I have argued before that ril's cost of diversion is considerable and hinted that its lure of technology may not be necessary. Well, time will tell about it more precisely.
As of now, it is interesting to see where its current operations have headed. Its 2013 annual report is out and is more telling.
Return on equity and return on capital have come down significantly. For 2013, ROE is just over 12% and after-tax ROC is just over 9%. I have considered effective tax rates rather than marginal tax rate. These returns were considerably higher in the prior years, especially during 2005 to 2010.
Operating margin and net margin too have deteriorated. For 2013, operating margin was 5.49% which until 2009 was in double digits, and for 2010 and 2011 was close to double digits; then it shrank badly in 2012.
Revenue has been increasing at a pretty good rate every year. However, it is quite worrying if operating margin and return on capital are not doing as well.
The reason?
The company has huge investments:
Existing business
Return on these segment assets can be better:
Return on these segment assets can be better:
Growth business
However, it is the other segment that is causing maximum concerns: Rs.323 crores earned on Rs.32,520 crores of investment.
We know that the management is betting huge on its retail and technology businesses and anticipates adequate return on investment. But the question is should these investments have taken place in the first place? Would minority shareholders have approved this?
The company has announced huge capex plans in the coming years. Rs.150,000 crores to be spent on all 5 segments: Petrochemicals, Refining, Oil & Gas exploration, Retail and Technology. The last 2 sound a little out of place within this energy giant though.
The minority shareholders
The minority shareholders have invested in the company to participate in its energy business betting on higher oil and gas prices. They already have taken risks related to the energy business which the company is facing - for instance, falling oil and gas production, not-so-good relationship with the government, cyclical refining and petrochemicals markets. They wouldn't want more (i.e. unrelated) risks. If they have to invest in retail or technology it is more logical that they go to that sector independently.
The minority shareholders have invested in the company to participate in its energy business betting on higher oil and gas prices. They already have taken risks related to the energy business which the company is facing - for instance, falling oil and gas production, not-so-good relationship with the government, cyclical refining and petrochemicals markets. They wouldn't want more (i.e. unrelated) risks. If they have to invest in retail or technology it is more logical that they go to that sector independently.
It is a bit strange to see this company which is pretty good at what it does in its core business to go out of place.
The focus
The management's focus should be to fix this problem:
This can be done by looking into the following:
- Increase oil and gas production on current fields;
- Look for exploration assets both within and outside India at reasonable prices;
- Improve relationship with the government;
- Invest in refining and petrochemicals businesses enough to maintain market share and operating margin;
- Use excess cash to buyback stock if the stock price is far lower than value of the firm;
- Come out of unrelated ventures.
There is no doubt that management has the ability to take this company much higher in its core business itself. India needs energy; the world needs energy, and they are ready to pay for it. The company should just take advantage of this.
