RIL: 1235-1275 Area May Be A Big Hurdle Despite R-Jio’s “Surgical Strike”; Rivals May Also Fight Back Hard To Protect Their Data Market Share Amid Looming “Bloodbath”; R-Jio Too Needs Huge Jump In Subscribers & Revenue To Breakeven

 26/02/2017 (08:30)

Considering R-Jio’s likely EQ base of Rs.60000 cr by FY-18 (from Rs.45125 cr on FY-16), for an EPS of 1.00, required yearly PAT may be around Rs.6000 cr (??) with revenue of around Rs.120000 cr assuming 5% net profit margin, which is equivalent to Bhart’s revenue of two years (current Q3FY17 NP margin of 2.77%). The task may be very challenging for RIL/R-Jio.

Telecom sector may enjoy a PE of around 12 in the days ahead amid R-Jio led disruptions and severe stress on the balance sheet for abrupt fall in the earnings and incremental capex to remain in the competition.

Trading Idea: RIL

LTP: 1183    
   

Sell on rise around: 1210-1225 OR further 1260-1275

TGT: 1170-1140-1095 & 1045-1015 (1-3M)

TSL> 1240 OR > 1295

For investments:

Buy/accumulate on dips around 1045-1015 OR on further dips around 985-935

TGT: 1140-1235 & 1340-1450 (FY: 17-18)*; 

*Depending upon the actual performance & progress of R-Jio in FY-18; R-Jio will have to perform well and must be positive on EBITDA/PAT level; otherwise it may be EPS dilutive for RIL at around 240/- per share (20*12) 

Note: For RIL, consecutive closing above 1240 area, it may further rally to 1260-1275 zone, which may again offer strong positional resistance and only consecutive closing above 1295 area, RIL may further rally towards 1340-1410 & 1450-1515 territory in the near to long term. Any one holding long position in the counter or planning to do so, may also watch 1170-1140 zone as nearest positional support.

For RIL: On consolidated basis

ACTUAL Q3FY17 EPS	25.4
TTM EPS (Q3FY17)	98.40
PROJECTED Q4FY17 EPS	26.11
PROJCTED FY-17 EPS	100.01
PROJECTED Q1FY18 EPS	26.84
PROJECTED TTM Q1FY18 EPS	102.76
PROJECTED FY-18 EPS	113.5

Valuation Metrics	Q3FY17(TTM)	FY-17E	Q1FY18E(TTM)	FY-18E
EPS (AS PAR NORMAL RUN RATE)	98.40	100.01	102.76	114.5
AVG PE	12	12	12	12
AVG FAIR VALUE	1180.80	1200.14	1233.07	1374.00

ANALYST PROJECTION (EPS)	FY-17	FY18
KR CHOKSEY	106.9	140.3
EDELWEISS	99.2	106.9
AXIS DIRECT	88	101.8
HDFC SECURITIES(STANDALONE)	91.2	103.2
PRABHUDAS LILADHAR	95.6	106.1
FT/REUTERS	95.39	95.66
MEDIAN FORECAST	96.05	108.99
AVERAGE PE	12.00	12.00
MEDIAN VALUATION	1152.58	1307.92

Note: Average PE of 12 may be ideal for RIL, considering its actual EBITDA & EPS growth in the last few quarters & years and projected growth on normal run rate, which is around 12%.

FY-18 EPS projected around 114.50 considering no negative effect of R-Jio on the consolidated RIL earnings. But, It may be at higher risk because R-Jio may report around (-) 20 EPS in FY-18 and in that scenario, actual FY-18 EPS may be around 94.50 (114.50-20), which translate a projected fair value of around 1134/- for RIL (94.50*12).

An earlier SOTP valuation guidance done by Macquarie for FY-16:

SOTP VALUATION (MACQUARIE)-FY16	NAV
DOWNSTREM	1113
DOMESTIC UPSTREAM	111
INTERNATIONAL UPSTREAM-SHALE GAS	47
CORE BUSINESS	1271
BROADBAND	-49
RETAIL	48
OTHERS	97
TELECOM	-285
TREASURY	57
NON-CORE BUSINESS	-132
REFERENCE PRICE(TP)	1139

RIL rallied by around 15% last week after R-Jio surprised the market with a 303/- monthly unlimited data plan (FUP: 1GB/day) with a 99/- flat yearly membership charge. Although actual network speed for this plan is not clear, it may be at 10 mbps, considering R-Jio’s average network speed on Pan-India and some other plans with similar speed limits. After FUP, speed will be reduced to 128 kbps as with other service providers and will be not usable. This scheme, actually translates around 30 GB for 30 days for 303/- at 10 mbps (i.e. 10/- per GB) with unlimited free voice (if voice network is available, especially with other networks!!).

