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Reliance Industries: The giant with a sprawling business - Outside View by Luke Verghese
 
 
Reliance Industries: The giant with a sprawling business

Growing in all directions with funds increasingly being put down on investments of siblings which do not appear to have any specific charter

The flag bearer of the Indian corporate sector

Readers may well be aware that RIL is the only private sector company from India to feature in the Fortune Global 500 of World's largest Corporations and World's Top 100 Companies ranking at No 99 in terms of revenue and at 130 in terms of profits in 2012. It has earned itself several other accolades along the way. It has the largest refining capacity at a single location. It is the largest producer of polyester fibre and filament yarn. It is also the 5th largest producer of both paraxylene and polypropylene, and is the 8th largest producer of mono ethylene glycol. To round out the picture it is the 9th largest producer of purified terepthalic acid. How's that for size and that too for a single Indian company to have built such humungous capacities in such a short operational time span. For the matter of record the company is 39 years old as a corporate entity. If my memory serves me right it started with trading in yarn before going into  the manufacture of commodities through backward and forward integration in the oil sector. Textiles per- se have since taken a back seat in the big picture. The company makes do with eight major plant locations - five in Gujarat, two in Maharashtra, and one in Andhra Pradesh. The company is still very Gujarat centric- period. The total numbers of plants actually add up to 14 units. This number excludes the oil and gas blocks that it is developing. At year end it also had a stake in 13 joint ventures involved in oil and gas exploration.

For all its show about size and capacities, the fact of the matter is that the share price has been under performing in the secondary market for some years now. The recent share buyback ostensibly orchestrated to give some lubrication to the indifferent price tunes in the secondary market turned out to be a non event. The buyback also cost the company some. But there is no respite whatsoever to the laggard share. The company is uniquely silent on this anomaly.

The moot point is also that its hold over the domestic economy is ever more exacting. The company's exports account for 14% of India's total exports, and it also accounts for 4.8% of the total indirect tax receipts of the Central government. So in a sense its financial performance has a very direct bearing on market sentiment in a manner of speaking. Such is the company's scale of operations that it makes do with 31 bankers. The consolidated entity is humongous for other reasons too. Under the related party disclosures it has unveiled the names of 147 entities consisting of 127 subsidiaries, 10 associates, and another five foundations and charitable trusts. The siblings and associates span across continents and include the Netherlands, Mauritius and the British Virgin Islands. The latter three are well known tax havens. The vast bulk is however incorporated in India. (According to the consolidated statement however the list includes 123 siblings, and 31 associates or joint ventures). Either way it is an impressive number. It is not known the number of such entities with which it had financial transactions during the year. For the matter of record the promoters own 45.34% of the outstanding equity capital of Rs 32.29 bn. This promoter shareholding level is indeed a very creditable achievement. During the year the company also bought back and extinguished 46.24 m shares at total cost of Rs 33.66 bn- thus increasing the promoter holding by a like amount, and at no cost to the promoters. The company had obtained shareholder permission to buy back 120 m shares at a total capital cost of Rs 104.4 bn. The present outstanding capital consists of 32.28 bn shares of Rs 10 each. The company talks big money, real big money folks.

The ten year stats

If one observes the 10 year operational statistics, both the revenue from operations, and the total income have been scaling new highs each year relative to the base year 2003-04. But the picture at the operating level has not been as rosy. The earnings before interest, depreciation, and taxes after peaking at Rs 411.7 bn in 2010-11 took an erratic route as was the case with the charge towards depreciation and amortisation. The depreciation which peaked at Rs 136 bn in 2010-11 fell steadily to Rs 94.65 bn in the latest year. This fall in provisioning was in line with the decline in the value of gross block. The gross block peaked at Rs 2,280 bn in 2009-10 before falling to Rs 2,055 bn in 2011-12 and then increased sharply to Rs 2,323 bn in 2012-13.

Why do I point to these figures? One will notice that the ability of the company to maintain the net profit level in 2011-12 and in 2012-13 to the level of 2010-11 was due to the lower provision for depreciation in these years. (There are other factors at play too and helped perk up the bottom-line- but more on it later in the copy). Inspite of the big addition to gross block in the latest year end, the provision depreciation fell sharply to Rs 94.6 bn. This lower provisioning helped the company to report a higher net profit of Rs 210 bn. In other words the bottom-line has been under severe strain the past few years. The revenue from operations however peaked at Rs 3,711 bn while the total income also touched a new high of Rs 3,791 bn.

