Analysis Beyond Consensus - Annual Report Analysis - Reliance Industries ::Edelweiss PDF link

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RIL FY12 AR depicts healthy net cash accretion contributed by BP deal and strong operating cash flows. While profitability on account of BP deal skirts FY12 profits, exchange rate and inventory gains supports operating profits. Investment phase of retail subsidiaries drags consolidated profitability.

BP stake sale accounting undermines one time profit during FY12, but boost future recurring earnings

·       During FY12, Reliance Industries (RIL) concluded sale of 30% participating interest in 21 oil and gas production sharing contracts (PSC) to British Petroleum (BP). The company has not recognised any gains on sale of stake, but has reduced sale consideration of INR321.9bn from fixed assets which will result in higher recurring PAT and ROE during future years as with reduced carrying cost of fixed assets depreciation/ amortisation will be lower.

Natural hedge theory: Whether adjusted in earning models? 

·       Outstanding currency derivative exposure as at FY12 end stood at INR545.2bn (FY11 INR644.6bn). Despite this, unhedged forex exposure stood at INR898.9bn (FY11 INR726.5 bn).

·       14.6% INR depreciation during FY12 led to forex loss of INR79.2bn (cumulative forex loss capitalised since FY06 is ~INR132.7bn) which has been capitalised to the carrying cost of fixed assets. The INR has depreciated 7.3% post balance sheet date, which will lead to further forex losses. Capitalisation of forex losses will put pressure on ROE/ROCE going forward.

·       While RIL’s USD earnings act as a natural hedge for unhedged forex loans, we would like to draw attention to the fact that impact of currency fluctuation continues to form part of sustainable earnings vis-à-vis exchange fluctuation on USD loans which skirts P&L. Our calculation suggests, FY12 profitability includes INR28.4bn on account of INR depreciation.

·       In our view, earning models should adjust EBITDA forecast (up to cumulative level of INR898.9bn) to the exchange rate at which forex loan has been taken (akin to taking forward contracts for exports) to justify the natural hedge theory.

·       Our calculation also suggests inventory gains of INR37.9bn (14.9% of PBT) forms part of FY12 profitability (rising commodity prices leads to higher unsustainable profitability, though the same gets neutralised in operating cash flows).

Analysis Beyond Consensus - Annual Report Analysis - Reliance Industries

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