It has been quite a while since we released our stock story article on Why Bajaj Finance and Avenue Supermart are risky at this point in time? In case, if you haven’t read it here is the link. We thought why not restart our stock story journey with India’s largest company – Reliance Industries.
Reliance Industries – Shining star in a dark sky?
Coming to the story, well, it has definitely been a long wait for the shareholders of Reliance Industries. The stock grossly underperformed the benchmark between 2007 to 2017. In fact, Reliance managed to break the high made in 2007 only in the second half of 2017, which is more than 10 years. However, ever since the launch of Jio which shook the entire telecom industry and fast-growing retail business, the stock has seen a considerable up move as it doubled in the last two years. Its market cap increased to ₹10 lakh crore which also makes it the largest company in India.
This was largely due to rising share in operating profits from consumer-facing businesses like Telecom and Retail. Both these businesses usually command higher P/E as compared to the cyclical oil & gas business. In fact, the consumer businesses contributed only 1.5% of Reliance’s consolidated operating profit in FY15 which increased to 24.2% in FY19 and 35.1% in FY20. Further, debt reduction also played a part in re-rating of the stock, as Mukesh Ambani had planned to make Reliance Industries net-debt free by FY21. All was going as per plan until Covid-19 came into the picture.
When the COVID-19 led to lockdown in several countries, crude prices turned southwards. It was not a good sign for Reliance that still gets a major share of profits from the oil & gas business. And what made things even worse was the debt, as lower profits would mean slower repayment of debt and markets usually don’t pay a premium for companies with higher debt. That’s the reason why the stock corrected to nearly 880 levels recently.
Below is Reliance Debt position
|Debt Position (Rs. Cr)||FY20||FY19|
|Cash & Cash Equivalents||1,75,259||1,53,418|
However, Mukesh Ambani had other plans as the company announced a deal with Facebook fetching 5.7 billion dollars (Rs. 43,574 cr) investment for a 9.99% stake in Jio. With this investment, Jio is valued at a whopping Rs. 5 lakh crore which is nearly half of Reliance Industries market cap. Not only will this help in debt reduction for Reliance, but the partnership can open new verticals for revenue. At this point, investors turned optimistic as getting a deal during such times from a company that has ~300 million users and that too at a valuation favourable to Reliance is truly commendable. The valuation of Jio was in fact on the higher side as against the street estimates.
But wait there is more!
The company approved a rights issue (largest in India) which allows its existing shareholders to buy additional shares if they wish to at a discounted price. The ratio is set at 1:15 shares and the price at Rs. 1,257 per share which is at a 12% discount to yesterday’s closing price. Most recently, a PE firm named Silver Lake Partners has agreed to buy a 1.15% stake in Jio for ~Rs. 5,655 cr. Remember, there are other deals for stake sale which are also in the pipeline. It includes Fuel retailing JV with BP and the biggest one is the Saudi Aramco sale which is valued at nearly Rs. 1.05 trillion.
Fund raising plans of Reliance Industries
|Company||Amount (Rs. Cr)|
|JV with BP for Fuel Retailing||7,000|
|Facebook - Jio (9.99% stake in Jio)||43,574|
|Silver Lake Partners (1.15% stake in Jio)||5,655|
|Saudi Aramco (20% stake in Reliance Oil Refinery and Chemical Business)||1,05,000|
Source: Company and News reports
What’s the road ahead?
It would be unfair to say that the road is smooth for Reliance Industries. The recent sharp fall in oil prices would lead to lower profitability for the company. It also puts Saudi Aramco deal in jeopardy. Further, given the lockdown, the retail business is also expected to take a hit.
So what will lead to the outperformance?
Even if the Saudi Aramco deal does not go through which is a fair possibility, Reliance has already garnered nearly Rs. 1.1 trillion through the Facebook deal, Rights Issue, and Silver Lake Partners deal which will help in reducing the debt to a certain extent. This will lead to lower interest costs and restrict the downside in profits of the company that will be caused by a slump in other businesses. Additionally, Jio’s business is likely to be least impacted amidst the lockdown. Therefore, with limited downside in the company’s profitability and higher share from non-cyclical consumer business, Reliance can continue to get re-rated (command higher P/E) and can potentially outperform the market.
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