Reliance Industries Ltd (RIL) may have to scout for acquisition opportunities to use up part of the $7.2 billion (Rs32,688 crore) it will get for selling a stake in its oil and gas blocks to BP Plc, as excess cash on its balance sheet may make it difficult to sustain earnings growth, analysts said.
BP agreed to buy a 30% stake in 23 oil and gas blocks operated by Reliance, India’s most valuable company, on Monday. Chairman Mukesh Ambani said the company would receive the initial $7.2 billion by March 2012.
BP may pay Reliance an additional $1.8 billion based on future commercial success in the blocks.
“RIL is struggling to deploy the cash it is generating from its businesses,” analysts Kumar Manish and Puneet Gulati of HSBC Securities and Capital Markets (India) Pvt. Ltd said in a 22 February note to clients. “Given the size of the company and limited organic growth options, maintaining its historical earnings growth of around 23% per annum is a tall order in the absence of an inorganic growth strategy.”
Reliance may have as much as $22 billion in cash and cash equivalents by 2012, including payments from BP and an estimated cash profit of $8 billion in the next fiscal year, according to the HSBC report.
In comparison, Reliance has plans to invest about $7 billion over 2012, which includes a few projects that are yet to take off, the report said. Reliance has a debt of about $8 billion.
Shares of Reliance have gained 1% since it announced the transaction with BP. That compares with benchmark Sensex’s 4% loss. The stock was little changed at Rs965.95 at the close of trading on Friday. In the past one year, it has gained 0.2%, trailing the Sensex, which rose 8.9%.
Even though analysts agree on the long-term positives that would accrue to the company because of the access to BP’s technical expertise and global gas pool, concerns over the utilization of the cash remains.
Given its existing debt and operational cash flow, Reliance could be net cash positive to the tune of $5 billion in 2012, even after factoring in its announced capex plans, said a 22 February Deutsche Bank report. “If RIL does not deploy this cash favourably, its return on equity could be adversely affected,” the report said.
“Reliance Industries will continue to seek opportunities for investment and create value for all stakeholders,” a spokesman said in response to an email, without elaborating.
Speaking to reporters from London on Monday, Ambani had said the cash from the stake sale would strengthen Reliance’s balance sheet and help the company reinvest in India. He did not specify if the company plans to acquire assets or set up new projects.
“We would not be surprised if RIL reconsiders overseas acquisitions,” HSBC said. “It could consider a petrochemical acquisition given the focus of its current investment continues to be on the petrochemical segment.”
Some analysts find concerns over excess cash on Reliance’s balance sheet unfounded.
“The $7.2 billion coming into the company could eventually get utilized for the company’s capex plans, which is $50 billion over the next five years,” said S.P Tulsian, a Mumbai-based market analyst. “In the meanwhile, they could employ funds in treasury operations, with a potential of earning 10-12% return per annum, as they have in the past.”
Others expect Reliance to use the cash to repay part of its debt. “We estimate that RIL had net debt of about $8 billion as at 31 December 2010,” a 22 February report by Daiwa Capital Markets said. “We believe the consideration of $7.2 billion...should help RIL to further reduce its net debt.”
Standard and Poor’s Rating Services revised its outlook on RIL to positive from stable on Thursday as it expected the company’s financial profile to improve.