Oil major Reliance Industries (RIL) - Valuation Analysis

Oil major Reliance Industries (RIL) has been in the news over the past fortnight. First, it was the preferential allotment of convertible warrants and then, it was the announcement of a merger with IPCL.

The big challenge for RIL at this point seems to be raising capital — both the above measures are aimed at that end. There are also reports about a reorganisation of the company’s businesses.

RIL is putting big money — $5.2 billion, $5.6 billion and $3 billion — in natural gas production, retail and petrochemicals, respectively, over the next few years. Neither of these businesses will generate any cash in the near future.

In addition, funds are needed for refining, fuel retail etc. RIL’s cash profit was $2.95 billion for FY06 and $2.6 billion for the first three quarters of FY07. The preferential warrants and merger with IPCL can help to mobilise additional funds.

Issue of warrants: The promoters of RIL are picking up 12 crore convertible warrants at a price of Rs 1,402. This will add a total of Rs 16,800 crore to the company’s balance sheet.

The promoter’s stake will go up to 55%, post issue. This has prompted some analysts to say that RIL may be thinking of selling off some of its shares held by its subsidiaries, as treasury stock, in the open market.

IPCL: IPCL recorded a net profit of Rs 1,164 crore for FY06 and Rs 1,014 crore for the nine months ended December ’06. The cash profit for the first nine months of FY07 was Rs 1,499 crore. IPCL had a debt-equity ratio of 0.25 at the end of FY06 — the company is virtually debt-free. An increase in cash flow is particularly useful, given RIL’s capex plans over the next few years.

Exploration & production: As per a revised development plan, RIL expects a production of 80 million cubic metres/day from the KG Basin discovery. The total capex earmarked is $5.2 billion, while production from the discovery is likely to start in ’08-09.

Reliance retail: The first public announcement on retail was made at the company’s AGM, while the first store was thrown open in November ’06. The number of stores is now 72 and the company is targeting 1,000 outlets by mid ’07.

The total capex earmarked for the venture is Rs 25,000 crore, of which, 40% could be the equity contribution by the parent. Reliance Fresh supplies vegetables, fruits, cereals, staples, grocery and meat (in select stores) to around 3,000 families within a 2 km catchment area.

These stores are backed by strong supply chain, which eliminates multiple middlemen and helps to keep costs low.

Industry watchers forecast a turnover of Rs 100,000 crore by ’11, though it is premature to make financial projections at this stage.

Valuations: RIL’s expected P/E multiple for FY07 is over 17, which is steep compared to the past. Its cash flows are unlikely to improve significantly over the next few quarters — at least until new businesses become operational. However, the P/E gives only the cash flow from the refining and petrochemicals businesses.

Gas production from the KG Basin and Reliance Retail are not part of this calculation — and it is too early to speculate on earnings from those.

RIL’s upstream assets are currently valued at Rs 400-450 per share — about onethird of the current market price. It is still too early to place a value on retail. Investors could continue holding the stock.