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O2C leads to earnings miss; fin-serv demerger first step towards monetization

RIL’s Q2FY23 earnings missed our estimates by 5%, underlined by weak O2C (7% EBITDA miss) due to softer demand, volatile margins along with windfall taxes. Upstream business did well with a 14% beat on lower opex. Retail and Jio EBITDA were broadly in line while other segments missed. Jio’s net subs addition was 7.7mn (vs. 9mn est.) QoQ and ARPU rose 1% to Rs177.2 (a miss, of 2%). Opex was however lower. Consol. net debt rose from Rs577bn to Rs933bn due to higher working capital, forex impact and first spectrum instalment (~Rs80bn). Capex in Q2 was Rs325bn, with an additional capex of Rs881bn on new 5G spectrum. We reduce our FY23/24/25E PAT by 10%/4%/3%, as we build-in lower O2C margins, partially offset by better upstream and Retail. Consequently, we cut our Sep-23E SOTP-based TP by 1% to Rs2,710. RIL announced the demerger and listing of its Financial Services business, thereby setting the stage for monetization of its verticals which we view as a positive trigger, unlocking value. We maintain BUY on the stock.

Results summary: D/A rose 9% QoQ, on higher gas output and Jio, while finance costs rose 14% on higher net debt and interest rate. Other income was a 46% beat. O2C sales volumes fell 4% YoY/QoQ to 16.2mmt, while EBITDA/mt was lower by 12% YoY/38% QoQ. Jio’s net subs addition of 7mn could have come from wireless and the remainder from broadband. ARPU miss could be due to seasonality and weak growth. Access/License-SUC charges declined 27%/8% QoQ (31%/13% below our est). Employee cost was up 16% QoQ. Retail revenue at Rs577bn saw a 3-year CAGR of ~16% in Q2 (vs. 20-24% by DMART/TTAN). The slower growth may be due to connectivity business, as EBITDA grew faster than expected, at ~23% CAGR over 3 years. Grocery was driven by sharp pricing-promotion, catalogue expansion and festivities; Electronics (CE) by exclusive launches, event-based activations and own-brand expansions; and fashion (F&L) by wardrobe refresh, new styles, etc. Gross store additions remained healthy at 795 in Q2 (total: 16,617). What we liked: Steady consumer business performance and better-than-expected upstream. What we did not like: Weak O2C, high capex and increase in net debt.

Management guidance: O2C earnings were impacted by volatile margins, subdued petchem demand (in China, India) and windfall taxes (Rs40.4bn impact). Polymer margins were weak (down 12-26% QoQ) amid volatile feedstock prices, while RIL witnessed saw higher OSPs and freight & insurance costs. The SEZ unit saw planned maintenance in Sep-22. There was no LNG intake, albeit due to strong gasifier performance. Co. expects middle distillate cracks to be steady and polymer deltas to recover. MJ is on track for year-end start. AOGO has told Parikh panel that new gas investments need pricing-marketing freedom. Recommendations to take few weeks. In Jio, 5G rollout would improve subs and per-capita metrics. It is a pure SA architecture, unlike peers. RIL has plans for a complete rollout by Dec-23. Retail saw strong consumer sentiments. Grocery-pharma doubled, CE and F&L was up 40%, while diginew commerce rose 60% YoY (18% rev. share). H1 capex was funded by cash profits.

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