Reliance Industries is the company of the country. It has a solid track record of projects execution and returns to its shareholders. It generates loads of cash each quarter.
Let's have a look at what it does with its cash.
Current core operations
The company currently operates in 3 prominent segments: Petrochemicals, Refining and Oil & gas.
The petrochemicals segment includes production and marketing operations of petrochemical products namely, High and Low density Polyethylene, Polypropylene, Polyvinyl Chloride, Poly Butadiene Rubber, Polyester Yarn, Polyester Fibre, Purified Terephthalic Acid, Paraxylene, Ethylene Glycol, Olefins, Aromatics, Linear Alkyl Benzene, Butadiene, Acrylonitrile, Caustic Soda and Polyethylene Terephthalate.
The refining segment includes production and marketing operations of the petroleum products.
The oil and gas segment includes exploration, development and production of crude oil and natural gas.
These operations are good as these are related businesses. There is synergy in these combinations. These businesses are profitable as we can see from below (consolidated as of 31 March 2012).
Future operations
Then there is another segment which includes - Textiles, Retail, SEZ development and Telecom / Broadband; and more: hotel and TV broadcasting businesses; and more: financial services(?).
The returns
A rough estimate of return on assets employed shows that energy related businesses have provided decent returns to the shareholders. Whereas, other businesses have not.
Bad business
As of March 2012, an amount of Rs. 31,000 crores was invested in these unrelated businesses (as much as about 11% of total capital employed in the company) but gave the shareholders zilch. They are yet to take off.
Excess cash
A large portion of that unallocated amount of Rs. 94,000 crores is actually cash, an excess cash. This cash can be used for repayment of debt, paying dividends or buying back stock. Alternatively, the cash can be used for reinvestment in and expansion of the current related energy businesses.
The company has chosen to keep the cash available for future investments. A small amount has been used for buying back stock.
Bad investments
While a good portion of this cash is planned to be invested in the energy businesses (See this for instance), the worrying factor is that a large portion is planned for investment in unrelated (bad) businesses as well. For instance, a whopping $9 billion (more than Rs. 45,000 crores) in telecom. There is significant investment in retail too. If these investments generate below-average returns over the next decade (no surprises if they do), the opportunity cost to the shareholders, including the controlling shareholders, would be massive. For instance, at 15% returns, Rs. 1,000 crores would earn about Rs. 3,000 crores in 10 years. Try translating this on the investment of the size that the company has envisaged in bad businesses. The difference when compared to the actual returns earned on these investments is the opportunity cost for the shareholders.
Profit margins in retail are very bad; unless you can turn over inventories at a very high rate, you are sure to earn worse-to-bad returns. Let's not talk about telecom / broadband business which is a technology-driven business.
Taking a leaf out of Exxon Mobil
Why can't the company which has a good operating business already stick to its roots? Taking a leaf out of Exxon Mobil would not be bad. Exxon has 3 segments: Upstream, Downstream and Chemicals, all in energy business. Return on capital employed is 26% (Upstream), 19% (Downstream) and 22% (Chemicals). Average for the company is 24%. On about $171 b capital, the return is about $41 b as of December 2011. Current market value of Exxon: about $410 b.
In contrast, Reliance Industries market value is just over $50 b.
Potential in energy business
There is immense potential for the company to grow within its current operating business, viz. energy. India needs energy; the world needs energy. Would it not be good for a Rs. 5,000-plus crore a quarter cash-generating company to get into profitable operations (based on price-value propositions) rather than getting into growth just for the sake of growth?
Imagine the amount of competition in retail and telecom; it's a little optimistic to think that the company, even with its muscle power, will be able to pierce into the competition and make its mark, meaning earn above-average profits.
There is no point providing capital to a business if it is not able to earn more than its cost of capital. That is corporate finance and maximization of shareholder value.
It would have been better for the company to pay heed to the fact that obvious prospects for physical growth in a business do not necessarily translate into obvious profits for investors.
The current year results reflect the following (stand alone numbers 9-month ended 31-Dec-2012):
These stand alone numbers are not strictly comparable to the consolidated numbers mentioned above. Nevertheless, it appears that return on capital is getting affected.
There is no mention of total capital employed so far in retail and telecom operations.