Although, this 303/- plan of R-Jio sounds great for amature consumers, movie watchers & social media users and also may be unique/lowest in the mobile internet category, similar plan & pricing is already available in the broadband (BB) category where 140GB (40+100 bonus) data is available around 1500/- in a monthly cycle at speed 16-80 mbps or more depending upon the feasibility & optical network infrastructure without any daily FUP of 1GB (i.e. 10/- per 1GB). A professional data user will never accept any plan under daily FUP limit like 1GB because of several limitations. So, for a professional BB data user, the latest R-Jio plan may be a marketing hype; but for an average amature user (mobile data), it’s certainly very attractive as the existing telecom operators are now offering only 1GB for around 150/- against R-Jio’s latest plan of 1GB for 10/- with all the advantage of a 4G/3G speed & wireless setup.

Typically, Indian consumers do consume data in an unlimited way only with a home/office broadband set up and in most of the private & corporate offices, it’s almost free and actually, the company bears the cost (corporate connection). In a home, with a single BB connection and a WI-FI router, all the family members do typically use data in an unlimited way with a decent network speed (16-80 mbps) without any daily FUP like 1GB as proposed by R-Jio. Also, there are free WI-FI zones available in various locations, like Indian Railways Platforms and other places courtesy various service providers where people are scrambling to download video contents freely. Most of the Indian data consumers are always envy for free and they will find another alternative “free” very easily, when R-Jio starts to charge them; so market will watch carefully for the next 30 days (March’17) to see this conversion ratio from free to pay for R-Jio customers. Most of the amature free data users of R-Jio may not waste even 303/- to download useless videos & other contents and they will look for some other “free” alternatives. Incidentally, a typical Airtel BB connection do also offer free unlimited land line telephone for voice calling, mostly used in corporate offices and SOHO/home segment.

R-Jio will need to capture the SOHO/corporate office/home data users (professionals) from other incumbent by offering lower rates or more data  without any daily FUP limit and only then it may be operationally feasible in the long term. The true wireless setup may be an advantage for it so far other incumbents are unable to offer similar complete wireless facilities.

Old telecom operators like Bharti, Vodafone, R-COM & Combination and also BSNL will need to match this 1 GB for 10/- plan of the R-Jio for mobile data also; otherwise they will lose their data customers eventually. Thus, we may see intense price war among the telecomm operators in the coming days, where R-Jio promised to match any aggressive data plan of the rivals by offering 20% of more data always,

RIL (R-Jio) is treating data like oil having unlimited supplies and focusing on its GRM (refining margin) and in this war of “Datagiri”, existence/viability of the other telecom players may be in serious question despite deep consolidation in the industry; it may be another scary picture of supply glut, like in Crude oil.  

In this war of “Datagiri”, R-Jio may survive for another five years, thanks to RIL’s huge FCF and strong balance sheet to take incremental equity & debt to fund capex. But, it’s now almost certain that the other telecom operators will also try to match the latest R-Jio offer by offering similar plan (30GB for 300/- with 1GB FUP at 4-10 mbps) and there may be “bloodbath” in the telecom sector despite its a game of only right “spectrum” having one time cost (to be paid in a staggered manner).

Also, the Pan-India infrastructure of optical fiber cable (OFC) and mini towers/hotspots is vital, in which R-Jio may be far ahead of its rival. But, other incumbents including Bharti are now also laying their OFC networks on war footing and this shows that they will not left the battle field abruptly and will also offer similar plan & price being offered by R-Jio; i.e. we may see more bloodbath in the entire telecom sector in the coming days and eventually voice telephony may be free directly or indirectly, if TRAI & Govt has no issue for their part of revenue collections from it.

For telecom operators, the spectrum acquisition & OFC laying cost may be the primary capex and once it is done, then operating expenses will be minimal like tower rentals, employee expenses etc. Thus, it’s a pure game of volume and ARPU to be profitable, even in the short term. After R-Jio’s 303/- plan, market may be relieved that ultimately R-Jio is adopting the “paid” model from its nearly 6 months “free” model, which nearly made bankrupt for the other incumbents; Q3FY17 earnings from both Idea & Bharti are extremely shocking and Vodafone also has to take a significant write downs for it India operation. Apart from demonetization pain, R-Jio’s free demo model may be large responsible for the poor performances of the other telecom operators. Earlier market was expecting that R-Jio may offer its freebies till CY-17 or FY-18 till it gathers sufficient subscribers and required infra for smooth voice calling across the networks.

