The stock markets have historically rewarded the RIL stock paying a premium since they anticipated, rightly, that the company would generate strong cash flows that would be channelled into new businesses, thereby creating value. Shareholders? expectations were justified; RIL?s earnings per share (EPS) grew at a compounded 15% between FY1993 and FY2001, and at an even more impressive compounded 24% between FY2001 and FY2011. However, the stock has underperformed the Sensex in the past two years, even though the oil and gas exploration opportunity was promising, and RIL?s refinery is undoubtedly among the most efficient in the world. The disenchantment probably set in about a year ago when chairman Mukesh Ambani announced at the company?s AGM that RIL was looking to double its enterprise value in ten years?it translated into an uninspiring return of around 7% a year. While the outlook was a tad disappointing, analysts figured the foray into the power sector would be a good way to use the huge cash flows that RIL would generate from its incumbent businesses. Little did they expect that RIL would abandon the idea altogether; this year?s AGM saw Ambani talking about the initiatives in broadband wireless and organised retail, businesses that are not likely to contribute meaningfully to the bottom line in the near term.
What?s really taken the sheen off the stock is the lower-than-expected production of oil and gas at the KG-D6 basin, where volumes are currently at around 17,000 bpd and 49 mmscmd, respectively, well below the peaks seen in the March 2010 quarter (of 25,000 bpd and 60 mmscmd). More important, the management hasn?t really provided any clarity about when production is likely to be scaled up, except to say that the KG-D6 reservoirs would be jointly assessed by RIL and BP to address the technical issues relating to ramping up of production. While there have been media reports suggesting that it may not be possible to scale up production of gas for a couple of years (an assessment reportedly made by RIL and its partner Niko Resources), these are unconfirmed. Nonetheless, the Street is nervous and reports to the effect that the CAG is looking into whether RIL inflated costs that adversely impacted government revenues haven?t helped. The stock has now fallen below R900, close to a two-year low and, given that it is the largest constituent of the benchmark 30-scrip Sensex, the severe underperformance in the last few months is disconcerting. Analysts who had pencilled in gas production for FY12, FY13 and FY14, at approximately 50 mmscmd, 55 mmscmd and 70 mmscmd, respectively, may now have to rework their numbers, which means that RIL?s earnings may not grow at the expected 8.5-9% compounded between FY11 and FY14. No one doubts that BP, which has committed an investment of $9 billion, will ultimately set things right. Meanwhile, though, RIL may want to keep shareholders posted, reassuring them that cash flows will be put to efficient use.