RIL again emerging a wealth creator

Analysts estimate company's earnings growth to sustain in double digit and return on equity to inch up, following a trend reversal in FY2016

The Reliance Industries’ (RIL)’s stock, which has been doing well since October 2015, scaled up to its 27-month high of Rs 1,129.55 on the National Stock Exchange (NSE) intra-day this week. And, there is more to come, analysts estimate the company’s earnings growth to sustain in double digits and consequently return on equity (ROE, a key valuation parameter) to inch up.

RIL’s earnings growth was muted since 2011-12, while ROE consistently fell from the peak level of 22.5 per cent in 2006-07 to 11 per cent in 2014-15. Both these parameters picked up in 2015-16. Analysts at Motilal Oswal see the ROE increasing to 12.4 per cent in 2016-17 and further to 12.6 per cent in 2017-18. This is despite the street expecting the company’s telecom venture to report losses in the initial years of operations.

These expectations are also reflecting in the sentiments. The upward trend in the stock has gained momentum, initially led by the core petrochemicals and refining businesses, and recently by the telecom venture, Reliance Jio (RJio). The company’s investment in RJio had been seen as a drag on return ratios ever since inception. Analysts have remained cautious about the investments and thereafter about the delay in launch of services. CLSA, in a note in May, said the RIL stock was pricing in $7 billion negative value for RJio though it felt the low expectations would be beaten.

As Mukesh Ambani, RIL’s chairman and managing director, announced the much-awaited details on RJio’s commercial launch during the company’s AGM on September 1, clarity started emerging. RJio has started its telecom services on complimentary basis from September till December, implying commercial launch in January.

Looking at the plans of RJio, which is an Internet-enabled content delivery and service platform, and the subscriber base it is acquiring, analysts’ confidence is also improving. Motilal Oswal believes RJio’s welcome offer of free data and voice over the next few months should lead to a significant shift in traffic away from incumbents and they expect RJio’s subscriber base to reach 75 million by 2018-19 (the management has a 100 million target with a monthly average revenue per user of Rs 244). With this, analysts expect RJio to break even in the third year at Ebitda level.

While it is yet to be seen how successful the RJio venture will be, for now the street is also willing to accord higher valuations to this business. Analysts at Edelweiss have pruned the discount they assigned on the invested capital in RJio to 20 per cent from 35 per cent earlier. This is anchored by their belief that it offers a strong value proposition in voice and data, its pricing strategy targets absolute ARPU while incentivising high usage, and strong response from consumers.

With uncertainties over the telecom venture easing, the stock that was trading at discounted valuations has started gaining momentum. What is more, the company’s mega capex in its core business is also coming to an end. The company not only has invested heavily in telecom, but also in refining and petrochemicals. Nitin Tiwari at Antique Stock Broking says RIL will be monitising its investments from now on, while analysts at Edelweiss say a structural revival in downstream margins and conclusion of its mega capex programme ($40 billion) will double RIL’s earnings over the next five years.

The underperformance of the RIL stock in past years can be attributed to soft earnings growth. RIL’s adjusted earnings, which stood at Rs 60.80 in 2010-11, grew to Rs 68.31 in 2014-15. The return on capital employed (ROCE, which measures a company's profitability and the efficiency with which its capital is employed)  was at 18.66-20.12 per cent in 2006-08 when RIL was a big wealth creator for investors. However, the ROCE continued declining and stood at 11.5 per cent in 2015-16. As a result, the RIL stock underperformed the Sensex for a long period. It is still much lower than its peak level of Rs 1,600-plus in early 2008. Adjusted for inflation, an investor who would have invested in 2009 stands to be a big loser. This compares poorly with the Sensex, which has more than doubled since mid-May 2009.

The underperformance of the RIL stock, however, is behind, and as the company starts growing fast, it should be able to generate more wealth for its shareholders and regain its lost glory. In the past one year, the stock is up 30 per cent versus 11.25 per cent gain in the Sensex. Analysts see EPS growing to Rs 104-120 levels in FY18, which should also drive the stock.