was de-merged and split between the brothers in 2005.