Reliance Industries: Buy ::Business Line

 The 15 per cent tax break on investments of Rs 100 crore or more in plant and machinery over the next two years should help Reliance.

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The continuing decline in gas output from its KG-D6 block has weighed on the Reliance Industries (RIL) stock for a long time now. While the stock has recouped quite some ground from its lows last year, it remains an underperformer in the market. But for investors with a long-term perspective, the weakness in the stock provides a good buying opportunity.

EXPANSION PLANS

Current valuations are not demanding. At the market price of Rs 851, the RIL stock discounts its trailing 12-month earnings by around 14 times, lower than average levels of 16-17 times it had traded at in the past.

Two, the company’s major expansion plans in its core business bode well for growth in the long-run. RIL is in the process of almost doubling its petrochemicals capacity and upgrading the refinery business by setting up a petcoke plant. This should boost growth in profits and margins over the next two-to-three years.

Other investment plans such as the butyl rubber plant with Russian company Sibur are also in progress.

In this context, the recent budget provision allowing 15 per cent tax deduction for manufacturing companies investing Rs 100 crore or more in plant and machinery over the next two years should aid RIL.

Cash for investment is no constraint for the company, which had reserves of around Rs 81,000 crore as on December 2012.

EXPLORATION TIDE TO TURN

Importantly, even in the floundering oil and gas exploration business, there are silver linings. In a little over a year from now, the current price of $4.2 per mmbtu for the gas from the KG-D6 block will be up for review.

If the Rangarajan Committee’s recommendations on domestic gas pricing are accepted — there is a good chance they will be — RIL’s price realisation could almost double from current levels. Rise in gas price, even if gradual, could encourage drilling of wells which were earlier deemed unviable.

Also, the slugfest between the Government and RIL over the last two years on issues such as drilling approvals, cost recovery and audit procedures seems to have abated, if not stopped. RIL and its partner BP plan to invest over $5 billion (Rs 27,500 crore) in the hydrocarbon exploration business in India over the next three to five years.

Even if the output from the main D1 and D3 fields of KG-D6 stagnates or declines from the current levels, output may pick up from satellite fields and other discoveries such as MJ1.

Earlier peak estimates of 80-100 mmscmd may be ambitious, but the new fields could help output increase from less than 20 mmscmd currently to around 50 to 60 mmscmd.

To be sure, this will be a long-drawn process. Besides, given the uncertainties associated with hydrocarbon exploration, the results may not meet expectations. Also, while RIL is strengthening its foothold in the petrochemicals and refining segments, the cyclical nature of these businesses will translate into troughs and peaks for the company’s margins, based on global capacity and demand dynamics. These make an investment in RIL at this juncture suitable only for a patient investor with a high-risk perspective.

OTHER BUSINESSES

The company’s shale gas output in the US is increasing gradually. But the gas price there is under pressure due to a supply glut. It may pick up if export of shale gas from the US is accelerated. RIL’s foray into other businesses such as retail and telecom are also long-gestation in nature and will take time to show results.

The recent move by the Department of Telecom to allow companies with broadband spectrum to offer voice services by paying Rs 1,658 crore will benefit RIL.

The company had in 2010 acquired 95 per cent stake in Infotel Broadband which had emerged as the sole nationwide player in the wireless broadband auction.

If the recent policy decision is implemented without hitches, RIL, which is laying the groundwork for its re-entry into telecom, may be able to establish itself as a player with meaningful size at a relatively attractive cost. That said, the competitive environment and fare structure in the telecom sector has changed radically from 2005 when RIL, the original price warrior, exited. Break-even therefore may be far out into the future.

FINANCIAL PERFORMANCE

After many quarters of decline, RIL’s December quarter profits grew by 24 per cent over the same period last year. This was mainly due to a good performance by the refining segment which posted gross refining margin (GRM) of $9.6 a barrel. This more than made up for the weakness in the exploration and petrochemicals business.

Over the nine-month period though, the company’s profit was lower 2.5 per cent, with the exploration business dragging down performance. In the December quarter, the share of ‘other income’ in RIL’s profit before tax decreased to 25.4 per cent from around 30 per cent a year ago. The higher share of the core businesses, if it continues, will benefit the company by improving return on equity. As on September 2012, RIL’s debt-to-equity was a reasonable 0.4 times. Adjusting for cash reserves, the company is debt-free.