We hope that these businesses yield above-average profits in the years to come. Hope that is. We sincerely hope that this company goes a long way further in the global arena.
Let's have a look at what it does with its cash.
Current core operations
The company currently operates in 3 prominent segments: Petrochemicals, Refining and Oil & gas.
The petrochemicals segment includes production and marketing operations of petrochemical products namely, High and Low density Polyethylene, Polypropylene, Polyvinyl Chloride, Poly Butadiene Rubber, Polyester Yarn, Polyester Fibre, Purified Terephthalic Acid, Paraxylene, Ethylene Glycol, Olefins, Aromatics, Linear Alkyl Benzene, Butadiene, Acrylonitrile, Caustic Soda and Polyethylene Terephthalate.
The refining segment includes production and marketing operations of the petroleum products.
The oil and gas segment includes exploration, development and production of crude oil and natural gas.
These operations are good as these are related businesses. There is synergy in these combinations. These businesses are profitable as we can see from below (consolidated as of 31 March 2012).
Future operations
Then there is another segment which includes - Textiles, Retail, SEZ development and Telecom / Broadband; and more: hotel and TV broadcasting businesses; and more: financial services(?).
The returns
A rough estimate of return on assets employed shows that energy related businesses have provided decent returns to the shareholders. Whereas, other businesses have not.
Bad business
As of March 2012, an amount of Rs. 31,000 crores was invested in these unrelated businesses (as much as about 11% of total capital employed in the company) but gave the shareholders zilch. They are yet to take off.
Excess cash
A large portion of that unallocated amount of Rs. 94,000 crores is actually cash, an excess cash. This cash can be used for repayment of debt, paying dividends or buying back stock. Alternatively, the cash can be used for reinvestment in and expansion of the current related energy businesses.
The company has chosen to keep the cash available for future investments. A small amount has been used for buying back stock.
Bad investments
While a good portion of this cash is planned to be invested in the energy businesses (See this for instance), the worrying factor is that a large portion is planned for investment in unrelated (bad) businesses as well. For instance, a whopping $9 billion (more than Rs. 45,000 crores) in telecom. There is significant investment in retail too. If these investments generate below-average returns over the next decade (no surprises if they do), the opportunity cost to the shareholders, including the controlling shareholders, would be massive. For instance, at 15% returns, Rs. 1,000 crores would earn about Rs. 3,000 crores in 10 years. Try translating this on the investment of the size that the company has envisaged in bad businesses. The difference when compared to the actual returns earned on these investments is the opportunity cost for the shareholders.
Profit margins in retail are very bad; unless you can turn over inventories at a very high rate, you are sure to earn worse-to-bad returns. Let's not talk about telecom / broadband business which is a technology-driven business.
Taking a leaf out of Exxon Mobil
Why can't the company which has a good operating business already stick to its roots? Taking a leaf out of Exxon Mobil would not be bad. Exxon has 3 segments: Upstream, Downstream and Chemicals, all in energy business. Return on capital employed is 26% (Upstream), 19% (Downstream) and 22% (Chemicals). Average for the company is 24%. On about $171 b capital, the return is about $41 b as of December 2011. Current market value of Exxon: about $410 b.
In contrast, Reliance Industries market value is just over $50 b.
Potential in energy business
There is immense potential for the company to grow within its current operating business, viz. energy. India needs energy; the world needs energy. Would it not be good for a Rs. 5,000-plus crore a quarter cash-generating company to get into profitable operations (based on price-value propositions) rather than getting into growth just for the sake of growth?
Imagine the amount of competition in retail and telecom; it's a little optimistic to think that the company, even with its muscle power, will be able to pierce into the competition and make its mark, meaning earn above-average profits.
There is no point providing capital to a business if it is not able to earn more than its cost of capital. That is corporate finance and maximization of shareholder value.
It would have been better for the company to pay heed to the fact that obvious prospects for physical growth in a business do not necessarily translate into obvious profits for investors.
The current year results reflect the following (stand alone numbers 9-month ended 31-Dec-2012):
These stand alone numbers are not strictly comparable to the consolidated numbers mentioned above. Nevertheless, it appears that return on capital is getting affected.
There is no mention of total capital employed so far in retail and telecom operations.
We hope that these businesses yield above-average profits in the years to come. Hope that is. We sincerely hope that this company goes a long way further in the global arena.
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