Why are investors wary of Reliance Industries?

Reliance Industries’ chairman Mukesh Ambani is quite bullish on India and expects India to beat China’s economic growth in the next few years. But RIL investors are a worried lot. The company’s shares are losing steam and are now down 4.5% in the past month and down 11% since the Narendra Modi government took office in May this year.  On the other hand, the BSE Sensex is up 15% in the past six months and was up 2.5% in the past month. Here are a few reasons on why investors are worried about RIL’s prospects: 

TELECOM PLAY:  Ambani has already spent a massive Rs 60,000 crore in the wireless telephony business which is expected to be launched early next year. RIL will need a ‘miracle’ pricing to oust the current big 3 players: Vodafone, Bharti and Idea Cellular. But RIL’s investors and analysts are worried about when and how RIL will get returns on its investment. There is no clarity on that.

FALLING COTTON PRICES: Cotton futures are down 28% since January this year but are actually down 37% from this year’s peak, and are now at a 5-year low. Being competing products in the blends segment (mainly PSF and not filament or PET), analysts believe lower cotton prices are generally negative for polyester prices, as cotton essentially sets the ceiling for polyester prices. In addition, history has shown that higher cotton prices allow all the participants along the polyester chain (PX/PTA/MEG producers) to make higher than average spreads, says JP Morgan. As a competing product, lower cotton prices leads to lower polyester prices, compressing the margin for the whole chain.  Both PX/PTA prices are more sensitive to oil prices than other key petchem products because Aromatics can only be made from crude oil. RIL is in the middle of spending a massive $10 billion to increase its petchem capacity.

SHALE GAS:  With falling crude oil prices, the US shale gas industry is in a bind. And so is RIL. Shale gas production will become unviable of crude falls below $60 a barrel. The return on capital employed on RIL's shale gas investments worth $9 billion were around 3-4% in 2013-14 and were estimated to hit double digits by 2021. A fall in crude oil prices might change the game. RIL's earnings per share from US shale gas assets was Rs 0.7 in 2013-14 and was expected to go up to Rs 11.2 by 2021, says Barclays. "Earnings from US shale, where Reliance has spent $7.4 billion so far, might rise as output increases but with the steady return on capital employed at 11-12 per cent, it might not be a key value driver," says Barclays, in a report dated October 8. RIL wants to sell its 45% stake in the Eagle Ford JV with Pioneer Natural Resource. But there are few takers.

GAS PRICING:  Even after the Indian government decided to increase the gas prices, RIL will not be an immediate beneficiary.  Under a new leader, though the CAG (comptroller and auditor general) has now asked the government to sort out the pending issues with Reliance, the final say on this matter will be of the Supreme Court which is hearing petition filed by Communist party leader Gurudas Dasgupta.  The case will come up for hearing January 16, 2015. The arbitration on gold plating charges is still on. 

REFINING MARGINS:  Falling crude oil prices are impacting the refining margins of RIL which is planning to set up its third world class refinery in Jamnagar.  The gross refining margins of RIL has come down but JP Morgan says RIL’s refining operations do not seem to be much impacted by the swing in crude prices. “The volatility in RIL’s refining profitability is much lower than the other regional refiners, which is something we don’t completely understand, but it could be due to the way RIL treats crude and product inventories from an accounting perspective,” it said.

(Dev Chatterjee is corporate editor, Business Standard)