The directors' report is chock a block with reams of copy of new business initiatives in oil and  shale gas exploration - which is basic to the company's welfare- and in related value added fields. The mainline activities now run into the retail, Infocomm and the SEZ businesses. The copy runs into some 80 pages of verbose matter. Much of the copy is beyond my scope of assimilation but the figures which complement the copy are there for all to see.

Prudent financial management

Companies which operate according to the rule books of prudent financial management will always prosper. In the ultimate analysis it is astute financial management which is the end product of a professionally run organisation -- where the goals of the management are not at odds with the very ethos of the company, and with all systems in place to boot. However for companies operating in the oil and gas sector it is doubly more difficult to function rationally on a day to day basis given the uncertainties that they have to contend with. It is being made all the more difficult to  plan ahead given that the government even after many years of vacillation does not still have a manicured policy in place for the industry. The industry also operates under numerous fiats and dictats including a non transparent end product pricing policy. But none of the uncertainties seem to be fazing Reliance Industries and this is the most remarkable aspect of its functioning. Barring the fact that it does not retail petroleum products, the company is steamrolling ahead with both backward and forward integration projects literally at will. You would think that India has the most transparent oil industry regulations under the sun.

So what do the financials have to tell us? Well for starters the standalone company generated a net cash flow of Rs 330 bn from operations during the year. Significantly, the cash generated was more than enough to fund its gross block expenditure of Rs 159 bn. Ditto for the preceding year too. One would think that the company initially pans out its expected cash flow for the year to end before splurging on fixed assets expenditure. For whatever reason the company also played heavily in the debt securities market by buying and selling securities of a humongous total value of Rs 9,603 bn. It appears to have made some money in the process.

What the figures reveal

With plenty of capital to spare the company indulged in such tricks as funding its numerous siblings either in the form of hand outs or in the form of investments, paying back old loans and availing of new loans, and also helping yours truly to equity share buyback schemes on the one hand, and helping the promoters to consolidate their hold on the company on the other. The sums involved are not to be sniffed at - on the contrary they are sums to be admired. The sum expended on the buyback of shares during the year amounted to Rs 30.8 bn against Rs 2.8 bn previously.

Consider the following data. The total book value of its portfolio amounted to Rs 525 bn at year end. This consists of non-current investments (long term) of the value of Rs 241 bn and current investments (short term) of the value of Rs 284 bn. The portfolio of the former is basically concentrated in just four group companies and it is also a mish mash of investments in equity shares, preference shares in siblings and associates, and in fixed duration debt instruments etc. It also includes investments in debt securities in unrelated companies of the value of Rs 50.6 bn. The latter includes investments in the debt securities of listed companies and totes up to Rs 284 bn at year end against Rs 270 bn previously. (Thus the total investments in debt securities amount to Rs 335 bn). The loans and freebies to group companies in turn amount to quite some too---Rs 234 bn at year end against Rs 162 bn previously. (On a collective basis the portfolio holdings and the loan portfolio together amounts to Rs 759 bn). Just one company, Reliance Industrial Investments and Holdings, is bountifully endowed with loans of Rs 173 bn, and Reliance Retail is  richer to the tune of Rs 9.2 bn. Juxtapose these outlays with the loans that the company has itself contracted. At year end the total borrowings amounted to Rs 545 bn against a higher Rs 586 bn previously. Probably there is a method in this madness of the company borrowing large sums and simultaneously investing large amounts in debt instruments etc. The borrowings however also include foreign currency loans amounting to Rs 110 bn with the currency deflation risk to be factored in.

