RIL: Core business to balance out RJio overhang

The Street is cautious about the prospects of Reliance Industries’ (RIL) telecom service launch and its ability to achieve early break-even. In addition, monetisation of the domestic exploration and production (E&P) business is a few years away. Lower oil and gas prices also suggest that the near-term prospects of overall E&P are muted. Analysts say, in the initial phase, Reliance Jio is expected to be a drag on RIL’s profits. This is due to high depreciation and interest costs accompanied by initial expenses of launch and ramp-up, all of which will be much more than the telecom business Ebitda (earnings before interest, taxes, depreciation and amortisation) generated, even if adoption is relatively quick. However, analysts say the expansion in core businesses (petchem, refining) is likely to offset the initial overhang due to the large investments incurred in rolling out RJio.

Abhishek Agarwal of Macquarie Capital Securities says the completion of $14 billion worth of core projects will offset the Jio drag. Better naphtha cracking margins, improved gross refining margins (GRMs) and revival of petro-retail due to deregulation are industry-related margin drivers, which RIL is benefiting from.

Given the consensus target price of Rs 1,044 after the Reliance annual general meeting (AGM), there is a 17 per cent upside on the stock. Valuations, too, are undemanding with the stock trading at 1.2 times its FY16 estimated book value, which is 31 per cent lower than its historical average one-year forward price/book of 1.75 times. Most analysts believe the scrip adequately captures concerns on RJio losses, delayed monetisation of domestic E&P business and weak show of the US shale business.

The company announced an ambitious plan to offer a digital platform on network with a capability to serve 100 million wireless broadband customers. While RJio is expected to expand the data market (estimated target of five million customers in a few days of launch), analysts are skeptical about its ability to make money soon given large fixed costs.

“It is difficult to make money in the business as the industry grapples with a single digit RoE (return on equity). In this challenging scenario, RJio is the lastest entrant with a technology which is probably ahead of time,” says Naveen Kulkarni, co-head Research, PhillipCapital.

Analysts add the market for fourt-generation (4G) services is less than one per cent and the handset ecosystem for 4G is not yet developed, so penetration might not be easy. Citing the difficult market conditions, an analyst at a domestic brokerage says Idea had launched 2G/3G operations in a few new circles in 2009-10 and those are yet to make money. “Being a large player with a decent brand, they are not able to make money after five years of operations.” Further, RJio’s operations are expected to be limited to the data market as voice on LTE (long-term evolution) is not a proven system.

The company, however, remains confident and believes that RJio, the most extensive telecom operations rollout in the world, will revolutionise the Indian market. However, analysts believe the brea-keven might take a few years with those at Barclays estimating net profit in FY2021.

More important, RIL's core business growth remains on track. Expansion in petchem as well as refining and marketing businesses, along with continued strength in GRMs are key positives for the company.

Bhaskar Chakraborty, oil and gas analyst at IIFL, says, “Refining contributes 65 per cent of RIL’s standalone EBIT (earnings before interest and taxes) and continued strength in regional GRMs augurs well for FY16 estimated earnings. Notably, for every dollar increase in refining margins EPS (earnings per share) moves up by 10 per cent.” Analysts believe the core earnings growth will step up significantly FY17 onwards after commissioning of the petrochemicals expansions and petcoke gasification plant.

RIL's domestic E&P business, however, is likely to witness incremental gas production only in FY19. The chairman reiterated in his AGM speech that domestic E&P holds resources worth five to sixtrillion cubic feet at different stages of development, appraisal and approval. While this number was largely known, analysts are awaiting clarity on monetisation of these reserves, likely post finalisation of gas pricing by the government.

After the AGM, a few analysts have pruned their earnings estimates for RIL, taking cognisance of the slight delay in downstream expansions — namely petcoke integrated gasification combined cycle plant and a refinery off-gas cracker. “The new timelines appear conservative, in our view, but we still cut FY17 estimated EPS by six per cent to reflect the likely delay. This is also a dent in our constructive investment view and defers substantive growth to FY18,” says Somshankar Sinha of Barclays. He maintains overweight rating on the stock citing higher than expected margins, 47 per cent EPS growth over FY15-18 and inexpensive valuations.