Reliance Industries Q4FY19 – Consumer business takes up the baton

Retail displayed a better set of operating margins.

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Reliance Industries (RIL) reported a mixed set of numbers wherein traditional businesses (petchem and refining) were weak, but largely in line with global trends. The consumer businesses were the saviour. Margins in retail improved and Jio’s quarterly performance remains robust. Despite the slower pace of customer addition, strong competition and falling ARPU (average revenue per user), Jio maintained its operating margin in Q4 FY19.

Key Positives:

Retail sales (19 percent of overall) surged 51.6 percent YoY primarily on the account of store additions. Sequentially, sales growth had moderated to 3.1 percent QoQ. A key highlight of the result has been margin improvement in retail business to 4.7 percent in Q4 (vs. 3 percent in FY18) on account of operating leverage.

Pls also read: Reliance Retail could be worth Rs 3.75 lakh crore, or half of RIL's mcap

Jio (part of digital services; 7 percent of sales) witnessed a 7 percent quarter-on-quarter (QoQ) growth in its net revenue to Rs 11,106 crore. The growth was driven by the net addition of 26.6 million subscribers during the quarter. With this, Jio’s subscriber base has expanded to 306.7 million.

Despite strong competition and offers by Jio, ARPU dipped 2.9 percent QoQ to Rs 126.2 per month. Jio maintained its earnings before interest, tax, depreciation and amortisation (EBITDA) margin at 39 percent on a QoQ basis.

Key Negatives

Traditional businesses, particularly refining (46 percent of overall), witnessed a weak set of numbers that reflect global trends. The segment posted sharp decline in revenues sequentially due to a planned shutdown. Further, weak product cracks adversely impacted GRMs. While GRM was better than the regional metric (Singapore GRM -$5/bbl), premium tapered off in Q4.

Further, petrochemicals business (22 percent of overall) sequential performance was a disappointment. However, it witnessed a 11.3 percent improvement in sales due to better pricing and realizations for PTA (Purified terephthalic acid), Paraxylene and Polypropylene. This helped in partially offsetting the weakness in other petrochemicals which were weighed down by the higher supplies from new US capacities.

While Jio’s subscriber base continued to expand, the pace of the growth moderated primarily due to base effect and increased competition. Interest cost outlay increased by 18.6 percent leading to a flat growth in profit-after-tax (PAT), lower than the 18.6 percent QoQ growth in EBITDA.

Key observation: Armaco & RIL – Tale of two transitions

While there was no official comment on the media report that Armaco is interested in 25 percent stake in refining and petrochemical business, such a possibility cannot be ruled out.

Armaco has been looking for strengthening its presence in the oil & gas downstream businesses in recent times. Earlier this week, Armaco bought a minority stake (17 percent worth $1.2 billion in the Hyundai’s oil refining unit in Korea.) Last month, Armaco bought a 70 percent stake for roughly $69 billion in Saudi Arabia’s petro-chem giant – SABIC. In India itself Saudi Aramco is working with other OMCs to develop a mega refinery complex in Maharashtra. A possible investment in RIL’s refining business could be a step towards further diversification making it a conglomerate having multi continent presence.

For RIL, this step can possibly mean refueling itself with ammunition to take on competition in the retail, telecom and digital businesses. Remember, RIL’s foray in recent years has been in territories dominated by global giants - Amazon, Walmart, Netflix and Alibaba.  As the peers have strong insights and investment appetite for reach and content, there might be greater need for investments particularly when the confluence of telecom, communication and entertainment intensifies.

Outlook:

Results were broadly as per our expectation barring the performance of refining. However, we take our cue from the CFO’s comments that segmental margins and product cracks are already on a rebound.

Jio continues to be core focus for expansion and is expected to drive the revenue growth in the coming quarters. We believe Jio would continue its stellar run, going forward, on the back of its strategy of deeper and wider market penetration (with over 1 million retailers for customer acquisition and selling prepaid recharges) that would continue to disrupt the entire value chain. The company is also making further inroads through various strategic tie-ups and partnerships (Disney, DEN, and Hathaway) and roll-out of new services (JioGigaFiber) in 1,600 cities.

Further we view the growing contribution of Reliance Retail and Jio at the EBITDA level as transformational. Currently both these segments contribute nearly 25 percent of EBITDA, which was 13 percent a year back and hardly 2 percent in 2015.

At a strategic level, business transition from a low multiple commodity business to consumer oriented business should be value accretive. So far, this move has been funded through debt and cash flows from traditional business. The competitive landscape may make it imperative to look for other avenues of funding to grow these businesses. However, it is noteworthy that company’s recent attempts to manage debt levels have helped in keeping debt to equity metric at a comfortable level of 0.67x.

A back of the envelope check on the SOTP (sum of the parts) valuation suggest that even at a conservative multiples medium term growth potential is not fully priced in.

Disclaimer: Reliance Industries Ltd. is the sole beneficiary of Independent Media Trust which controls Network18 Media & Investments Ltd.

Moneycontrol Research analysts do not hold positions in the companies discussed here.

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