Last week, the Government allowed Reliance Industries (RIL) to hike the price of KG-D6 gas from April 2014. This provided a breather to the company’s beleaguered oil and gas business and saw the stock rise nearly 5 per cent on Friday. The poor show in this segment over the last few years has been the main reason for the RIL stock’s underperformance on the bourses.
While the Sensex has recovered more than 150 per cent from the lows of March 2009, RIL has managed to gain just 56 per cent. Gas output from the KG-D6 block, instead of rising as expected, fell from a peak of 60 mmscmd in June 2010 to around 10 mmscmd currently. Consequently, the segment’s profit is down nearly 80 per cent over the last three years. The other two core businesses — refining and petrochemicals — while holding fort, have seen profits flow and ebb with cyclical highs and lows. Also, they have not quite lived up to the “growth is life” philosophy of the company. Over the last two years, the profits of these segments have remained almost flat.
Adding to the stock’s woes was the Government’s antagonist stance regarding the decline in gas output. It rejected RIL’s contention that technical problems were responsible for the fall in production, and held the company responsible for not drilling enough wells. The Government has sought to disallow RIL to recover around $1.8 billion (Rs 11,000 crore) incurred on the KG-D6 block development. There was also a proposal to deny the company the benefit of the proposed gas price hike.
Not helping matters is the current weakness in the refining market, which is expected to keep RIL’s gross refining margins (GRM) subdued in the near-term. (GRM is the difference between the price of its product basket and the cost of crude oil).
At the current price of Rs 893, the stock trades at around 13 times its trailing 12-twelve month earnings, much lower than the 16 to 17 times it has traded at in the past. While the stock has been marked down for good reasons, investors with a long-term perspective can consider buying it at current levels.
Valuations are not demanding, there has been relief in the oil and gas business, and with big investments, the prospects of the refining and petrochemicals segments seem bright. RIL’s shale gas ventures in the US are also doing well. Besides, the retail and telecom businesses hold promise over the long term.
Silver lining
Amidst the challenges in the oil and gas business, there are a few mitigating factors. RIL has contested the Government’s move to disallow cost recovery, and the matter is under arbitration. Also, the Government has now agreed to an arrangement whereby pending investigations, RIL will deposit a bank guarantee for the value of the unmet supply commitment, and in turn be entitled to the gas price hike.
A positive outcome in these cases, even if it is long drawn out, could boost sentiment in favour of the stock. It is also pertinent that after its poor show over the last three years, the oil and gas business now pulls far less weight in the overall scheme of things for the company. The segment, which accounted for around a third of RIL’s operating profits in June 2010, contributed just 6 per cent to the company’s operating profit in the recent September quarter. This perhaps explains why these days the stock does not react much to negative news pertaining to this business.
Even as the currently producing wells — D1, D3 and MA — in the KG-D6 block flounder, there is hope that gas production will get a leg-up from the satellite fields and discoveries such as MJ1. Reliance Industries and its partner BP plan to invest over $5 billion (Rs 30,000 crore) in the exploration business in India over the next three to five years.
Meanwhile, RIL’s overseas hydrocarbon business seems to be paying off. Output at the company’s three shale gas joint ventures in the US increased nearly 50 per cent in the first half ended September 2013.
While the volume growth prospects appear good, gas price in the US is under pressure due to a supply glut. However, prices may pick up on export of shale gas from the country in the coming years.
Investing for growth
The big investments being planned by RIL over the next two to three years hold the potential to put the company back on the high-growth path. The company is nearly doubling its petrochemicals capacity and plans to spend $8 billion (Rs 40,000 crore) towards this.
RIL is also setting up a petcoke plant as part of upgrading its refinery business, a project in which an outlay of around $4 billion (Rs 24,000 crore) is envisaged. This is expected to enhance the company’s product basket and reduce its dependence of costly imported gas.
It also plans to invest $1 billion (Rs 6,000 crore) in its fledgling retail business, which achieved cash break-even in FY13. There is hope that this segment could start contributing to profits soon. The company is also making deft moves in its telecom business by tying up with rivals, such as Reliance Communications and Bharti Airtel, to share infrastructure.
This should help reduce costs and expedite the launch of its offerings. Policy changes now allow companies with broadband spectrum, such as RIL, to also offer voice services at a relatively attractive cost. While break-even may be far out in the future, the telecom business in which RIL intends to invest nearly $3 billion (Rs 18,000 crore) could emerge as another growth driver in the coming years.
The company is well positioned to undertake these ambitious expansion plans thanks to its formidable cash hoard of over Rs 90,000 crore and comfortable debt-to-equity position (0.35 times) as on September end.
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