Market may be also very optimistic that the latest plan of 303 (effective ARPU 250-270) by R-Jio is well above the average ARPU of 200 and as such, other telecom operators may not be in great pressure to match R-Jio’s offer. Thus, telecom space may not be under immense rate war for R-Jio contrary to earlier perception. But this may be wrong and to protect the existing market share, the old incumbents will also try to match the latest R-Jio plan of 303 and also expand their OFC infrastructure rapidly, which may in turn put further pressure by way of incremental capex on their already stressed balance sheet.

For R-Jio, considering its huge capex of around Rs.2 tln by FY-17, a breakeven turn over for around Rs.1.24 tln may be required by FY-22. The company is targeting a turnover of Rs.1 tln by FY-18 itself. The present free subscriber base of R-Jio is around 10 cr (100 mln). With an expected net ARPU of 250 per month; i.e. 3000 per year, R-Jio needs at least 30-33 cr paid subscribers (300-333 mln) by FY-18; i.e. 3 times from the present free subscription base. Even after assuming retention of all the existing free subscribers, R-Jio need to add around 23 cr new subscribers by next few months which it may be a big challenge for R-Jio, considering they have added 10 cr free subscribers in nearly 6 months.

The revenue target of Rs.1.24 tln may be 42% of overall Indian telecom market and the subscriber base of 333 mln might be around 31% of total Indian telecom subscribers of 1074 mln. Bharti is now the leader in the telecom space with a subscriber base of 266 mln (around 25%) with average revenue of Rs.0.60 tln per year (around 20%).

R-Jio is targeting itself revenue of Rs.1 tln and 400 mln paid subscribers (almost 37%) by FY-18.

As par another estimates, R-Jio will need at least 200 mln (20 cr) paid subscribers for at least $4 (roughly 270/-) for 12 months; i.e. around $50 yearly ARPU for the $10 bln revenue goal by FY-18 in order to justify its huge investment of around $25-30 bln in R-Jio; almost 45% of RIL’s capex. The average ARPU of Bharti may be around $4.50 at present, almost similar to R-Jio’s new plan. But Bharti also need to match the $4 plan of R-Jio by offering similar data & free voice; otherwise it will lose its customers.

As par FY-16 P/L A/C of R-Jio, its net loss is Rs.23.88 cr on a EQ capital of Rs.45125 cr (FV: 10/-), translating a EPS of (-) 0.005 ~ (-) 0.01; its authorized share capital is Rs.50000 cr; but it may soon issue another Rs.15000 cr rights issue to fund incremental need for capex and by FY-18, EQ base is likely to be around Rs.60000 cr. Thus, for an EPS of 1.00, it may need at least Rs.6000 cr of PAT and if we assume an industry average PE of 10 (downgraded from previous 20 because of earnings slowdown and CAGR will likely to be around 10% in the coming years for fierce competition), then even if R-Jio will generate a PAT of Rs.12000 cr by FY-22, its fair value may be only 20-40 (2*10 or 20) on standalone basis.

If we look at the standalone performance of Bharti, its average yearly revenue is around Rs.60000 cr with OPEX around Rs.40000 cr leaving an EBITDA of around Rs.20000 cr and PAT margin of around 3-5%. If we assume R-Jio to clock similar revenue of Rs.60000 cr in FY-18 with comparable OPEX & PAT margin of 5% on the higher side, NP may come around Rs.3000 cr and considering its future EQ base of Rs.60000 cr (FV:10), EPS may be around 0.50 for FY-18. If the revenue will double by FY-22, then at this run rate EPS will be around 1.00. Having said that, in Q3FY17, revenue of Bharti was at around Rs.15240 cr and NP margin was 2.77%, thanks to only 2 months pain of R-Jio’s free offer and demonetization; in Q4FY17, both top & bottom line may be squeezed further. Despite consolidation, aggressive pricing policy may continue among telecom operators and due to increased capex, OPEX and balance sheet debt; net profit margin may continue to be below 3% in the coming days. This may be one of the primary reasons (wafer thin net profit margin), why Telenor is exiting India & Bharti is able to buy it almost free (? Rs.1700 cr of spectrum obligation will be paid in a deferred way as usually) and from nearly 120 telecom operators few years ago, prior to 2G scam, we have now only 4-5 strong players having very deep pocket and can withstand the telecom disruptions for quite a few years. In the game of consolidation, R-Jio may eventually also acquire R-COM & Aircel/MTS/TATACOMM (?) leaving only 3 listed telecom operators in the game (Bharti/Vodafone-Idea/RIL-RJIO).

