A Constructive Case For Reliance Infrastructure

BMI View: The stock price of one of India's largest infrastructure companies Reliance Infrastructure appears to have broken out of its long-term downtrend, which, coupled with the near-record low valuations on offer, suggests a more constructive long-term outlook. While we believe that the macroeconomic backdrop and business environment of India have improved in recent months, several milestones need to be achieved for Reliance's stock price to really take off from here. They are a break in its near-term resistance line, greater evidence of project execution, and favourable government rulings.

The stock price of one of India's largest infrastructure companies Reliance Infrastructure appears to have broken out of its long-term downtrend, consolidating above its multi-year resistance line to reach around INR412.00 at the time of writing. This, coupled with the near-record low valuations on offer, suggests a more constructive long-term outlook for the stock. While the firm's financial position is concerning (i.e. high net debt, negative free cash flow), the value of the company has prices such vulnerabilities in. The price-to-earnings ratio and price-to-book ratio for Reliance Infrastructure currently stands at 4.8x and 0.4x respectively. This is close to the record low of 3.6x and 0.3x in August 2013, and amongst the lowest ratios in the Indian infrastructure space.

Furthermore, we believe that the macro outlook for India could start to heal from next fiscal year, FY2014/15 (April-March). We are forecasting India's real GDP growth to improve from 5.0% in FY2013/14 to 5.6% in FY2014/15. This is not only due to an improvement in India's export outlook, but also due to an improvement in India's credit conditions (see 'External Adjustment To Pave Way For Rate Cuts In 2014', October 10 2013). By the end of FY2014/15, we are expecting rate cuts to bring down India's benchmark interest rate to 7.00% from the current 7.50%, while the Indian rupee is expected to appreciate to INR55.00/US$ from the current INR62.00/US$.

A Technical Change
Reliance Infrastructure - Share Price Performance, Eight Year Time Horizon, INR

A Constructive Case For Reliance Infrastructure

BMI View: The stock price of one of India's largest infrastructure companies Reliance Infrastructure appears to have broken out of its long-term downtrend, which, coupled with the near-record low valuations on offer, suggests a more constructive long-term outlook. While we believe that the macroeconomic backdrop and business environment of India have improved in recent months, several milestones need to be achieved for Reliance's stock price to really take off from here. They are a break in its near-term resistance line, greater evidence of project execution, and favourable government rulings.

The stock price of one of India's largest infrastructure companies Reliance Infrastructure appears to have broken out of its long-term downtrend, consolidating above its multi-year resistance line to reach around INR412.00 at the time of writing. This, coupled with the near-record low valuations on offer, suggests a more constructive long-term outlook for the stock. While the firm's financial position is concerning (i.e. high net debt, negative free cash flow), the value of the company has prices such vulnerabilities in. The price-to-earnings ratio and price-to-book ratio for Reliance Infrastructure currently stands at 4.8x and 0.4x respectively. This is close to the record low of 3.6x and 0.3x in August 2013, and amongst the lowest ratios in the Indian infrastructure space.

A Technical Change
Reliance Infrastructure - Share Price Performance, Eight Year Time Horizon, INR

Furthermore, we believe that the macro outlook for India could start to heal from next fiscal year, FY2014/15 (April-March). We are forecasting India's real GDP growth to improve from 5.0% in FY2013/14 to 5.6% in FY2014/15. This is not only due to an improvement in India's export outlook, but also due to an improvement in India's credit conditions (see 'External Adjustment To Pave Way For Rate Cuts In 2014', October 10 2013). By the end of FY2014/15, we are expecting rate cuts to bring down India's benchmark interest rate to 7.00% from the current 7.50%, while the Indian rupee is expected to appreciate to INR55.00/US$ from the current INR62.00/US$.

Macro Environment To Improve
India - RBI Policy Rate And Exchange Rate (LHS); Real GDP Growth (RHS)

An improving Indian macro story is crucial to Reliance's financial performance as the company derives the vast bulk of its revenues from the domestic market - the company has a portfolio of 33 projects across 16 Indian states, as well as an EPC orderbook consisting of INR89bn (US$1.5bn) worth of Indian infrastructure projects at the end of June 2013. An increase in economic activity could increase traffic volumes for its road and airport projects as well as electricity demand from its power plants. Meanwhile, a decline in interest rates could reduce the cost of borrowing and debt repayments for Reliance Infrastructure, while an appreciation in the Indian rupee could reduce external debt repayments and the cost of overseas equipment.

