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Building the next engine of growth

We delve deep into Reliance Industries (RIL)’s FY22 Annual Report, underscoring the key initiatives and business outlooks for its various segments. The key highlights of our analysis are furnished below:

* RIL’s FY22 belonged to the O2C segment performance that outpaced other segments, even as RJio retained its market share and Retail business saw a steady recovery. The high crude prices led to 56% YoY EBITDA growth in O2C business while Retail grew 28% YoY; RJio growth, however, decelerated to 22% YoY.

* Post-equity raise during the last couple of years, FY22 saw a strong capex with heavy investments, especially in RJio, which included a large-scale spectrum investment. Retail witnessed aggressive footprint additions, while new energy reported aggressive acquisitions.

* The growth momentum and improved margin profile across the sector will drive RIL’s revenue/EBITDA growth of 25%/32% in FY23E, respectively. These, however, do not factor in any incremental growth from 5G capex, new energy and other segments. Over the next two-to-three years, RIL is likely to create the next engine of growth but it could put pressure on its near-term return ratios.

Digital services witnessed tariff-led improvement

* RJio posted healthy revenue/EBITDA growth of 10%/22% YoY, respectively, fueled by 7% ARPU growth in FY22. Subscribers declined by 16m during FY22 while during FY19-21, the company added 80m subscribers annually.

* RJio’s operating cash flow decreased to INR313b in FY22 (from INR326b in FY21), owing to higher working capital. RJio’s capex stood at INR288b, though, capitalized capex was 3x of it. RoE/RoCE/RoIC stayed in single digit, albeit, improved marginally.

* RJio bought spectrum of 488.35MHz for INR571b in Mar’21. Further, it bid for additional 5G spectrum of INR881b in Aug’22 across different bands, which is good enough to launch a full-fledged 5G network.

Reliance Retail benefitting from Covid-19 recovery and store additions

* Reliance Retail clocked a robust growth of 29%/28% YoY in standalone revenue/EBITDA, respectively, propelled by recovery in footfalls as well as footprint additions. Core EBITDA too rose 35% YoY, though merely 6% over pre-Covid levels, as resumption in business included incremental costs.

* Store additions (of 2,485) remained strong and the continued focus on online segment too reaped benefits, with its contribution rising to ~20% on exit basis.

* Subsequently, higher capex increased gross debt to INR408b in FY22 (from INR147b in FY21 and INR47b in FY20). Hence, FCF continued to remain negative at INR87b (v/s negative INR76b in FY21).

O2C segment benefiting from higher crude prices

* RIL restructured its Refining and Petrochemical segments into the O2C segment to attract strategic partnerships.

* Demand improved in FY22 YoY (on a lower base), which led to expanded margins in refined products. Gasoline margin improved sharply to USD11.4/bbl in FY22 (from USD3/bbl in FY21); Gasoil margin increased to USD12.3/bbl in FY22 (from USD5.7/bbl in FY21), while ATF margin spiked to USD9.1/bbl in FY22 (from USD1.2/bbl in FY21).

* Global PP/PE/PVC demand grew 5%/4%/4% YoY, in CY21, while domestic PP/ PE/PVC demand rose 16%/4%/6% YoY, respectively, driven by healthy demand.

* Opening up of the economy and removal of travel restrictions would enable demand to pick-up faster than expected. SG GRM to remain high at an average of ~USD18/bbl in FY23, as demand continues to outweigh supply.

* Management believes that low Chinese exports and peak maintenance season will support product margins going forward. Although, PX, PTA and MEG margins are likely to be rangebound due to capacity overhang, Polyester/ Polymer demand is expected to improve with opening up of the economy and return to normalcy.

Capex and debt

* RIL’s total capex stood at INR970b, primarily for the Digital, Retail, and O2C businesses along with the forex impact, while capitalized capex stood at INR1.5t primarily due to RJio.

* Consolidated net debt surged 2.5x YoY to INR1.4t, while consolidated gross debt was up 26% YoY to INR2.8t.

Valuation and view

* The crude price improvement continues to prop up strong growth momentum in FY23. We expect consolidated revenue and EBITDA to clock 15% CAGR each over FY22-FY24, which do not factor in any incremental growth from 5G capex, new energy and other segments. These could create the next engine of growth over the next two-to-three years as each of retail, telecom and new energy is seeing notable technological advancement with ambitious growth targets. However, this has the potential to dent the existing single-digit return ratios.

* RJio is valued at 19x Mar’24E EV/EBITDA, to arrive at a valuation of INR1,027/share (adjusted for its 66% stake). The higher multiple captures the revenue growth opportunity in Digital, potential tariff hikes, and steady market share gains.

* Retail: We value Reliance Retail’s core business at 41x FY24E EV/EBITDA and assign 5x to Connectivity, to arrive at a valuation of INR1,202/share – after excluding the 10% stake sale. Our premium valuation multiples capture the accelerated growth in new store openings, aggressive acquisition programs to improve product portfolio and its focus on improving the digital segment.

* O2C: We value the Refining and Petrochemical segment at 7.5x FY24E EV/EBITDA for standalone business to arrive at a valuation of INR721/share. RIL believes that a recovery in aviation demand, waning pandemic woes and lower exports from China will support product margins going forward. Although, PX, PTA and MEG margins are likely to be rangebound due to capacity overhang Polyester/Polymer demand is expected to improve. Strong GRMs with better throughput in the coming month would further support the refining segment

* Using SOTP, we value the Refining and Petrochemical segment at an FY24 EV/EBITDA of 7.5x, arriving at a valuation of INR721/share for the standalone business. We ascribe an equity valuation of INR1,027/share to RJio and INR1,202/share to Reliance Retail, factoring in the recent stake sale. Our higher EV/EBITDA multiple of 41x for Retail and 19x for Digital Services, underscore new growth opportunities in the Digital space and steady market share gains. We reiterate our BUY rating on RIL with a TP of INR2,880.

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