Model Portfolio Stock #2: RELIANCE Industries CMP 1092. Dated: July 18, 2018
Reliance Industries, is one of the most complicated stocks to write about as finding simple words to explain a large business indeed a difficult task. Complication is because of the diversified nature of the business. It is a vertically integrated company in energy with presence across petrochemicals, refining, textiles, exploration, oil marketing. I would give more importance to refining and petrochemicals as they constitute about 80-85% of current EBITDA. It now has sizeable presence in organised consumer retail, telecom and is moving towards creating scale in education, ecommerce, healthcare and the big wholesale cash and carry market of Indian retail. In this entire write up, I am only trying to explore which is lesser explored and spend less time on what is widely covered.
What is the Street Opinion?
Average Target Price by Reuters Poll: Rs 1113
But this is as of now and targets keep getting updated after every quarter, every year due to time rollovers also. So, remember, these targets are as of now. This implies, currently street believes, stock is near to fair valuation. So, let’s check if key metrics support this view.FY21 Net Profit is estimated at Rs 55000 cr, which is an improvement of only Rs 12000 cr from FY19 estimates. Consensus is expecting average profit growth of 14% over FY19-21 period. That itself is a sign that street is not pricing in any major surprise in growth from telecom or retail. The PE multiple still remains at the lower end.
My own view is that stock is moving towards 2000 levels over FY21-22 period. This would be more than doubling from current price. But as per regulations, I would like you to do your own discussion with your financial adviser and don’t consider this post as a recommendation or endorsement.
Before you start reading the article and different business segments, You need to understand how I am looking at the business. In my view, RIL is building consumer business from ecosystem perspective. When you build an ecosystem around a subscriber, you also create a moat for yourself. So, businesses like retail, telecom, ecommerce, home appliances, payment solutions, financial services, education, healthcare and many more will form a part of integrated ecosystem which will continuously help RIL to increase its wallet share of consumer spend from its subscriber. So, the moat is not coming from core business but from number of services you are offering to same person. Remember this. Now, let’s talk about the different moving parts.
#1 Jio – Telecom Business
My own understanding is that street is having a misplaced notion on expectation of increase in tariff plans. I think they are not going to increase at all. Basically, when Mr. Ambani announced a target ARPU per subscriber of Rs 400-500, he never meant Wireless ARPU. To me, he said, they will like to have about 45% EBITDA margins and revenue market share of 40-50% and average revenue per subscriber of Rs 400-500. For achieving this, they will need to launch multiple services which cumulatively will bring the revenue per subscriber to higher levels. Pure vanilla wireless ARPU will always be low. So, if anybody has his expectation based on uplift in tariff plans, I am very sure, they are going to get highly disappointed over next 2 years. RIL’s plan seems to be subscriber acquisition from top pyramid to middle pyramid and to lower middle pyramid and then launch multiple services across this pyramid to grab the largest revenue spend of the subscribers across different services.
On Pure wireless business, I expect Jio subscribers to hit 37-40 cr and revenue market share to hit 45-50% over the next 18 months. These will include both mobile users and JioFi which is at present dominating the dongle market. You might say that I am being too aggressive in my estimates. Just go on reading this article and you will understand that I am bullish on the ecosystem and not on wireless alone. Just from wireless, at average ARPU of Rs 100 or Rs 1200 per annum, Jio revenue will reach Rs 43000-48000 cr. Yes, I don’t expect tariffs to move higher. Also, higher JioPhone customers will keep the blended ARPU lower. Remember, ecosystem will drive subscribers to wireless. Let’s go to next piece of ecosystem.
