Ril’s Outlook Is Decent But Capex Is A Rising Discomfort

A key sore point has been that the capital expenditure (capex) has increased at a faster-than-expected rate and free cash flow (FCF) was negative. “RIL reported a negative FCF of ₹29,200 crore in FY22, in comparison to FCF generation of ₹7,300 crore in H1FY22. Capex increased to ₹1.2 trillion from ₹1.06 trillion in FY2021,” said Hemang Khanna of Kotak Institutional Equities in a report on 9 May. RIL’s net debt was also high. “Our estimate of effective net debt increased to ₹88,300 crore from ₹59,400 crore at the end of FY21, partly reflecting the increase in deferred spectrum liabilities by ₹18,300 crore,” Khanna said.

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The earnings growth trajectory is strong, especially driven by optimism on RIL’s energy business. Kotak has raised its FY2023E earnings per share (EPS) by 7% and FY2024E EPS by 3% primarily by factoring in higher refining margins, which is partly offset by slower subscriber additions for Jio and other small changes.

In Q4FY22, benchmark Singapore gross refining margin (GRM) averaged at $8 per barrel, up from $6.1 per barrel in Q3FY22. Better refining environment aided the oil-to-chemicals’ (O2C) segment’s sequential Ebitda growth of 5%, partially offset by weak petrochemicals margin.

The petrochemicals margins continue to be subdued, but refining margins are stronger, reflecting a healthy outlook for the O2C business as we enter FY23. “Refining outlook is strong over CY22 on diesel inventories at five-year lows, likelihood of loss of Russian exports, weak Chinese exports, and low European refinery operating rates,” said analysts from Jefferies India in a report on 8 May.

As such, whether the strong refining margin sustains would be key to watch. “The strength could, however, be tempered if China decides to ramp up fuel exports. We have raised FY23E O2C Ebitda 18% to factor in the unprecedented strength in refining but would treat the supernormal profits as one-off,” Jefferies said.

The outlook for RIL’s other segments, retail and telecom, is also on a firm footing. The Omicron wave of coronavirus hurt the retail segment’s operations at the start of Q4, but business picked up momentum later on. Retail Ebitda fell by 3% sequentially. Store additions remain critical. At the end of FY22, the total store count was 15,196. Separately, the telecom segment may see a positive impact of tariff hikes on revenues in FY23.

All said, RIL’s key return ratios have been on a decline. Return on equity or return on capital employed are at sub-10 or low double-digit levels throughout FY19-FY24E, said ICICI Securities analysts in a report on 8 May. “Dividend payout has also remained low despite strong earnings,” the report said. Investors should track execution in the new energy segment, which will be amalgamated into the standalone entity.

Higher crude oil prices augur well for RIL’s foreseeable earnings. “RIL is among few Indian companies benefiting from higher energy prices. We see investors seeking it as a safe haven in today’s context and looking through the elevated capex and marginal miss on earnings,” said Jefferies’ analysts.

RIL shares have gained 30% in the past one year, suggesting that investors are factoring in the optimism adequately. This may keep significant near-term upsides at bay.