Reliance Industries: Good buy, bad buy

The stock has taken a beating as the company’s motive behind the stake purchase in EIH is not clear.

The jury is still out over the decision of Reliance Industries (RIL) to buy a 14.12 per cent stake in East India Hotels (EIH). Reactions are mixed, as RIL’s intention behind the purchase is not clear. The markets did not seem happy with the Rs 1,021-crore outflow in an unrelated investment. Hence, the share price tanked.

At the purchase price of Rs 184, the enterprise value (EV) for adjusted rooms at Rs 2.9 crore is much higher than the Rs 2-2.3 crore EV/adjusted room norm in the industry. Considering EIH’s FY10 numbers, RIL’s price is around 109 times its earnings, while the enterprise value works out to 28 times the operating profit. This looks a tad expensive. Instead of this investment, the company could have returned this money to shareholders, reckon analysts.

On the flip side, the argument is that FY10 was a bad year for EIH, with poor tourist arrivals and properties being closed. EIH’s adjusted net profit dipped 61 per cent to Rs 71 crore in FY10. However, with old properties coming on stream and new ones being launched at a time when there are robust tourist arrivals, the company is set to put up a better performance.

Moreover, RIL is sitting on free cash worth Rs 14,000. This purchase is too small to make an impact. EIH has a strong record of dividend payout and has seen its market capitalisation grow 30 per cent over the last year. So, from an investment perspective, EIH will be a decent bet, reckon analysts. In case RIL wants to foray into the hospitality business, then EIH’s presence is strong. However, the modalities are not yet clear. The use of free cash for investments is seen as a positive, but RIL’s move to invest in broadband, and now in hotels, could send a wrong signal that the growth prospects in the core oil and gas business is not that lucrative.

According to Credit Suisse, “While the current investment is relatively small, it may indicate lack of core oil and gas growth opportunities, which, if persists, can cause further lacklustre stock performance.”