Fiscal 2004 will go down as a record year in the history of Reliance Industries. The company's net profits crossed the $1 billion mark. Over the last 25 years, RIL has seen its sales grow from Rs 120 crore (Rs 1.2 billion) to Rs 74,418 crore (Rs 744.18 billion).

Net profits during the period grew at a compounded annual growth rate of 26 per cent to Rs 5,160 crore (Rs 51.6 billion).

This remarkable performance was reflected in the stock markets too: shares of Reliance gave a return of 39 per cent on an annualised basis.

Figuring among the top 150 companies globally in terms of net profit and among the top 450 in terms of sales, Reliance's past performance has been admirable.

But what is even more surprising is that even now the company is not showing any signs of sluggishness. While announcing the annual results for fiscal 2004, vice-chairman and managing director Anil Ambani said the company would continue to grow at the rate of 20 per cent over the next five years -- that is almost double the country's expected economic growth rate.

Since RIL accounts for 12 per cent of the Sensex's market-cap and one out of four investors in Indian equities is a Reliance shareholder, RIL's future performance is significant for the overall market performance.

What is Reliance relying on to keep the growth engine chugging feverishly even on a larger base?

Petrochemical upturn

The petrochemicals segment, which still accounts for 41 per cent of Reliance's revenues and 45 per cent of profits, is favourably poised, thanks to the upturn in the Indian economy and demand from the rest of Asia.

In FY04, Reliance recorded modest volumes due to capacity constraints. The company produced 12.4 mmt (million metric tonnes) of petrochemicals compared to 11 .8 mmt and 11.5 mmt in the previous two years.

Capacity utilisation in polymers was 108 per cent and in polyester 99 per cent during the year. It is planning to up its petrochem capacity from 12.5 mmt to 15 mmt over the next two-three years.

It has budgeted a capex of Rs 6,000 crore (Rs 60 billion) for the same. Meanwhile, volume growth is likely to be modest in FY05. Margins, however, are expected to be better. Currently, petrochemical prices are at a 50 per cent discount to peak prices achieved during the last petrochemical boom in 1995.

Analysts say though prices may not rise to their 1995 peaks, the direction is upwards, given the demand-supply equation. Profit margins in petrochemicals, which hold the key to the supply side of the equation, are ruling at 40-60 per cent of the 1995 annual average levels.

Analysts say even a small margin expansion in petrochemical products can help boost profits substantially for Reliance, given its large volumes. The company expects margin expansion to continue for four years, starting 2005. But analysts predict profit margins to peak in 2007 and slide from there on.

Gas will gush in...

Even if the petrochem cycle peaks in 2007, Reliance should have other gushers coming up by them. For that's when Reliance's gas production will go on stream.

While Reliance continues to gather seismic data on its various fields - it is drilling more wells in KG (Krishna Godavari) D6 and the Yemen block (the overseas block in which the company has a 25 per cent interest), it is gearing up for gas production from KG D6 by fiscal 2006-07.

A recap: it spotted the world's largest gas source in 2002 in the KG basin.

Reliance expects a turnover of Rs 10,000 crore (Rs 100 billion) from the gas business and a EBIT margin of 40-50 per cent.

Analysts concur on the profitability of the business and add that Reliance should be in a position to ramp up revenues from the gas business to Rs 10,000 crore by 2010.

...but refining is slippery

Fiscal 2004 was a great year for refining companies as refining margins were firm, aided by improved economic climate, political uncertainties and low commercial inventory worldwide.

Reliance's gross refining margins were $6.6 per barrel for FY04 and in the last quarter it achieved a historic GRM of $7.2 per barrel, the highest in its history.

However, the spread over Singapore refining margins, which averaged $6.05, was lower during the quarter as Reliance had to opt for higher exports, which are less profitable. Reliance's crude throughput for the year was 29.6 mmt and the refining capacity utilisation was 109 per cent.

This year, tighter global inventories, strong demand growth in China and tightening product specs in various parts of the world paint an optimistic picture for the industry.

Singapore refining margins will continue to be strong this year, too, say analysts. Domestic demand growth too is likely to be healthy on the back of strong economic growth.

However, Reliance may not capture the entire margin gains. There are two key issues. Firstly, it will have to up its exports as public sector oil companies have decided to settle for lower offtake from Reliance.

In FY04, the PSU oil marketing companies picked up 11 mmt from Reliance. This year they have given a commitment of only 7 mmt. The balance will have to be marketed directly by Reliance.

Given that Reliance's retail outlets are not ready yet, the only option for the company is to export.

Overseas sales are less profitable whereas domestic realisations are higher due to higher tariffs. The squeeze on profits due to exports was evident in the fourth quarter refining margins as well.

While the government has not gone ahead with the divestment of oil companies, which was seen as crucial for Reliance's marketing strategy, Reliance has been slow to build its retail network as well.

