The curious case of Reliance Industries Ltd’s gravity defying stock price – Or, how you should learn to stop worrying about gas prices and buy RIL stock now: Vineeth Sukrithan
This is a guest post by VINEETH SUKRITHAN
The stark contrast between RIL’s latest march quarter performance and the almost- three-year highs that its stock price is perched on top, merits a deeper analysis. On April 18th, 2014, RIL released its quarterly data showing disappointing results that were entirely in line with industry expectations. Petrochemical business revenues fell 3.7%, while oil and gas turnover dropped 18.2% q-o-q. Net profit growth in its January-March quarter (Q4FY14) was at Rs 5,631 crore – only 0.7 per cent higher than Rs 5,589 crore it earned a year ago. The petrochemicals business’s Ebit was lower than in the December quarter and the company’s outstanding debt over shot its cash and equivalents. (Rs 89,968 crore against cash, and equivalents of Rs 88,190 crore.)
Yet, for a company that has always been known to be reticent about taking on high levels of debt, RIL has gone on what can only be called a remarkable splurge in capital expenditure. Its capital expenditure during the year was the highest ever. The company reported net addition to fixed assets of Rs 35,210 crore in FY14. In FY09, when the company commissioned its second refinery and K-G basin gas production, its capex was only Rs 24,907 crore. So, on all accounts, RIL’s actions and stock price seem counter to the predicaments of its current financial health, which begs the question, where does Reliance derive this level of confidence in its future profitability to be willing to take on tremendous amounts of debt?
On April 20th, quite remarkably, RIL stock price closed at Rs 958, a level not seen since 3rd May 2011. In fact, as Pallavi Pengonda reports in Live Mint, RIL stock has run up sharply in recent months; it has gained about one-fifth from its lows in 2014 so far, compared with a 7% gain in the Sensex. The mystery of Reliance’s burgeoning stock prices can be traced back to an extraordinary rally encompassing two days in March, specifically, March 7th and March 8th 2014, when its stock price surged 7.4 % in two day’s trading (Rs 825 to Rs 886). Trading volumes were 858,000 on average for those two days as against 225,000 for the previous two days. Usually, such heady trading is reflective of good quarterly earnings or other similar positive news, but quite curiously, no such easy explanation is forthcoming in this instance as no new data was released at that time to justify such a rally.
Except that there was one particularly interesting event that occurred on Apr 6th at 8pm after trading hours. The respected CNN-IBN-Lokniti-CSDS Election Tracker of the Lok Sabha polls was released, showing that the BJP would win 213 seats by itself (with a total of 232 seats going to the NDA). This was the highest ever predicted total for the BJP alone, until that point in time. Thirty one percentage of the 29,000 people polled preferred Mr. Narendra Modi as the next prime minister while just 13% preferred Mr. Rahul Gandhi. The message was crystal clear- Mr. Modi would be the next Prime Minister and there was serious money waiting to be made by investing in one particular company- Reliance Industries Ltd.
The story of RIL’s cat-and-mouse game with the regulatory authorities on the KG-D6 blocks is an epic saga that dates back to the time of the NDA government. In 2000, RIL inked an agreement with the Petroleum Ministry run by Mr. Ram Naik, the terms of which would be deemed as being extraordinary largesse today. RIL was allowed to corner 80% of the profits from its blocks as long as the Investment Multiple (Ratio of Revenue over Expenditure) remained less than 1.5. Once the Investment Multiple increased to more than 2.5, the government would be entitled to 85% of the profits henceforth. These rather strange terms have ensured that it is in Reliance’s best interests to increase capital expenditure while keeping production constrained. Not surprisingly, that is exactly what has transpired. In return for raising production to 80 mmscfd, RIL gained clearance for raising the capital expenditure to $8.8 billion, but quite extraordinarily, production has in fact plummeted.