#2 Broadband Business
This is the next big opportunity. RIL’s target is 5 cr customers. This is tougher business than launching wireless. Launching fibre needs multiple approvals from different authorities. But we will make a mistake if we just look at a market size of only 30 cr households in India. What about more than 10 lakh schools, more than 4000 hospitals, merchants, more than 4 cr SMEs in India? For the purpose of integrating merchants, SMEs with ecommerce and RIL ecosystem, RIL is aiming to integrate them with Gigafiber, Jio payment instruments. On the other side, RIL has invested in start-up which is working on AI driven digital education. RIL has created large cloud server driven storage capacity which will be offered to schools and hospitals for digital education and remote healthcare services. For this reason, RIL will aim big to penetrate this potential large market. RIL is already in talks with thousands of schools for providing cloud, broadband and digital education services.
Overall, revenue opportunity for 5 cr customers would be about 30000 cr on an ARPU of Rs 500. Again it would be a mistake to think that RIL would not be aggressive on pricing or data limits. Remember again, it wants to capture market share for its ecosystem. You would be missing one key point, broadband will come with router, set top box which will imply, TV services are coming free with broadband. Now, any tariff higher than Rs 500 per month will only provide upside to the overall earning potential. If in addition to Rs 500, it is additional Rs 100 for TV services also, then it can provide upside of about Rs 6000 cr annual revenue to broadband business revenue potential.
#3 Network Membership or Prime Group Revenue
I believe Jio could also plan its prime strategy like — By signing up for Jio Prime offer, you can get “cash” in your Jio Ecommerce wallet which you can use for shopping online. Jio Prime customers will get exclusive coupons across Jio network including retail, telecom. Of course, Jio Prime customers will be able to watch all Jio apps including music, cinema, news, entertainment for free.
In US, more than 50% of Amazon customers are now Prime customers. If I add up potential 35-40 cr Jio customers and Retail’s own unique customers then potential for Jio Prime is more than 10 cr customers. This could also imply potential incremental earnings opportunity of Rs 5000-10000 cr per annum. Also, remember, such niche earnings stream can only be generated when you have ecosystem under control. So, throughout this article, you will realize my focus is on ecosystem.
This is something which is hard to understand and really not talked about in the market. Take a step back and think, if RIL has 5 cr subscribers on broadband, they will also have access to the television sets, many mobile subscribers. Consumers will increasingly spend more time on interactive screens, content from mobile and desktop, OTT. Correspondingly, brands will increase their digital spend. US has seen internet advertising grow to more than $100bn last year. Thats US. Indian Digital spend is forecasted at Rs 12000 cr this year and total media spend is forecasted at Rs 60000 cr by IAMAI (Internet and Mobile association of India). With large adoption of 4G and Broadband, we are getting set for a big disruption in digital advertising spend patterns. I am not estimating any spend for RIL but I am expecting advertisement revenue to be the biggest trump card for RIL.
#5 Retail Business
I am not a great fan of how RIL is conducting its retail business. Yes, they have established large retail network but the way DMart is conducting its business with utmost discipline and focus, Reliance Retail is not there at present. Their focus on perishable products and expensive locations is not positioning them the way DMart is positioned. But still, store and distribution reach expansion will continuously add margins and economies of scale to the business.
I see Jio ecosystem strengthening by integration of ecommerce and offline retail business. I see three big triggers for retail – Launch of ecommerce business and massive expansion of wholesale business; new approach to serve all kirana or mom and pop stores through cash and carry and technological platform; Introduction of digital coupons or tokens which will enable further selling within the ecosystem. For simplicity of understanding, if you are a Jio Sim user, you will get Jio token which you can take and go to nearby store for encashing as a discount on FMCG products. That store owner will be a Jio network store which will have Jio technology platform which can read this Jio token. That store will also have merchant tie up with Reliance Retail for stocking. By partnering with brands from FMCG to electronics to furniture to other brands; Jio can give discount coupons for usage on its retail network which can in turn increase volumes back to the retail network.
This will be easy to do, so you imagine the scale when this is done on pan India basis and what an ecosystem moat this is going to create. Now, link this to ecommerce with similar effect. The only thing RIL has to demonstrate is how they will beat heavy discounts which are offered by DMart in offline or Flipkart and Amazon in ecommerce. Only then, they will be able to attain the invincible moat.
