In the second week of March 2009, Reliance Industries Ltd (RIL) cancelled a tender offer for naphtha (April 2009-March 2010) as it received very low price bids. In the same week, it also terminated a contract for a drill ship Neptune Explorer that was contracted for use from the April-June quarter for exploring oil and gas on the east cost.
Around this time a year ago, signs of hiccups in the global economy were evident. But few analysts expected Mukesh Ambani’s Reliance Group to be so badly hit. The core operations were visibly affected even then—although RIL’s superior profitability and resilience were expected to hold it in good stead. Yet, it was Ambani’s largescale growth plans that were eliciting ecstatic responses from equity analysts, many of whom were putting out fanciful (at least in hindsight) target prices for the company on the basis of the sum of the group’s parts.
The sum of these many parts— right from exploration and production of oil and gas to special economic zones (SEZs), organised retailing, city gas distribution, and other new forays reported in the media like semiconductors, for one, not to mention reports of a third refinery— was indeed huge. But like most valuations, this number was based on future cash flows. Today, some of those new projects are stuck in the economic slowdown, although the RIL top brass doesn’t see next fiscal’s cash flows being hindered. They are still confident of churning out $8 billion in hard cash in 2009-10—that’s in line with what the RIL top brass had told analysts a year ago.
Opportunity in adversity the slowdown is doing RIL no favours…
Not just that—RIL’s top team, which includes Ambani’s lieutenantin-chief, Manoj Modi, is confident of maintaining the track record since going public in 1977 of doubling profits every three years. RIL now aims to feature in the top 50 most profitable firms in Fortune’s Global 500 in three years. In the last Global 500, it was ranked at 206 in terms of its revenues. With profits of $4.85 billion, Reliance was within striking distance of China Mobile’s $8.42 billion (China Mobile was ranked last in the top 50 most profitable companies by Fortune in 2008).
The RIL-RPL equation
However, at a time when petrochemical prices have fallen by 50-75 per cent from peak levels, touching five-year lows, and refining margins are at least $8 lower than recent highs, you have to wonder how is RIL going to generate so much of moolah? Clearly, cash conservation is one way out and cost-cutting is an integral part of that plan. According to BT estimates, RIL has downsized by at least 4,000 people over the past few months across its various businesses, including Reliance Retail and the SEZ ventures. With construction largely over at the second Jamnagar refinery as well as the gas pipeline, a lot of contracted workers have left Reliance’s indirect employment in 2008.
Reliance Industries officials said that the number is as low as around 1,200 out of which 600 were from the retail business and 400 were due to the voluntary retirement scheme at the Hazira plant. A SAP automation project implemented in 2008 also created some redundancies. The company also managed to cut its staff cost to Rs 588 crore in the September quarter from Rs 651 crore at the end of the June 2008 quarter. In the December quarter, however, it climbed back to Rs 605 crore. The global recession is hurting and is the biggest problem—aggravated, no doubt, by a “dysfunctional financial market,” as Alok Agarwal, Chief Financial Officer, RIL, puts it. Another way to conserve cash is to go easy on capital expenditure. A $2-billion gas cracker planned at Jamnagar has been put on the backburner; only Rs 1,000 crore—of the proposed Rs 25,000 crore— has been sunk into organised retail, with value retail becoming the focus area; and exploration of oil & gas is in go-slow mode.
P.M.S. Prasad, President & CEO, RPL says: “We have discussed the current situation with the Director General of Hydrocarbons and have decided to focus on production of gas and oil from D6. For that, we have to slow down our exploration activity.” In fact, exploration is facing problems globally. Prasad explains how in Canada the production cost of a certain grade of heavy crude is $60 per barrel and exploration has totally stopped—as the crude would be unviable at today’s prices. “It’s different from what was a given earlier—that if there is crude underneath you get it out—selling was never a problem.” Also, on the backburner, are SEZs in Haryana and in Mumbai—the latter involves a non-RIL company, that of Anand Jain.
It’s against such a backdrop that last fortnight’s merger of Reliance Petroleum Ltd. (RPL)—the company floated to build the second refinery at a cost of Rs 27,000 crore—with RIL has got the go-ahead. The amalgamation comes in the wake of 5 per cent shareholder Chevron, the US energy giant, walking away from a possible deeper alliance. The relationship with Chevron was rooted in two crucial agreements: The US major would supply heavy crude needed for the complex refinery (which means it can process heavier crude, and thereby rake in chunkier margins); and it would also pick up some of RPL’s offtake. However, the global downturn has hit Chevron, which makes it difficult for the company to guarantee these proposed agreements. Result: Exit Chevron, enter RIL.
The Chevron Factor
The merger has many benefits, right from economies of scale in sourcing (for two refineries at a go rather than individually). Other similar advantages include offering package deals to vendors of crude, buying up all their grades and extending easy credit facilities with suppliers to the new refinery. “We do not need to open fresh letters of credit for our existing suppliers to RIL, after the merger, for the new refinery. After the merger, RIL’s easy credit norms will automatically get extended to the new refinery,” explains Agarwal.
According to Jal Irani, Equity Analyst at Macquarie Bank, the fact that the RPL refinery is in an SEZ and, that RIL’s export-oriented unit (EOU) status ends in 2010 provides “… incentive for RIL to maximise gross refining margins and profits at the new refinery even at the cost of lower profits at the existing refinery.
We believe this is practically possible by using cheaper crude and producing high-margin products at the new refinery.”
What’s more, since the two Reliance units at Jamnagar (postmerger) are amongst the three most complex refineries in the world (in a universe of 700 refineries, roughly half of which are complex), Reliance’s consolidated refining capacity will theoretically be amongst the last three standing if the world’s entire production shuts down. This, tied in with RIL’s claim of being the lowest-cost, highest-quality producer of petrochemicals, give it the staying power to not just survive the downturn, but in fact, to use the global recession as an opportunity to thrive even as a number of global rivals fall by the wayside.
Indeed, RIL’s ability to see opportunity in the face of adversity is legendary. Way back in 1989, its project in Patalganga—the village on the Konkan coast that is home to an RIL petrochem unit—was submerged under water. Some 400 people lost their lives and 1,500 families were rendered homeless. In less than three weeks, the RIL top brass got the plant running at normal capacity. Similarly, in 1998, in Jamnagar, when RIL’s first refinery was being built—then the world’s largest grassroots unit— was struck by a storm. Some 550 people went missing.
In 15 days, the company succeeded in getting 60,000 workers back to work. The Jamnagar unit was commissioned within the stated deadline—of less than 36 months. Other natural calamities that have struck the group include a plague (at Hazira, home to a polyester unit), and an earthquake (in Gujarat). Much like retail, Reliance’s mobile telephony game plan—then Reliance Infocomm, now Reliance Communications, which is owned by younger brother Anil after a famous split four years ago—had come unstuck initially. The biggest difference this time around, however, is that virtually every Reliance business—along with the global economy—is in the wars. Clearly, this is Mukesh Ambani’s biggest test yet.
Jain on the wane?
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