Commodities

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Shareholders in Reliance Industries haven't had it this good for a long time. After years of under-performance, the Indian oil refiner's stock has zoomed 21 percent since the end of September, versus a 6 percent drop in the benchmark Sensex. Chairman Mukesh Ambani's net worth has swelled to $21.7 billion. And now, its latest quarterly earnings have shown that cheap crude is lubricating margins even more than analysts had expected.

Steady Climb
The cost to protect Reliance's debt against default using credit-default swaps has been increasing
Source: Bloomberg

Yet the bond market doesn't seem to have got the merry memo. Those who purchased the company's 2025 notes at the start of last quarter have made a 0.6 percent return to date. The cost of insuring Reliance's debt against nonpayment using credit-default swaps, meanwhile, touched 219.4 basis points in early October, the highest since February 2014, and remains a rather elevated 184.7 basis points. This despite the company announcing a $2.2 billion rights issue, which will improve its debt-to-equity score.

It seems bondholders can't bring themselves to be as enthusiastic about Ambani's return to the telecom industry after a decade. Stock holders are reacting to the company's aggressive $15 billion investment in fourth-generation wireless as if it were already a runaway success -- never mind that the Reliance Jio service is yet to be commercially launched. The former are looking at the same money-guzzling 4G venture and wondering if it will work. Who's right? Tuesday's third-quarter earnings report offers some clues.

Something They Know?
Bondholders are taking a very different view to Reliance than equity holders
Source: Bloomberg

Start with refining, which is what's spewing out the cash to pay both debt and equity investors. Operating income from refining almost doubled from the same period of 2014 to $985 million, or about 67 percent of the total. The company's exploration business, of which great things were expected when Reliance struck gas off India's southeastern coast some 10 years ago, is already a dog. Just 2 percent of the conglomerate's revenue last quarter came from producing oil and gas. Reliance Retail, the company's optimistic bet on India's emerging middle class, is more than three times as big by sales but barely contributes anything to profit. So the question is, will Reliance's $11.50-a-barrel refining margin, the highest in seven years, hold?

Margin Benefits
Reliance Industries' refining margins per barrel are the highest in seven years
Source: Reliance financial accounts

It might. Sanford Bernstein expects another $2-a-barrel boost from a coke de-gasification plant that's on track for completion this year. Plus, there aren't many new refineries in the pipeline. Australia's refining industry is shrinking and China doesn't intend to boost capacity either, according to Bloomberg Intelligence.

For now, equity investors seem to have the more convincing argument. Even with the latest run-up in Reliance stock, it's still trading at less than 13 times estimated earnings, compared with 15 to 25 times for Caltex Australia, Idemitsu Kosan, Formosa Petrochemical and TonenGeneral Sekiyu. The only way bondholders' caution could turn out to be correct is if the telecom venture ends up requiring more investment amid a price war in data services that crimps cash flows. That might turn people's attention to the $26.9 billion in debt on Reliance's books, almost six times the operating income in the past year. 

With a little luck, though, crude prices will stay low and the cash from refining will allow Ambani to scale up his mobile business quickly. But don't expect Reliance to return more money to shareholders. Its sub-1 percent dividend yield, among the lowest of rivals in Asia, might hold back any big jump in the stock. Unless 4G turns out to be a dud, there'll be plenty going around to pay bondholders.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net