I am also enthused with the prospects of RIL supplying to all wholesale stores, engaging with them on working capital financing on technology platform, helping them on inventory management, giving them a pan India network for selling, cross selling to other stores. Even if RIL is able to supply 5-10% of requirement of Indian kirana stores, they would be adding more than Rs 2 lakh cr to their revenue. RIL’s retail business has multiple levers of growth. From wholesale to textiles to electronics to ecommerce to retail store to fuel retailing. I see retail business growing to Rs 2.5-3 lakh cr annual revenue by FY21 and 5 lakh cr annual revenue by FY23. This could imply 8-9000 cr annual profits by FY21 and Rs 15-20000 cr by FY23 in Retail business. So, those who are not understanding significance of Retail business, At Rs 9000 cr annual profit, Reliance Retail could get valuation of Rs 2-3 lakh cr. Numbers can vary but I am giving you the material significance of this business and what it could change for RIL stock
I also want to answer most common asked question to me on retail. People often talk about that retail has low margins. But the fact is that this business has therefore high entry of barriers. Once you attain a scale, you then become the defacto cost leader and new entrants will find it difficult to operate at top 2 players cost curve and discount offering. That’s why, you have walmart and amazon in US, Tesco and Carrefour in Europe and UK, Alibaba in China. You dont hear many names in any region of the world. I believe, Only 2 players will succeed in both telecom and ecommerce in India. So, for example, if you have a scale of Rs 5 lakh cr turnover in retail business then your scale becomes mammoth. Even a 4% net profit margin business will imply 20000 cr retail earnings. It will be a repeat business and cash generating business. Once you are in commanding position then you just go on generating cash every year. Remember this, even a low margin business if it is cash generating, its ROCE will be more than 13-14%, that’s a solid business and stock price mover business too. Contrary to perceptions, I believe Only two will whip the cream and rest will go on serving the niche markets.
# 6 Fintech Business: Jio Payment Bank
Before you read this section, remember Ant Financial journey. Those who don’t know Ant Financial, its arm of Alibaba in China. Ant Financial is now worth more than $100bn. Last financial year, Ant financial saw consumer transactions of more than Rs 603 lakh cr, Assets under management of more than Rs 15.8 lakh cr. The question is why I am saying all of this, Jio Payment bank journey is intended to be similar to Ant Financial. Because it is moving towards same aim and same journey, it will get similar ecosystem gains. I know you would be saying, how can we believe that Jio Payment Bank and Jio Pay will be able to achieve what Alipay and Ant Financial achieved. Alibaba is the dominant business ecommerce platform in China. Let’s keep those doubts alive but assess the potential of this opportunity for RIL. Stock will trend up only when it starts seeing first insights into development. Ant Financial for an example, scaled to more than 52 cr active users on payment platform, more than 33 cr users on wealth management platform, 10 users on micro financing platform, 40 cr users on insurance distribution platform, 26 cr users on credit check platform. The only thing you should decipher from this data is that once RIL is able to put 35-45 cr users combined from Retail and Jio in its ecosystem, they can cross sell number of services to every subscriber and can earn far higher revenue per subscriber than their peers.
Now, let’s talk in detail. First of all, remove payment bank term from your head because then you will just think about recharge and some small payments. Jio’s game will increase to a large level. From wealth management, stock trading, micro financing, SME loans, insurance distribution, merchant payments, peer to peer payments, Jio will be entering all of them. Thereby, it will become a one stop payment platform for the entire ecosystem. Out of all, let me give you one flavour to give you sale of the idea. Jio wants to grab a major pie of Indian SME ecosystem. Now, to bring them into Jio ecosystem, they have to offer Jio ecommerce platform, Jio money instruments to merchants, Jio coupons, Jio SIMs or Gigafiber and JioPayment systems. The SMEs might be given working capital financial arrangements, expansion financial facilities.
