As the country’s largest company by market capitalisation, it wouldn’t be far-fetched to state that Mukesh Ambani-owned Reliance Industries Limited (RIL) has become a cornerstone of the Indian economy.
Ambani’s seven-year investment spree from 2012 to 2019, largely fuelled by his telecom gamble, single-handedly boosted the rise in private investment. As Credit Suisse noted in October 2016, Reliance by itself contributed nearly 15% of the $117 billion in investment that was made by India’s top 1,250 publicly traded companies in 2015. This analysis included capex by the Indian Railways and state-owned electricity boards as well.
For decades now, RIL has held a commanding industry position, a situation that only changed once it started expanding into the telecom and retail businesses.
Until 2012, RIL was debt-free on a net basis, but since then it has witnessed a 438% increase in its gross debt. As Reliance Industries ended FY’19 with net debt of Rs 1,54,478 crore, chairman Mukesh Ambani has been trying to assuage investor concerns over the group’s rising debt levels.
In August 2019, he declared that RIL would be a zero-net-debt company in 18 months, announcing a number of asset sale plans, prompting analysts to call it everything from a ‘debt-diet’ plan to Reliance’s ‘great deleveraging’.
How did Reliance Industries get to that position though and why did it reach the point where it demanded critical attention?
The company has an accumulated gross debt of more than Rs 2.87 lakh crore, as it expanded rapidly into the consumer-focused businesses of retail, telecom and e-commerce over the past few years besides majorly upgrading the core refining and petrochemicals businesses. The rising debt level of Reliance demands critical attention as there has also been a consistent decline in revenue from oil, gas and petrochemical business.
Investments in acquisitions is another cause for the huge debt pile of Rs 2.87 lakh crore at the end of 2018-19. Over the past 24 months, RIL has acquired stakes in about 20 start-ups and in half-a-dozen small firms. The acquisitions have become a necessity, especially after Jio was launched. RIL’s target is to create a bouquet of digital products, which can counter the likes of Google, Amazon and Netflix. RIL has Rs 1.33 lakh crore cash in hand and, as noted above, a net debt of Rs 1.54 lakh crore.
RIL’s total liabilities, as disclosed in its annual report, include debt, higher crude payables, customer advances, capital expenditure creditors and spectrum payouts. For 2018-19, RIL’s finance cost had more than doubled to Rs 16,495 crore from Rs 8,052 crore in the previous year. In its annual report, the company also states that the increase was primarily on account of commencement of its digital services business, petrochemical projects at Jamnagar and higher loan balances.
Credit Suisse Downgrades RIL share rating
In August 2019, global brokerage Credit Suisse red-flagged RIL’s total financial liabilities, pegging it at $65 billion (Rs 4.6 lakh crore). It downgraded RIL’s stock from ‘neutral’ to ‘underperform’ and slashed its target price from Rs 1,395 apiece to Rs 995 citing high liabilities, lower refining and petrochemical margins, and slow enterprise rollout and Jio’s weak average revenue per user in the first quarter of FY20. RIL shares had taken a hit after Credit Suisse downgraded the share rating.
The brokerage’s downgrading of RIL was also because the conglomerate has been free cash flow (FCF) negative for six years. As RIL’s liabilities have dramatically gone up to $65 billion in FY19 from $19 billion in FY15, Credit Suisse predicted in its August 2019 report that the negative FCF trend is likely to continue in FY20-21 too, just as it has been for the last six years, given the margin pressure in refining and petrochemical.
It also forecast that the petrochemical segment will continue to be under some pressure because of the large capacity additions in China, Middle and Africa. These pressures will not ease off in the next 12-18 months due to continued large capacity refinery projects like Al Zour in Kuwait, Aramco’s Jazan in Saudia Arabia, Sinopec’s project in Zhanjiang and others. Credit Suisse has also expressed worry that ethylene, the primary petrochemical feedstock produced by RIL will not ease from its current ‘low spread’ status anytime soon. Nearly 62% of the ethylene is converted into polyethylene, the demand for which has been muted due to the US-China trade issues.
Optimistic plans for the Future of RIL
Keeping this negative report and addressing investor concerns, Mukesh Ambani, chairman of RIL made several optimistic pronouncements about the future of the company at its 42nd annual general meeting (AGM) in Mumbai on August 12, 2019. Primarily, he focused on the plan to sell a 20% stake in its oil and petrochemicals business to Saudi Aramco for an enterprise value of $75 billion or around Rs 5.3 lakh crore. Saudi Aramco will also supply 500,000 barrels per day of crude oil on a long-term basis to RIL’s Jamnagar refinery. The 20% stake sale is likely to fetch RIL $15 billion or around Rs 1 lakh crore.
Within days of Ambani’s speech, Credit Suisse upgraded its rating on Reliance Industries to ‘neutral’ while raising the price target from Rs 1,028 to Rs 1,210. It apparently factored in the stronger balance sheet with debt reduction of $22 billion till FY21, and low capex intensity guidance and higher Jio valuation. The shareholders have been told by Mukesh Ambani that hitting zero net debt will come with higher dividends, bonus issues and other goodies “at a more accelerated pace than any time in our history.” However, this may be overly optimistic, as with deepening economic slowdown investors may struggle to reinvest the cash returned by Reliance.
Declining refining margins
For RIL, the major concern stems from the recent underperformance of its refining business. Hit by volatile crude prices and trade wars, RIL’s refining margins have consistently been declining for the past seven quarters. The refining margin (Gross Refining Margin or GRM) of RIL has fallen to $8.2 a barrel in Q4FY19, registering a slip for the sixth straight quarter. In this situation, RIL’s talks about selling 25% of its stake to Saudi Aramco fits in. In 2011, when production had depleted, RIL had sold 30% of its hydrocarbon assets to British giant BP Plc for $7 billion (Rs 51,000 crore).