Heavy Infrastructure Exposure
Reliance Infrastructure - Project Portfolio, No. Of Projects, as of June 30 2013 (LHS); Revenues in Q1 2013/14 (April-June), By Sector, % (RHS)

There have also been attempts by the government to speed project execution and improve the overall business climate for infrastructure. A host of regulatory changes have taken place or are in the process of being implemented across various infrastructure sub-sectors. These changes could improve the viability of Reliance's portfolio of infrastructure projects and speed up the implementation of its EPC orderbook. Some of the key changes that have already been implemented include:

  • The approval of a new bill to increase clarity and speed up the land acquisition process.

  • The de-linking of forest and environmental clearances for linear projects such as roads and transmission lines.

  • The complete substitution of concessionaires at any stage of their highway projects as long as financial closure is reached.

  • The creation of a new model power purchase agreement for Case-II power projects.

  • New tariff guidelines to allow private operators to fix market-regulated tariff for new projects at major ports.

Key Catalysts For Entry

While the long-term story is starting to look compelling, we believe that several milestones need to be achieved for Reliance's stock price to really take off.

Break In Near-Term Resistance: We believe that further confirmation of a sustained uptrend in Reliance's stock price will depend on the company being able to hit new highs. The stock has failed to make a clean break above its September highs of around INR413.00, and a break above this cyclical peak would be a bullish technical signal.

Seeking Technical Confirmation
Reliance Infrastructure - Share Price Performance, One Year Time Horizon, INR

Greater Evidence Of Execution: Reliance's track record with building and operating infrastructure projects is mixed. It has been relatively successful in completing and operating its road projects, but its performance on urban railway and power projects has been less impressive. The company decided to terminate its concession agreement to operate the Delhi Airport Metro Express in mid-2013, and there are delays to its Mumbai Metro projects (i.e. Mumbai Metro Line 1 and 2) due to a dispute with the Maharashtra state government over various issues (e.g. fare structure, land acquisition).

Meanwhile, of the three ultra mega power plant (UMPP) projects awarded to Reliance Infrastructure and its subsidiary Reliance Power , two of them - the Tilaiya and Krishnapatnam UMPPs - have yet to start construction works despite being awarded in 2009, while the remaining UMPP - the Sasan UMPP - has only completed the first of six units despite being awarded in 2007. In addition, the two ultra mega transmission projects awarded to Reliance Infrastructure in 2010 - the North Karanpura and Talcher II transmission projects - have yet to start construction works, with Reliance Infrastructure applying to the Central Electricity Regulatory Commission (CERC) for an extension to the completion date.

While the failure to implement these projects are partially due to India's poor business environment, Reliance's failure to anticipate these issues raises concerns about its risk management systems. Therefore, even though the company has so far been relatively successful in rolling over its borrowings, a consistent failure to implement its projects on time and within budget will prevent the company from reducing its debt burden and achieving returns originally expected from its investment. Such a scenario could push the company to divest profitable assets to meet its debt obligations, further dampening the company's growth prospects. To be sure, the Mint reported (citing unnamed sources) that Reliance Infrastructure is planning to sell all or most of these road assets to pare down its debt levels.

Favourable Rulings: Reliance Infrastructure is currently undergoing several legal proceedings that, if favorable, will boost its financial performance over the coming years. The company is seeking to increase the electricity tariff for all of its power projects and has so far been successful in getting tariff hikes approved for some of its electricity distribution networks in Delhi and Mumbai. Reliance's decision to terminate its concession agreement for the Delhi Airport Metro Express is also currently under arbitration and, if successful, could allow the company to claim termination payments. Reliance is also facing a petition from Power Grid Corporation , in which the state-owned transmission utility is requesting that the CERC cancel Reliance's license to build the North Karanpura and Talcher II transmission projects. Lastly, Reliance is also negotiating for a fare increase and advertising rights for its Mumbai Metro Line 1, which, if successful, could increase the returns from the project.

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