Reliance Industries Rating- add; Return ratios were weak in FY22

Reliance Industries Rating: add; Return ratios were weak in FY22

A look at Reliance Industries’ (RIL’s) FY22 annual report provides insights into the way the company’s character has transformed over the past 3-4 years. The fiscal saw record profitability and margins for RIL’s consolidated operations, with growing scale of the consumer businesses complemented by recovery in ‘oil to chemicals’ (OTC) margins as well. However, substantially higher capex across business segments has meant that return ratios have compressed sharply over the past 2 years – overall RoE increased just 28bps and RoCE dipped 57bps y-o-y, driven by massive capex of Rs 1.4 trn, in FY22. Material capex of Rs 827 bn in digital services and Rs 298.7 bn in retail were key reasons for the weakness in return ratios.

Despite the inflow of Rs 2.6 trn over the past two years via the unlocking of value in RJio and retail, as well as the rights issue of Rs 529 bn, net cash fell by Rs 135 bn in FY21 and increased by only Rs 178 bn in FY22. FCF yield therefore remained muted at 0.5% in FY22. Reiterate Add, with a revised SoTP based target price of Rs 2,805/sh.

Capex remains ahead of estimates: Post the completion of downstream expansion and mobility capex by FY21, there was optimism around material FCF generation from RIL over FY22-FY24E. However, the capex run-rate has remained well ahead of earlier estimates of Rs 500-600 bn over FY21-FY22, averaging more than Rs 1 trn. The capex includes a sizeable Rs 48.7-bn interest capitalised for the year vs Rs 45.9 bn capitalised in FY21.

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Gross borrowings jump 13% y-o-y: Despite the stronger profitability and inflow from the strategic sales/rights issue over FY21-FY22, gross long-term debt has risen by Rs 414 bn y-o-y to Rs 3.6 trn. This includes deferred payment liabilities rising by Rs 183 bn for the year. Net interest costs, however, declined, thanks to a refinancing of $9 bn of debt during the year, which has reduced the effective cost of debt.

Stellar performance priced into CMP: We are strongly optimistic about the prospects for RIL’s green energy business as well as the strong momentum being seen in consumer business segments over the next 12-18 months. However, we believe current valuation multiples are at a ‘zero things can go wrong’ scenario, one which we do not find tenable. RIL has for the past three years consistently shown a decline in key return ratios, with RoE/RoCE remaining at sub-10 or low double-digit levels. Dividend payout has also remained low despite strong earnings. From an investment standpoint, muted return ratios, coupled with higher multiples, which underplay all risks (lower margins, green energy execution/scale/timelines falling short), should give some pause. Our valuation implies ~7.3% upside from CMP. We maintain Add.