RIL’s crude sourcing strategy has negatively impacted its petrochemical business, with very high crude payable days at 121 days. This is because RIL has historically bought oil from Iran and Venezuela, which have come under US sanctions
The new deal would help RIL secure its supplies while Aramco gets to enter a new market like India, even as the US cuts down its dependence on Saudi Arabia for oil. After the announcement of this deal, RIL’s stock rose by nearly 46%. Although Aramco has had plans for over a year now to set up a refinery in Maharashtra’s Ratnagiri in a tie-up with Indian PSU refiners, the project is yet to take off. There are concerns about how and whether Saudi Aramco will stay committed to the mega Ratnagiri refinery project, while simultaneously showing interest in Reliance Industries’ refining and petrochemicals business.
In a move to hinder RIL’s deal to sell 20% stake (worth $15 billion) to Saudi Aramco, the government has filed a petition with the Delhi high court. The government’s attempt to block the RIL-Aramco deal is ostensibly in view of pending dues estimated at $3.5 billion, with respect to Panna-Mukta and Tapti oil and gas fields (PMT) production-sharing contracts (PSCs), but the fact remains that the strategic sale of Reliance’s 20% stake is a crucial concern for the GoI.
Meanwhile, the PMT case is another roadblock that RIL will have to deal with. An international arbitration tribunal issued a partial award in October 2016 in the dispute between the Government of India (GoI), BG Exploration & Production India (BG) and RIL regarding the Panna-Mukta and Tapti PSCs. Pending the determination of all issues before it, appropriately, it did not award any monetary sums. RIL maintains that except as quantified by the tribunal, no amount can be said to be payable at this stage.
There are further indications that Reliance’s proposed deal with Aramco, which is intended to reduce its massive debt and ensure assured supply of crude oil to its refineries, is now unlikely to be concretised by the end of this financial year. “It will not be a deal which will get done by March,” RIL’s joint chief financial officer V. Srikanth stated during RIL’s quarterly results announcement recently.
Earlier, a legal respite awarded to RIL in August 2018 by the international arbitration tribunal, in the dispute with state-owned Oil and Natural Gas Corp’s (ONGC) may also be short lived as the government intends to challenge the arbitration tribunal’s decision. In November 2016, the oil ministry had filed a $1.4 billion demand on the RIL-BP-Niko (UK-based BP Plc &Canada’s Niko Resources) consortium for allegedly unfair practices and pilferage of 18 billion cubic metres of gas from two ONGC’s gas blocks in the Krishna-Godavari (KG) basin in the Bay of Bengal. RIL’s troubles don’t end there. The government is reportedly also pressing the company to cough up $174.9 million of additional profit petroleum after certain costs were disallowed after the output from the KG-D6 block was lower than the target. Profit petroleum refers to profits from gas production after recovering costs that are available for sharing between the contractors and the government. Significantly, disallowing cost recovery will result in the government’s profit share rising. The cost recovery issue is reportedly being arbitrated separately.
Reliance Industries and JM Financial Asset Reconstruction Company have received conditional approval by the National Company Law Tribunal to acquire Alok Industries for Rs 5,050 crore under the newly-instituted Insolvency and Bankruptcy Code. However, Mukesh Ambani’s plan to buy out Alok Industries at a fire-sale price is unable to reach a breakthrough in its negotiations with the State Bank of India (SBI), HDFC Bank and ICICI Bank to fund the acquisition.
If Mukesh Ambani’s proposed plans are to work out, RIL is looking at a bonanza of investments in the coming financial year. It is hoping to raise money from global investment in its telecom assets. It was announced that Canada’s Brookfield Infrastructure Partners L.P. and affiliates will invest Rs 25,215 crore in its telecom tower assets. It has also announced a 51% stake in the fuel retailing joint venture with British oil major BP Plc to launch 5,500 retail outlets in five years. The partnership will also market aviation turbine fuel to cater to India’s growing aviation industry. RIL will earn Rs 7,000 crore from the deal.
It is also considering financial investors in consumer businesses, Jio and Reliance Retail, which are the potential jewels of his new industries. If Ambani finds deep-pocketed partners for general retail, as well as for telecom, reaching his goal will be simple enough. Banks, however, may rue the end of Reliance’s debt-fueled expansion if loan syndication deals are only for refinancing and not new money.
With decreasing assets efficiency, the company should concentrate on assets efficiently in the future to generate more profits, with control over expenses. RIL must rectify its cash availability to meet its immediate requirements.
RIL is the only conglomerate which managed to achieve involvement in all the industries it was able to diversify into through its sequence of expansion. In both its textiles as well as petrochemicals phase, the Reliance group secured for itself a larger share in the expansion of its chosen areas as compared to most other participating enterprises. And in each venture it undertook, Reliance acquired a dominant position despite being a later entrant.
So, when a company that is known for expanding and establishing businesses goes for such significant assets’ dilution, especially of its flagship businesses, it is indeed noteworthy and disconcerting. As a keystone of the Indian economy, the success or failure of Reliance Industries reflects on the corporate atmosphere of the nation, especially at a time when overall business sentiment is not at its best.
Vaishali Basu has worked as a consultant with the National Security Council Secretariat (NSCS) for several years. She is, at present, associated with the think tank Policy Perspectives Foundation.