Present average ARPU of the telecom industry is around 200 and previously market was expecting similar (200) ARPU from R-Jio also for FY: 18-19. But, as R-Jio unveiled this new 303/- plan, the average ARPU may be around 250-270 (FY: 18-19) after adjusting tax & other regulatory fees. Thus, R-Jio may be EBITDA positive by FY: 18-19 itself contrary to the earlier market perception of FY: 20-22 and the stock rallied quite smartly.

Another market buzz was that RIL may list R-Jio sooner than later and some strategic investor may also take some stake in R-Jio to reduce debt and also to fund incremental capex (like Softbank rumour of taking stake at Idea-Vodafone merging entity). But, to become a decent ROE and positive EPS, R-Jio has to wait for several years until pricing power returns to the telecom sector. R-Jio has to capture the high end professional data users (individuals & offices/corporates/SMES) for its long term growth story.

Incidentally, nearly 50% of Bharti’s revenue is coming from ARPU at 550+ averages, which is much above the 300 ARPU being offered by R-Jio. Surely, to retain its customer base, Bharti will also try to match the offer by R-Jio and it may be an intense competition in the telecom sector and negative for all the players.

Market is expecting that, almost 60-70% of the existing “Free” data users (demo) will convert to “Paid” mode from 1^st April’17 with its 303 plan. Next month (March’17) may be vital for R-Jio as by 31^st March, it will close the 303 plan registration both for old and new subscribers. Time is very limited and we may again see some chaos in the R-Jio outlets as number of subscribers will be huge. R-Jio may eventually again extend the this 303 registration offer and to be very fair & reasonable, the company may need at least another 6-12 months to be operationally smooth and by FY-19, one may expect some positive net earnings (EPS); i.e. it may not be a “cat walk” at all in the initial years.

Also, R-Jio subscribers may not take “risks” to abandon their primary voice/data SIM (of the existing operator) for voice telephony as R-Jio SIM is not reliable at all presently due to various operational & point of interconnections issues (with other telecom operators).

Govt/Telecom Commission/TRAI may also take some regulatory actions against R-Jio (if there will be some political will of course!!) as for its unprecedented free offer, Govt may have already lost around Rs.685 cr of revenue from other telecom operators, where Govt do charge some license fees on a proportionate basis on the revenue. In Q3FY17, there was significant dip on the overall revenue primarily for the R-Jio led telecom disruptions and also for the demonetization led economic disruptions. Also, R-Jio extended its free offer beyond the stipulated 90 days and the present 303/- offer may also lead to immense competition in the telecom sector, resulting in further fall in the revenue by around 8%. All these are not good for the overall health of the telecom sector of the country, considering they owe around Rs 1 tln to the Govt on account of deferred payments of spectrum and Rs. 4 tln to the banks (loans). In this scenario, Govt will lose further revenue; there may be default in future payment of spectrum and banks may also be in more trouble for the stressed assets. Thus, viability of the entire telecom sector may be at stake, if Govt will not take any corrective action despite theme of an affordable “Digital India”.

There may be lots of noise and disruptions in the coming days for the old telecom operators because of R-Jio; but high end BB data users may not shift to R-Jio immediately because they are already enjoying comparable data plan ( around 150 GB of high speed data for 1500/-) being offered by R-Jio (30GB for 303/-); often such high end users BB plan are being offered by incumbent like Bharti Airtel on a customized basis and also not even publicized for various reasons. Also, most of the high end BB users may not shift so easily to R-Jio despite promise of 20% more data as they will prefer more on quality of network without any daily FUP of 1GB and after service. Thus, high end BB users will likely to wait for some months to see the actual performance of R-Jio network under “pay” mode and only then they will think for any shift, if at all.

In Q3FY17, RIL’s earnings were good/at par consensus/mixed; but not great; on consolidated basis: (Rs. in cr)

EBITDA: 11552 (YOY: + 2.70%; QOQ: + 3.36%)

PAT: 7506 (YOY: +3.29%; QOQ: + 5.18%); helped by other / treasury income

Interest: 1209 (YOY: +27.94%; QOQ: +35.39%)

TOTAL DEBT: 194381 (QOQ: +2.78%); interestingly, at FY-12, Debt was at 82635 and at FY-16 it was at 165954 (+100.83%); 

By FY-17, total debt may exceed Rs.200000 cr; i.e. above 140% increase in debt over 5 years; 

Cash & cash equivalents/investments are also steadily decreasing, which increase in net debt from 77824 at March’16 to 118042 at Q3FY17 at Dec’16; i.e. an increase of 51.68%. 

