RIL's return on capital on the decline

Gap between returns on investment and operational yield shrinking fast; trend to continue for now, say analysts

Reliance Industries’ (RIL) fourth quarter results have thrown up numbers that would worry investors.

The country’s largest private sector company’s return on capital employed (RoCE) – showing how much a company earns after deploying its capital – has been falling in the past four quarters. It declined from an annualised 11.72 per cent to 7.84 per cent between June 2011 and March 2012.

On the other hand, profit from investment is increasingly becoming important to Reliance. It is the third largest contributor to its earnings before interest and tax (Ebit). The contribution of investment income doubled from 10.35 per cent in March 2011 to 21.06 per cent in March 2012.

And, the gap between operational yield and investment yield is fast shrinking, implying its cash and cash equivalent are earning almost as much as its core business.

The importance of investment income can be gauged from the fact that though Reliance’s turnover has increased 2.5 times from Rs 133,443 crore in 2007-08 to Rs 329,904 crore in 2011-12, net profit has increased only marginally from Rs 19,458 crore to Rs 20,040 crore. This, too, is because of a high ‘other income’ component, up from Rs 895 crore to Rs 6,192 crore during the period. The major component of ‘other income’ is investment income.

Obviously, analysts are worried that unless business picks up over the next couple of quarters, the return on investment will exceed returns from its core businesses. Priyakant Dave, oil analyst from Sharekhan, says treasury income is expected to remain high till the company expands its business.

Analysts expect this trend to continue over the next few years. Not many are hopeful that the business will pick up in the near future. The next meaningful expansion is two-three years away, says Abhijeet Bora, oil analyst from IFCI Financial Services. Operational earnings are expected to be either flat or decline.

Finance issues
Enam Securities in its post-analyst meet report has said earnings are expected to be subdued and any upside in numbers due to increase in gas production or commissioning of petrochemical facilities would be felt only after financial year 2014. Treasury income will keep on increasing, as the company will be generating at least Rs 15,000-16,000 crore as cash every year.

However, such a high level of cash is also a sign of worry among the analyst community. Kotak Securities, in its research report on the company, has been advocating that Reliance either increase dividend payout or buy back its shares to strengthen investment sentiment. In January 2012, Reliance had announced a buyback to utilise Rs 10,000 crore of its cash reserve.

Interestingly, RIL has debt almost equal to its cash and cash equivalent. On debt dues of Rs 68,259 crore, it pays interest of Rs 2,667 crore. While on a cash and cash equivalent of Rs 70,252 crore, the company earns Rs 4,414 crore.

The company manages to raise funds at low rates because of its high credit rating in the international market. Reliance raised $1 billion in February 2012 at a rate of 5.468 per cent in the US market. As it exports more than the debt it raises, there is no need for it to hedge, which keeps the borrowing cost low. This enables RIL to redeploy the funds and generate higher income. Reliance earned a spread (difference between interest earned and interest given) of Rs 1,747 crore (Rs 300 crore in the previous year) or roughly 2.5 per cent for the year ending March 2012.