RIL not FAANG-like yet as O2C, telecom make up 70% of value: Edelweiss

It downgrades stock from 'buy' to 'hold'; CLSA, too, lowers rating

Shares of Reliance Industries (RIL) have been on a tear over the last few months. This has driven up the valuation for the stock. To justify these high valuations many on the Street have started to club RIL with so-called FAANG stocks — an acronym for Facebook, Amazon, Apple, Netflix, and Alphabet (Google). 

The American technology giants comprising the FAANG stocks have a combined market capitalisation (m-cap) of $5 trillion. These stocks have seen a huge surge in their valuations and enjoy price-to-earnings (P/E) multiple much higher than the market.

RIL, too, has diversified from pure-play oil-to-chemical (O2C) business to new-age digital (through Jio) and retail businesses. So does it deserve lofty valuations like those for FAANG? Domestic brokerage Edelweiss thinks otherwise.

“RIL’s FAANG-like valuation (particularly Jio’s) is misplaced as O2C and telecom make up 70 per cent of value,” said Edelweiss analyst Jal Irani in a note downgrading the stock from ‘buy’ to ‘hold’, with a price target of Rs 2,105. Shares of RIL ended at Rs 2,177 on Tuesday, valuing the company 35 times its estimated earnings for the ongoing FY21. CLSA, too, has downgraded the stock from ‘buy’ to ‘outperform’, voicing similar concerns. 

The Edelweiss noted: “We believe the stock’s primary triggers — deleveraging, asset monetisation and digital momentum — have played out. We also believe the pendulum has swung entirely: From extreme pessimism to exuberance, infallible expectations on execution and a peak analyst ‘buy’ ratio (at 80 per cent). That the valuation is pricing in overly high growth expectations when its WACC (cost of capital) is rising and economic spread being negative suggest risks lie on the downside.” 

Edelweiss highlighted that RIL’s stock had previously been through three bouts of exuberance — in 1994, following economic liberalisation, then during the dotcom boom in 2000, and ahead of the global financial crisis in 2008.

 

 

The brokerage said at the current valuation, the market is factoring in a 35 per cent CAGR (compound annual growth rate) for 10 years. “The market is baking in a very high earnings CAGR of 35 per cent for Jio Platforms and 31 per cent for Reliance Retail sustaining over the next 10 years, which by any measure is a tall ask,” it said.

Shares of RIL have jumped nearly 2.5 times from this year’s lows in March. The company’s m-cap is fast-approaching the $200-billion market. RIL alone currently accounts for a tenth of India’s m-cap and a fifth of the Sensex’s m-cap.

“We believe that comparing Jio Platforms with the FAANG companies is the market’s newfangled makeover of the stock. While RIL’s management has a tenable vision that promises a long-term growth potential in that direction, we believe it shall be a long journey nevertheless,” the note said. “In our view, the markets have significantly and prematurely fired up the valuation of the entire consolidated entity — RIL — to those commanded by the FAANG companies… The cutting-edge FAANG companies boast large free cash flows already; for RIL in stark contrast, it is primarily the O2C business that shall continue to generate the bulk of cash flows over the medium term.”

On the other hand, though analysts at CLSA have downgraded the stock, they projected RIL’s m-cap to rise to $220 billion by March 2022. “Despite a lenient valuation framework, our new target of Rs 2,250 (Rs  1,753.38 earlier) offers only 4 per cent upside, which sees us downgrade our rating from ‘buy’ to ‘outperform’,” wrote Vikash Kumar Jain and Surajdev Yadav, of CLSA in a note.