Reliance Industries on course to hit $100 billion m-cap in 4 years, says Morgan Stanley; here’s how

Shares of Reliance Industries have surged over 14 per cent in the past 12 months compared with a 7 per cent drop in the S&P BSE Sensex during the same period. “This is just the start. RIL is nearing the completion of its largest-ever capex programme of $46 billion over F14-17, paving the way for a multi-year cycle of strong FCF generation,” said the report. RIL is nearing the completion of its largest-ever capex programme of $46 billion over F14-17, paving the way for a multi-year cycle of strong FCF generation,” said the report.

The investment bank said the stock price history of over the last 15 years suggests RIL has typically outperformed once it starts generating FCF after its capex mode and a similar cycle is likely to play out now.

Morgan Stanley maintains an overweight rating on the stock with a 12-month target price of Rs 1,329, which translates into an upside of 37% from current levels in the next 12 months.

Morgan Stanley cited five reasons to drive a rally on the counter:

Strong FCF generation starting F17: Reliance Industries is almost at the end of its largest ever capex cycle of US$46bn over F14-17e, and a large part of which has gone into downstream expansion and its new venture in telecom (Jio), which is nearing its launch.

Due to this, RIL’s FCF was negative for the past four years and its ROCE i.e. return on capital employed fell below its cost of capital. This is led to RIL underperforming the market by over 65% in last five years, said the report.

RIL is set to deliver lumpy 50% growth in PAT by F18 resulting in ROCE expansion by 240bps despite the initial losses in telecom business, said the global investment bank.

Telecom (Jio’s) turnaround is key: Investors are currently giving zero value for RIL’s telecom investments which we estimate to beat US$18.6bn by F16. Key investor concerns center around whether RIL’s telecom investments which we estimate to beat US$18.6bn by F16. Key investor concerns center around whether Jio will be able to make reasonable returns from these investments.

“We highlight that Jio has ingredients which can make its telecom venture profitable, hence surprise positively. Its spectrum portfolio and fiber reach is formidable compared to existing incumbents,” said the report.

RIL’s infra sharing deals with RCOM coupled with lower network costs can help it deliver better margins of over 40% by FY20. In addition, LTE is a superior technology and its consumer adoption could be much faster as both availability and affordability of 4G handset/device is improving rapidly.

Increase in oil prices to $60/bbl: In the event oil prices rebound to US$60/bbl, RIL will benefit from its exposure to oil through downstream expansion projects. After the commissioning of projects, its profitability would also be linked to crude oil prices with every $10/bbl change leading to 8% change in earnings.

“At US$60/bbl, we expect downstream projects to generate incremental EBITDA of US$3.6bn compared to US$2.5bn we assume at US$41/bbl oil price in our base case,” added the report.

Reliance Retail revenue to more than double: Retail has now turned around and can aid its telecom launch Reliance retail is already the largest retailer in India by revenue with a network of 3,043 stores. “Although, its earnings contribution is currently small, but we also note there doesn’t appear to be any major capex planned, and the focus is now on growing the business and profitability,” said the report.

“We estimate RIL current revenue (F16e) of $3.2 billion or Rs 21,200 crore which is 5% of current retail modern trade which we expect to grow to US$8.1bn or Rs 53,200 crore by FY20 which will be 5.5% of industry size then,” added the report.

Valuations are attractive: The stock valuations are now at compelling levels. RIL’s F18 P/E is now 8.8 times, which is near its five-year trough levels. Similarly, its F17e P/B of 1.1 times is at a 10-year low.

Relative to Sensex, RIL’s relative P/E of 0.68 times and relative P/B of 0.4 times is near 10-year lows. On F18eEV/EBITDA of 6.5 times, the stock is at a discount of more than 20 per cent to its historical average of the last 10 years.

“We think these valuations form a compelling entry point. We think they are likely to return to normalized levels as RIL nears the start of its earnings growth cycle in F17 and the market starts to discount these earnings,” said the report.