The stock was up 3.1 per cent during trade on Thursday, against 0.76 per cent decline in the benchmark index.
The premium valuation is a recent development and the company has largely traded at a discount to the broader market historically. For example, RIL’s 10-year average P/E multiple is 14.7x against BSE Sensex’s 20x. This changed beginning in December 2019, and the gap increased during the April 2020 rally, when RIL was one of the biggest gainers.
The stock is up 72 per cent from its 52-week low seen on March 23, in the wake of the Covid-19 sell-off on Dalal Street.
Historically, Reliance has traded at a discount because of its relatively lower return on equity (RoE) — a measure of corporate profitability. For example, RIL’s 15-year average RoE was around 13.8 per cent, against 17.5 per cent for index companies
The recent spike in valuation, however, has not been accompanied by a commensurate rise in its RoE. The company reported 39 per cent year-on-year (YoY) decline in net profit in the quarter ended March 2020 (Q4FY20), leading to nearly 220 bps decline in its RoE for FY20 on a YoY basis. The ratio declined to 9.4 per cent in FY20 from 11.6 per cent a year ago. This is the lowest RoE reported by the company in nearly two decades.
In comparison, index companies’ RoE was 12 per cent, down 50 bps from a year ago. Analysts expect a further drop in index average return ratio as more large-cap companies
declare results for Q4FY20.
Analysts attribute RIL’s premium valuation to the rising share of high margin and non-cyclical consumer businesses, including retail and telecom, in the company’s consolidated revenues and profits. “Our view that the stock should outperform is premised on rising share of non-cyclical domestic consumer business in Ebitda (earnings before interest, taxes, depreciation, and amortisation) to 58 per cent in FY21 against 41 per cent in FY20, and a clear path to a stronger balance sheet,” said Hashad Katkar of HDFC
The company has announced plans to become debt free by raising fresh equity through a rights issue to existing shareholders and selling a minority stake in various parts of its business to strategic investors such as Facebook, BP and Saudi Aramco.
Fresh equity infusion, however, could put downward pressure on its RoE — as net worth expands — unless it is matched by incremental rise in net profits.