Widening gap: Why RIL earnings have lagged behind the rise in its m-cap

Its m-cap is up 150 per cent in 12 quarters, against 24 per cent cumulative growth in net profit

Reliance Industries (RIL) was the biggest loser among index stocks on Monday. It closed the day with losses of 8.7 per cent, against 0.2 per cent rise on the Nifty50 index during the day. This was a sharp reversal for a stock which has been the biggest market mover in the past six months. RIL’s market capitalisation (m-cap) is, however, still up 75 per cent since the end of March this year, accounting for nearly 30 per cent rise in Nifty during the period.

Analysts say the recent decline in RIL’s stock price was long overdue, given its earnings have lagged behind the sharp rise in its m-cap in recent quarters; that gap has been growing steadily. 

RIL’s m-cap is up 150 per cent in the past 12-quarters, against 24 per cent cumulative growth in its net profit on a consolidated basis during the period. 

This has created a wedge between its earnings per share (EPS) and the stock price. That gap has widened to record levels at the end of September this year.

Most of the gains in the RIL stock price in recent years came from an expansion in its price-to-earnings (P/E) multiple rather than earnings growth. 

The stock was trading at a record P/E multiple of around 35x at the end of September this year, against a P/E of 15x at the end of September 2015 and 13.4x at the end of March 2014. The P/E multiple is based on a company’s reported net profit on a trailing 12-month basis.

The valuation is now down to 30.3x, but RIL remains one of the most expensive large-cap stocks on the index, with the exception of fast-moving consumer goods majors such as Hindustan Unilever, Nestlé, Asian Paints, and Britannia Industries, among others.  

“The RIL stock price implies flawless execution on the RIL’s multi-pronged growth aspirations and the stock is trading at our blue-sky valuation,” writes Aditya Suresh and Abhinil Dahiwale of Macquarie Research on RIL’s second-quarter (Q2) 2020-21 (FY21) earnings report. 

The brokerage has cut its 12-month target price for RIL to Rs 1,320 per share — down 30 per cent from its Monday close of Rs 1,876. The immediate trigger for the stock correction is a 15-per cent year-on-year decline in the company’s net profit during Q2FY21 and lower-than-expected improvement in its balance sheet despite a large cash infusion from the stake sale of its telecom and retail arms. 

This has forced many analysts to recast RIL’s forward earnings estimates. “We refresh our earnings model for RIL and see 18-23 per cent downside to its consensus EPS for FY22-23,” write analysts at Macquarie Research. 

The brokerage expects a slower recovery in RIL’s refining and chemical margins, slower pace of average revenue per user hikes, lower retail margins, higher working capital at its retail division, and higher-than-expected capital expenditure at Jio and retail.

Similarly, analysts at Emkay Global Financial Services have cut their earnings expectation from RIL for the next year. “We cut RIL over earnings before interest, tax, depreciation, and amortisation for FY21 by 11 per cent due to an 18 per cent and 4 per cent reduction in the segment profits of Jio and retail, respectively. We also lower forward EPS for FY22 and FY23 by 2-3 per cent,” write analysts at Emkay Global Financial Services.

The biggest worry for the Street is RIL’s sluggish growth in the oil and gas and petrochemicals businesses hit hard by the Covid-19 pandemic and a general slowdown in consumer and industrial growth in India and globally in the recent quarters. 

“The long-term prospects for RIL remain intact due to the potential value unlocking in its retail and telecom ventures. But in the short-term, the stock could fall by another 5-10 per cent due to the sluggish growth in its oil and gas and petrochemicals businesses,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.