From Reliance Jio to Reliance Holding USA, here is what dragged Reliance Industries down
RIL’s FY17 annual report analysis highlights an improvement in adjusted operating cash flows post interest to Rs 370 bn (FY16: Rs 293 bn). This was largely on the back of increased payables of Rs 309 bn, of which 50%+ are non-trade. High capex (>Rs 1 trn, of which 60% pertains to Jio) led to FCF post interest (adjusted) remaining negative at Rs 396 bn. With Rs 3.2 trn of assets under development (CWIP+ITUD), RoCE remained subdued at 7.5%. Operating performance was muted. Consolidated PAT grew just 1% to Rs 299 bn due to aggregate losses at subsidiaries, despite capitalising project development expenses and non-amortisation of assets at Jio. Adjusted debt increased to Rs 2,693 bn (FY16: Rs 2,334 billion), with Rs 155 bn of interest and forex (7.4% borrowing cost) being capitalised and Rs 38 bn (2% borrowing cost) being expensed. Cash and investments declined to Rs 787 bn; yield of 10.3% on these led to positive carry in the income statement. Expenses paid to related parties remain high at Rs 84 bn, 22% of opex.
Subsidiaries drag overall performance: GRMs were at an 8-year high of Rs 11/bbl (Singapore complex: Rs 5.8/bbl), resulting in an increase in standalone PAT to Rs 314 bn (FY16: Rs 274 bn). However, subsidiaries dragged performance, with an aggregate loss of Rs 86 bn. Reliance Holding USA reported a loss of Rs 61 bn, while Jio generated a loss of Rs 0.3 bn. Rs 325 bn to be expenses once Jio stops capitalising expenses: Reliance Industries’ telecom venture, Jio, commenced commercial operations from Sept 5, 2016. It currently capitalises project development costs (FY17: Rs 217 bn). The capitalised costs and depreciation of assets used for Jio will be expensed when the management believes the assets are available for use in the manner intended by it. When this happens, we believe Jio will incur annual expenses of at least Rs 325 bn. Of these, Rs 110 bn will be depreciation, and the balance will be recurring expenses (which may increase depending on the level of operation and the period for which it is considered as operational).
FCF remains negative, supported by non-trade payables: FCF post interest (adj.) declined to negative Rs 396 bn on higher cash capex at Rs 766 bn (FY16: Rs 466 bn). We note that FCF in FY17 was significantly supported by increase in trade and other payables of Rs 309 bn (FY16: Rs 80 bn). Of this increase, Rs 171 bn pertains to other payables, which include security deposits, creditors for capex and financial liability for fair value.
Ind-AS transition leads to Rs 98 bn decline in net worth: This is primarily on account of a decline in value of assets recognised for (i) change in accounting for oil and gas activity: Rs 376 bn, (ii) CWIP and ITUD of Jio: Rs 120 bn, and (iii) FV of proved developed reserves of shale gas: Rs 58 bn. However, this was partially offset by upward revaluation of land by Rs 511 bn.
Standalone performance was impressive; subsidiaries a drag
RIL’s FY17 GRM was at an eight-year high of Rs 11/bbl (v/s Singapore complex GRM of $5.8/bbl). Standalone operations — a steady business and a major contributor to revenue and profitability — grew 4% to Rs 2420 bn. Ebitda margin expanded to 17.9% (FY16: 16.9%) on the back of higher gross margin. However, subsidiaries dragged overall performance, with an aggregate loss of Rs 86 bn. Reliance Holding USA posted a loss of Rs 60 bn and Jio along with its subsidiaries reported a loss of Rs 1 bn. For the first time in four years, consolidated profits are lower than standalone profits. At the consolidated level, lower other income resulted in just 1% PAT growth in FY17, despite revenue growth of 11%.
Rs 325 bn of expenses to be recognised once Jio stops capitalisation
The total expenditure towards the digital services project capitalised till FY17 stood at Rs 1,780 bn. This comprises of CWIP of Rs 1,124 bn and ITUD of Rs 656 bn. Jio’s accounting policy highlights that depreciation/amortisation will commence when the assets are available for use in the manner as intended by the management, i.e. when all the Quality of Service parameters set by the management are met. Our calculations suggest that once Jio stops the capitalisation of expenses, its annual expenses will increase by at least Rs 325 bn (which may increase depending on the level of operation and the period for which it is considered operational). This will comprise of (i) Rs 217 bn of expenses currently being capitalised, (ii) amortisation cost of ITUD of Rs 33 bn, and (iii) depreciation of assets in CWIP of Rs 75 bn (assuming a life of 15 years).
Cash earnings supported by high payables
Earnings to cash flow conversion improved to 129% for FY17 due to improvement in cash conversion cycle to -24 days (FY16: -13 days). The improvement in cash conversion was primarily on account of higher payable days and lower inventory days. CFO increased significantly to Rs 496 bn (FY16: Rs 381 bn). However, we note that the operating cash flows are primarily driven by increase in payables. Trade payables increased by Rs 163 bn to Rs 766 bn; other payables increased by Rs 171 bn to Rs 882 bn. The other payables include security deposits, creditors for capex, and financial liability at fair value. FCF post interest declined significantly to – Rs 396 bn owing to higher interest cost and capex.
Strong earnings pie used for capex Over the last five years, CFO have contributed 58% of funds, and borrowings have contributed 24%. Of this, 78% was expended for capex and 4% for investments generating a yield of 10.3%.For the third consecutive year, capex stood at over Rs 1 trn, mainly comprising of telecom operations. Cumulatively, over the past five years, RIL has spent Rs 4.3 trn for capex.