As Sujay Mehdudia reports in The Hindu, during 2012-13, production stood at 25 mmscmd, leading to a loss of around Rs. 45,000 crore to the exchequer. After resisting calls for a CAG audit into their exploration and production activities, RIL finally gave in and submitted but only after successfully evicting the Petroleum Minister responsible for initiating it, M. Jaipal Reddy. In the subsequent performance audit report, the management committee (MC) of the D1 and D3 fields in the KG-D6 block and the Directorate General of Hydrocarbons have been pulled up by the CAG for ‘not effectively regulating’ RIL’s activities and then continues to state that, “Till March 2012, RIL has incurred expenditure of $5.76 billion on development of D1 and D3, against the MC-approved cost of $5.20 billion for Phase-I,” thus confirming widespread suspicions of over-spending, under-drilling and under-recovery.
As Pallavi Pengonda explains, “According to calculations by JPMorgan a reduction in the expected gas price by $1 per million British thermal unit would cut RIL’s fiscal years 2015 and 2016 earnings per share by 3%. Not only that, it would potentially affect the viability of new deepwater exploration/development, causing a potentially larger impact on long-term production estimates, the brokerage firm points out. Second, the sustainability of refining margins is another factor shareholders should watch out for. There is not much headroom for an improvement from here on and excess capacity addition in the global refining industry may affect refining margins adversely.”
Taken together, a clearer picture emerges. And that is the inevitability of the rise in the price of gas from the current levels once May 16 comes around and the huge windfall this entails for RIL. Mr. Modi has faced accusations of serious conflict of interest from India Against Corruption and others about the doling out of portfolios such as Energy, Finance, Small-scale industries, Petrochemicals, Minerals, Civil Aviation, Surface Transportation and Salt, all to one man – Mr. Saurabh Patel. Due to intense scrutiny, he was forced to submit an affidavit to the Election Commission recently stating that he was indeed a son-in-law of the Ambani family. Mr. Patel is widely tipped to hold the most important portfolios in Mr. Modi’s Union cabinet as well, including Petroleum, come May 16 and any excess capacity that RIL invests in now is sure to bring in handsome profits in the near future.
Ultimately, this state of affairs is reflective of the primal tension that exists at the heart of all liberal democracies. Corporations such as Reliance eke profits from the extraction of natural resources that inherently don’t belong to them. In such a model, the margins depend on the ability to obtain raw materials cheaply and sell them at a premium. Both these aspects require the consent of the citizens of the sovereign state, who are simultaneously both the true owners of the resources as well as the principal buyers. To this end, subverting the strength of democratic institutions becomes important to the calculus of profit generation. Post-liberalization, these tidal forces have grown and multiplied manifold in tandem with the ability of corporations to accumulate vast amounts of capital. This situation has played itself out endlessly in various parts of the world – the monopoly of Mexican Mogul Carlos Slim’s Grupo Carso (the consequence of which is that Mexicans pay the world’s highest mobile tariff rates), the geopolitical muscle of Russia’s Gazprom and the central role played by ‘Big Oil’ in the American conservative political landscape. But since a majority consensus has to be reached among the citizens of a democracy to discharge the will of the people, this mechanism acts as a balance that counters the unlimited corporate influence in the interests of the people.
But manufacturing pro- ‘Big Business’ consensus in a country requires some extra level of subterfuge because the prevailing scheme is one of mass populism. So, massive sums of money are spent to control the media and polarize the narrative because it is infinitely easier to sway opinion in a charged atmosphere of hatred and paranoia than one of enlightened debate. Thus, it becomes entirely unsurprising that the biggest corporate interests in India have thrown their weight behind the candidature of a highly controversial and polarizing figure head like Mr. Modi. The extent to which our democratic institutions and freedoms have been corroded under corporate pressure, is reflected by the state of our News Networks which have degenerated into 24 hour self-perpetuating manufactured rage machines, the glaringly obvious bias of our biggest broadsheet newspaper and the all out witch hunt that Paranjoy Thakurtha’s book ‘Gas Wars’ is facing.
Ultimately, Reliance is a multinational corporation which remains accountable only to its promoters and share holders, and that’s exactly how it ought to be. The prime responsibility of keeping behemoths like RIL honest, lies with the elected representatives of India’s citizenry and that is where we have failed spectacularly. “Follow the money” is an adage that seems to be painfully obvious in its applicability to the political climate of today. And in this case, following the money leads us straight into the gas pits in the murky depths of the Krishna-Godavari basin.
Vineeth Sukrithan, MD, is a Post Doctoral Fellow at Johns Hopkins University (2013-14)