Overall capex for Q3FY17 increased sharply to 37791 from 17210 in Q2FY17 (+119.59%) due to ongoing projects in Petrochem & Refining business, US Shale gas projects and R-Jio. Another Rs.30000 cr capex is expected for R-Jio in the coming quarters; Total capex for 9MFY17 was at $12 bln.

EPS: 25.40 (YOY: +3.67%; QOQ: +4.10%); median estimate: 24.60 (+3.25%)

GRM: 10.8 (YOY: 11.5; QOQ: 10.1); median estimate: 11.5

EBITDA Margin: 14.55% (YOY: 16.66%; QOQ: 14.67%)

NP Margin: 9.53% (YOY: 10.85%; QOQ: 9.45%)

Refining EBIT: 6194 (YOY: -4.32%; QOQ: +3.67%)

Refining EBIT Margin: 10% (YOY: 11.3%; QOQ: 9.9%)

As the stock already rallied prior to the Q3FY17 result, it corrected subsequently after the overall result came largely in line with expectations with no big surprise. Lack of any big announcement regarding R-Jio was also one of the reasons for its post result correction by some extent. Also, the big disappointment came on the back of benchmark SGX GRM, which jumped to $6.70 from $5.10 (sequentially +31.37%); yet RIL’s GRM fall on QOQ basis (-6.49%); i.e. RIL underperformed the benchmark SGX GRM in Q3FY17. Traditionally, RIL has better GRM than the SGX GRM, because of its ability to source relatively cheaper crude (heavy) from some of the Gulf countries (efficient crude sourcing) and sell the resultant high quality refined product (gasoline) at premium, thanks to its unique refining technology (has strong R&D).

Overall Q3FY17 & previous quarter’s earnings may be also an indication that growth in RIL’s core business may be saturating as average EBITDA & EPS is growing with tepid 2.72% & 3.64% on annualized basis against previous rates of 6.44% & 9.09% respectively. Perhaps, this may be the primary reason, why RIL is now putting all its money muscle for the R-Jio and various retail ventures as it may take the opportunity of a robust domestic consumption story & trying to diversify in an organic way (direct consumer facing business). As par some reports, RIL/R-Jio may also venture into DTH business with usual free service for initial 6 months (?) and may also launch UBER/OLA types of app based cabs service in the near future (although, this was denied by RIL yesterday).

Some analysts are also very optimistic about Crude Oil price recovery to $65 and its correlation with RIL’s EPS. A 10% increase in oil should boost EPS of RIL by 10% and TP by 7% (??). But, in the last one year, Crude bounced back by more than 110% (from around $26 to $55); yet RIL’s EPS has grown by only 3.67%; similarly EBITDA also grew by only 2.70%; something must be wrong here!!

Some analysts are also hopeful that Oil will rally to around $65 and in that scenario; RIL may be a big beneficiary for its upcoming core projects in petchem. But, there is still significant uncertainty about exact timeline of RIL’s finishing of core petchem projects as now all the thrust/capex may be on R-Jio infrastructure completion and its commercial start from FY-18. But, the OPEC & Non-OPEC agreement may not be extended beyond Q1FY18 (Jun’17) and in that scenario, coupled with increased US shale production, Crude Oil may again fall good to around $40-35 in the coming months (LTP: 54). The operation of the above petchem projects worth $18.5 bln capex may start by Q2FY18 and analysts are very hopeful for an incremental EBITDA from these petchem projects ($1 bln capex is still due for spending on it).

Apart from weak GRM, demonetization also affected partially the petchem demand in India as benefit of demonetized notes was only applicable in the PSU outlets; not private outlets. Muted petchem demand in domestic market has forced RIL to export more with lower margin.

It’s no doubt that RIL is a great portfolio stock; but it has also underperformed for the last few years on the back of huge capex being deployed in its petchem projects and R-Jio (Telecom venture) hangover. Market is not concerned about its petchem business, which is quite robust; but may be concerned about huge investments being made in R-Jio or telecom sector. The sector is now operating in a wafer thin margin with incremental requirement of huge capex to fund growing need of telecom infrastructure and very low in ROE. Although, consolidation is happening at a faster pace, it does not guarantee for return of immediate pricing power and one can expect further price war or bloodbath for the sector in the coming months amid fierce competition. Going forward, RIL’s performance will depend upon the actual performance of R-Jio and thus as an investor, one can accumulate the stock in dips rather than chasing it at near multiyear high for a decent harvest.  The world’s largest start up (R-Jio) has to show some result and contribute meaningfully to the bottom line of RIL and only then the stock will further fire.

Analytical Charts:

RIL