Here's why CLSA and Edelweiss have downgraded Reliance Industries' stock

RIL's announcement of becoming a net-debt free entity way before its schedule of March 31, 2021, made Street in awe of the company. (In pic: RIL Chairman Mukesh Ambani)
It has been a dream run for Reliance Industries' (RIL) stock in calendar year 2020 (CY20). From hitting a low of Rs 868 on March 23, the stock has skyrocketed over 150 per cent to a record high of Rs 2,199 on July 27. The stellar rally came on the back of a series of big-ticket investments by marquee names such as Facebook, Google, Intel Capital, and Qualcomm Ventures into RIL's digital arm, Jio Platforms. Further, the company's announcement of becoming a net-debt free entity way before its schedule of March 31, 2021, made Street in awe of RIL, thus firing up the stock price.

However, not everyone looks convinced with the current valuation of the stock and believes that the market is way too optimistic on Mukesh Ambani-controlled RIL, overlooking the risks associated with it.

For instance, Edelweiss Securities, in its report dated July 27, notes that the stock’s primary triggers — deleveraging, asset monetisation and digital momentum — have already played out. Also, the current exuberance witnessed in the stock seems redux of euphoria seen earlier, in 1994 (India liberalisation), 2000 (Y2K bug), and 2008 (KG-D6 offshore gas field), which suggests associated risk is high. Edelweiss has downgraded the stock to ‘Hold’ from ‘Buy’ with the target price of Rs 2,105.

Edelweiss Securities notes that its two-stage reverse-discounted cash flow (DCF) analysis of RIL stock shows that the market is baking in high earnings per share (EPS) growth, particularly for Jio Platforms - 35 per cent compound annual growth rate (CAGR) and 31 per cent for Reliance Retail sustaining over the next ten years, which by any measure is a tall ask.

The brokerage notes that the Street has prematurely fired up the valuation of the entire consolidated entity—RIL—to those commanded by major tech companies such as Facebook, Amazon, Apple, Netflix, and Google, popularly known as FAANG stocks / companies. "This unhindered run-up in the stock price is primarily fueled by a slew of big-ticket investments in Jio Platforms at heady valuations. The cutting-edge FAANG companies boast large free cash flows already. In contrast, RIL is still primarily an oil-to-chemicals (O2C) business that shall continue to generate the bulk of cash flows over the medium term, the brokerage says.

Another issue raised by the brokerage firm is that RIL has ventured into multiple business verticals, right from telecom, e-commerce, entertainment to the education sector; however, what matters is the ability to achieve leadership in these areas. That apart, the business integration process, Edelweiss believes, will be a long-drawn affair.

 “Although RJio launched its entertainment apps at an early stage of business evolution, invested aggressively in business, and forged the right partnerships, it has not been able to achieve leadership in any of these businesses," the brokerage notes. In the entertainment ecosystem, too, RIL faces a Herculean task to displace the existing market leaders while in the healthcare and internet of things (IoT) ecosystems too, RJio, is lagging. Further, in the Education vertical, taking on BYJU’s is again a tall order.

Those at CLSA, too, have shared similar concerns and have downgraded the stock from ‘buy’ to ‘outperform’ even as they project Reliance’s market cap to rise to $220 billion by March 2022 as per their valuation framework.

 “Despite a lenient valuation framework, our new target of Rs 2,250 (Rs 1,753.38 earlier) offers only 4 per cent upside, which sees us downgrade our rating from BUY to outperform. Following a 400 per cent rally over the past seven years and over 150 per cent in four months, the stock may take a pause. Its promising long-term story and underweight positioning in institutional portfolios should provide support. Any big surprise beyond $70 billion, if and when the stake in Retail is sold, could be needed to justify large immediate upside," wrote Vikash Kumar Jain and Surajdev Yadav, of CLSA in a July 28 note.


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