As RIL announces big capex plans, analysts fear dent in return ratios

Speaking at the AGM, Mukesh Ambani announced plans to invest Rs 2 trillion in set-up a nationwide fifth generation (5G) mobile network by the end of next year

Reliance Industries (RIL) announced the next big phase of growth and expansion plans at its 45th annual general meeting (AGM) on Monday. The planned new investment in its telecommunications, oil-to-chemicals (O2C), and green energy business will consolidate RIL’s market dominance and industry, but the company’s mega investment plan has raised fears of further decline in its already low return on networth (RoNW) and return on capital employed (RoCE). This, in turn, will weigh on RIL share price and market capitalisation.

The company reported RoNW or return on equity of 9.17 per cent on a consolidated basis in 2021-22 (FY22), up from 8.42 per cent in 2020-21, but down from 12 per cent in 2016-17 (FY17).

In the past 15 years, RIL’s RoNW has been 12.5 per cent on average. Similarly, the company’s RoCE improved to 9.36 per cent in the last financial year on a consolidated basis, from 7.8 per cent a year ago, but remained below the 15-year average ratio of 10.9 per cent.

The improvement in RIL profitability ratios in FY22 was largely due to relatively faster growth in its earnings, compared to its balance sheet. The company’s consolidated net profit grew 23.6 per cent year-on-year (YoY) to Rs 60,705 crore in FY22, from Rs 49,128 crore a year ago.

By comparison, its consolidated networth or shareholder equity was up 11.3 per cent YoY to Rs 7.8 trillion, while its capital employed was up 11.7 per cent YoY to Rs 11.13 trillion at the end of FY22, from Rs 9.97 trillion a year ago.

Historically, the company’s balance sheet continues to grow at a faster pace than its earnings. RIL’s networth on a consolidated basis has trebled in five years, from Rs 2.63 trillion at the end of FY17 to Rs 7.8 trillion at the end of March this year.

Likewise, its capital employed is up 126.4 per cent cumulatively during the period, from Rs 4.92 trillion to Rs 11.13 trillion at the end of 2022-23. In contrast, RIL’s annual consolidated net profit doubled during the period, from Rs 29,091 crore in FY17 to Rs 60,705 crore in FY22.

Many analysts fear a reversal in this trend as the company makes fresh investments in its existing businesses and makes aggressive pushes into new sources of energy, such as solar power and hydrogen.

“Over the next two/three years, this could create the next engine of growth with large technological advancement and ambitious growth targets. But it could dent the existing single-digit return ratios in the near term,” write analysts at Motilal Oswal Financial Services.

Speaking at the AGM, Ambani announced plans to invest Rs 2 trillion in setting up a nationwide fifth-generation (5G) mobile network by the end of next year. He announced plans to expand the company’s O2C business at an investment of Rs 75,000 crore. He also announced foray into the fast-moving consumer goods segment and commencement of solar photovoltaic cell manufacturing.  

All these expansions and diversifications are expected to result in rapid growth in RIL’s capital employed and balance sheet over the next few years. Given this, a slowdown in the company’s earnings growth either due to domestic or global factors will dent its profit and return ratios.

“A slowdown in global demand or larger-than-expected capacity additions could impact RIL’s refining and chemical margins,” wrote Jal Irani and Iqbal Khan of Edelweiss Securities in their recent report on the company.

They expect RIL to face headwinds from a global rise in the cost of capital as central banks raise interest rates to tame inflation.

“Deleveraging to zero debt has swung the needle to the other extreme, raising RIL’s weighted average cost of capital (WACC) to match the cost of equity. The sharp rise in WACC precipitates a negative economic spread for RIL, even after we assume robust earnings growth,” they wrote.

The analysts worry about the future trajectory of RIL’s return ratio, stating it could partly explain its poor showing on the bourses since the day of its AGM.

RIL stock price is down 2.2 per cent from its Friday close, against 0.1 per cent decline in the benchmark BSE Sensex during the period.

The company held its AGM on Monday. The stock was the biggest loser among Sensex stocks on Thursday and was down 3 per cent during the day.