The other income factor

The point is also that other income is a big player in the bottom-line coloration. In 2012-13 such income amounted to Rs 80 bn and accounted for 30% of the pre-tax profit of Rs 262.8 bn. In the preceding year the contribution of such income was lower at 24%. The other income is a concoction of receipts totally disconnected with the main line of activity. The biggest single entry is ‘interest income from others' amounting to Rs 48.9 bn. This receipt is over and above the interest receipt under the head of current investments amounting to Rs 8.9 bn and interest receipt under long term investments amounting to Rs 4.6 bn. What is coming out quite clearly is that the revenue returns per-se from both long term and short term investments is only a pittance or something. And, what the big cap revenue receipt of Rs 48.9 bn pertains to is not very clear- unless it relates to the returns on the loans and freebies that the company has doled out to its siblings and other underlings. If so, then this is a humongous return on investment and certainly off key and suspect. The other big players in this concoction is ‘net gain from sale of current investments' amounting to Rs 12.3 bn and ‘net gain from sale of long term investments' amounting to Rs 4.2 bn. (The biggest movement in its long term stock portfolio during the year pertains to the exit in its holding in Reliance Retail valued at Rs 52.2 bn and the simultaneous acquisition of a stake valued at Rs 56.6 bn in a company called Reliance Commercial Associates). Just like that! Then there is the dividend income from current and long term investments- which as stated earlier amounts to frugal pickings. The other income has to also be seen in conjunction with the interest outflow of Rs 30.4 bn on its cumulative borrowings. The company comes up trumps in the process on a net basis of ‘interest received' to ‘interest paid out'.

But the point to also note here is that the percentage payout of interest on the outstanding borrowings appears to be only a trickle or something. The average of the loan outstanding for the two years amounts to Rs 566 bn. The total interest payout of Rs 30 bn would work out to 5.3% on an annualised basis on the average outstanding loan. The bulk of the borrowings consist of term loans from banks, or foreign currency borrowings or debenture bonds. This is truly exemplary management of its finances and is another pointer to its ability to generate an ‘adequate' bottom-line. The trick of course is to continue to earn a higher return on its investments etc Vis a Vis the interest that it is paying out on its borrowings.

The consolidated entity

This in effect shifts the focus to the consolidated entity. The consolidated entity doled out revenues of Rs 3,970 bn during the year. Thus the valued add by the siblings amounted to Rs 367.6 bn. The consolidated entity reported a pre-tax profit of Rs 262.1 bn. This implies that the siblings collectively reported a net pre-tax loss as the standalone company dolled up a pre-tax profit of Rs 262.8 bn. But such a group performance is entirely in keeping with the manner in which India Inc is driven. Bindaas is the name of the game. The management does not consider itself to be held accountable for the performance of flunkies by the shareholders of the parent company. This is precisely where drastic changes have to be incorporated in both Company Law and in the powers that SEBI can wield to make companies more accountable. For the matter of record the company has appended separately the brief financials of 121 siblings. Though the numbers are many, the companies of any significance are few and far between. Some of the siblings like Reliance Global Business B.V. make do with only preference share capital it appears. So what one could counter. The biggest company in revenue terms by far is RIL USA which reported a turnover of Rs 296 bn, but not unexpectedly reported a pre-tax loss. Never mind. The second and third largest in revenue terms is Gapco Kenya with sales of Rs 69.7 bn and Recron Malaysia with revenues of Rs 55.8 bn. The former reported a marginal pre-tax profit while the latter reported an indecent loss. And so on and so forth. Then at the other extreme there are exotica like Wave Land Developers which managed a pre-tax profit of Rs 370 m on revenues of Rs 372 m. This is swell!

Then there are the entities with large paid up capitals. At the top of the heap is Reliance Retail with a paid up capital base of Rs 83.1 bn followed by Reliance Jio Infocomm with a capital base of Rs 78.2 bn. This was followed by Reliance Commercial Associates with a capital of Rs 60 bn. And guess what? The first named boasted revenues of Rs 246 m and posted a loss of Rs 601 m. This can be referred to return on investment par excellence! The second named has yet to open its account but then the telecom business is still in the infant stage. The third celebrant has also yet to open its account. What in heaven's name is one to make of all this? Then there is another outperformer. Reliance Industrial Investment and Holdings Ltd which apparently is the down and out investment arm of the parent. It has a piddling capital base of Rs 1.5 bn but has availed of extra large loans of Rs 173 bn from the doting parent. This worthy in turn has an investment portfolio with a book value of Rs 27 bn. But its investment portfolio pales in comparison with the loans it has availed of. In any event it ratcheted up revenues of Rs 6.8 bn, but poor toots could only manage a pre-tax loss of Rs 120 m.

The siblings yet unnamed are far too numerous to be enumerated on and the copy will only get more boring with each passing sentence. So what does one make of it at the end of the day? Like the proverbial curates egg the company is good in parts but at the end of the exercise the good part appears to outweigh the negative signals.

Disclosure: I hold 24 shares in the company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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