The company's retail plans have taken a back seat over the past year or so. Reliance has opened only 11 outlets to date while 400 are under construction.

By end of FY05, the company targets to set up 2,000 retail outlets, mainly on the highways. Throughput per outlet will nearly double the current industry average due to better technology, says Anil Ambani.

The second reason for some pessimism on refining is that Reliance may not be reimbursed for central sales tax from FY05 as the central government has made no provision for irrecoverable taxes (which includes reimbursement of CST) paid to oil refiners in the interim budget presented in February this year.

If the new budget, to be presented by whichever government is formed at the centre after the general elections, does not remedy this, the company may even have to reverse a part of the Rs 770 crore (Rs 7.7 billion) sales tax credit it took in FY04.

In the interim budget, the government has slashed the revised estimate for irrecoverable taxes to Rs 201 crore (Rs 2.01 billion) from Rs 1,570 crore (Rs 15.7 billion) in the budget estimate for FY04. Analysts say the CST component constitutes at least a half of the company's total sales benefits.

In effect, the strong refining margins expected in FY05 will at best mitigate the profit pressures arising from the loss of CST benefits, the reversal of CST benefits already taken credit for in FY04 and the profits squeeze on account of lower PSU offtake.

Refining profits will thus remain flat unless Reliance manages to grab hold of a PSU oil company in the divestment game. Over the medium term, the key concern will be competition.

Analysts say petro-products will see price competition once private players step in a year from now. This again can cause temporary instability in the sector.

Infocomm will grow exponentially

Reliance Infocomm, where Reliance Industries holds a 45 per cent stake, has silenced skeptics.

Reliance's telecom business has been growing fast and furious after the initial hiccup early this year. The company has set up its CDMA network in 1,100 cities and towns spread over 20 telecom circles.

It has also set up 60,000 route km of nationwide optic fibre cable backbone. It has seven million mobile subscribers and a mobile market share of 22 per cent.

Reliance Infocomm recorded a net loss of Rs 390 crore (Rs 3.9 billion) in FY04 and is likely to record net profits in FY05. Beyond that the telecom business is likely to see exponential growth given the immense market potential.

RIL expects Infocomm to fund further investments for expansion on its own - through debt or equity - though no IPO is planned anytime soon.

Why the Reliance story is reliable...

Reliance's financials are strong. The company has a net worth of Rs 35,277 crore (Rs 352.77 billion).

In FY04, the company earned a 14.6 per cent return on net worth. Its net debt-to-equity ratio improved to 0.53 from 0.57 in FY03. Interest cover also improved from 3.8 to 4.7.

For the next five years, the company is planning a capex of Rs 35,000 crore (Rs 350 billion), much of which will be financed through internal accruals.

Analysts expect Reliance to grow its consolidated profits by 20 per cent per annum in FY 05 and FY 06 primarily on the back of strong performance by the petrochemical segment.

Beyond that one could see some value unlocking on account of the telecom business, followed by gas business taking off.

What makes Reliance a reliable bet is its diversified business profile. Given that Reliance has several businesses, which are seeing a lot of action in terms of regulatory changes, events or change in business prospects, the management has enough latitude to maintain investor enthusiasm at the counter.

Even as Anil Ambani put the sum of parts valuation of the company at Rs 912 - attributing the figure to anonymous research reports - analysts from prominent broking houses contacted by The Smart Investor indicated a target price in the range of Rs 650-700. Even that is a good 30 per cent higher than the current price of Rs  532.30.

...and why not

However, the investing community would be happier if only the management is more transparent. The Reliance balance-sheet continues to be the way it used to be some 10 years ago in terms of disclosure standards, says one analyst.

While the company is occasionally more forthcoming on details, analysts believe that the management should be more open in its approach. The fact that Reliance operates in business areas where government still has a large role to play (or has had a larger role in the past), there is a case for being more transparent about tax and other regulatory matters.

Even now, how much Reliance gets by way of several tax concessions remains a mystery to many. The investing community would rather have the company say on paper what ongoing incentives it is receiving, how long these will continue and disclose other details, which are critical to its future profitability.

Another case in point is Reliance Infocomm. Considering that RIL has invested Rs 12,000 crore (Rs 120 billion) in Reliance Infocomm and holds a 45 per cent stake in it, investors would be better off with more clarity on its financials. Reliance has announced that Infocomm made cash profits last year and that Reliance Industries' share of losses in Reliance Infocomm was Rs 265 crore (Rs 2.65 billion).

However, some analysts suspect that the net loss incurred by Infocomm last year could be in the range of Rs 800-900 crore (Rs 8-9 billion) as Reliance is understood have deferred certain expenses.

Market participants feel that while the company has built a phenomenal track record when it comes to scaling up its business, it has not lived up investor expectations in terms of governance standards.

Ironically, late comers like Infosys have set new benchmarks in corporate governance, which has earned them premium valuation even at difficult times.