Now, we don’t know yet about the success because let’s be honest, PayTm became successful because of its ease of use and now, network advantage. Jio will have ecosystem to its advantage but from there, it has to provide very easy seamless platform. Jio payment ecosystem can be a big factor for Jio ecommerce and also huge advantage from merchant transactions and financing needs. This financing and money management business can increase to a mammoth scale which is not talked at all at present for RIL valuations. Remember, Jio will have huge transaction behaviour on its lakhs of merchants and subscribers across the ecosystem and that will further help in selling financial products like savings, insurance, mutual funds, stocks and other investments. Major income will come from money market funds, financing operations. Merchants for the grabs would be 6-7 cr, Subscribers would be 35-40 cr. Imagine when the ecosystem money comes into short term money, wealth management, financing interest income, insurance options; this has the potential to generate more than $100bn in AUM. So, big story is not recharges or payments but financing and AUM story which can unfold over the time. It has the potential to become first $10bn fintech company. That again will be power of ecosystem. So, watch out ecommerce story, its success will lead to massive financial story unfolding in front of you.
# 7 Other services: Gaming, Virtual Realty, Entertainment, Media, Movies Production and others
50% of the India’s population is under 25 and about 65% of population is under 35 years of age. Smartphones or feature phones is a choice of affordability but 4G, internet is almost going to be there with everybody. It is just a matter of time. One of the studies estimates 50 cr smartphones and 65 cr internet users in India by 2020. I am not calculating any revenue from these services but these have the potential to gain material scale in the future. Also, remember, these all will again be a part of the same ecosystem and add to the overall moat. I see them important more from the perspective of moat enablers.
# 8 Refining and Petrochemicals
Currently, the most important business and the bread and butter business of RIL is refining and petrochemical. It is a cash generating business and is widely covered. So, I won’t go in detail for this section. Street estimates for Refining and Petrochemical division profits project Rs 35-40000 cr profit by FY21. This also implies that this division will become an annuity business. I am not worried about the cyclicality because it has very strong integration between refining and petrochemicals and last 4 year historical capex has made refining business very cost competitive. Also, IMO regulations which will mandate usage of low sulphur oil will increase diesel cracks and GRMs during FY21. But remember, its a cyclical industry and price competitive, so over few quarters period, things balance out and we can safely say that overall, refining and petrochemical will continue to be a solid cash generating unit.
Finally, in the end, I know you will still be thinking about some division being covered with less depth but I will keep on updating the blog and I have tried to present something new rather than already covered topics in the market.
# 9 Oil Exploration
Another division which could see material improvement in earnings once more gas starts coming out of RIL’s fields from FY20. I am not going much into detail since it is well covered in the market. In my own view, this is an area, where RIL has disappointed the investors in terms of negative returns on invested capital.
Overall, In my view and without any attempt to go into finding target price for the stock, Reliance Industries total profit is likely to cross Rs 1 Lakh cr over the next 3-5 years. This includes refining, petrochemicals, telecom, retail and reasonable contribution from exploration, and fintech businesses. That could help the stock to achieve a market cap of Rs 15 lakh cr at PE multiple of 15x. This is higher than current PE multiple because market would increase the multiple if RIL delivers strong double earnings growth over next 2 years. This could translate to stock price of more than Rs 2000-2100 vs current price of Rs 1092. Please feel free to draw your conclusions on the numbers but my attempt is to draw a canvass on which you can draw your own painting of portfolio.
Finally, as always, I would love to talk about technical. I see a strong continuing breakout on long term charts. Volumes are shooting up, suggestive of higher accumulation. Stock now will see strong support in 900-950 area. Bulls are in complete command at present in this stock.
Disclaimer: Please consult your financial adviser before taking any financial decision. All posts are neither recommendation nor endorsement. Model portfolios are for analysis and based on facts and forecasts. Those forecasts are subjected to my discretionary views and analysis.