The Hindu Business Line : Reliance Capital: Hold

SHAREHOLDERS of Reliance Capital can continue to hold the stock. Fresh investments can be avoided now as there is nothing substantive to base the investment decision upon. Reliance Capital's performance has not been encouraging. The stock price too factors in the gain in market value of the company's substantial investments and, perhaps, more.

Everything now hinges on Mr Anil Ambani's promise that Reliance Capital will emerge the second or third largest financial services company. Investors excited about his entrepreneurial skills can stay on. Others can even consider partial divestments of their holdings to lock into gains.

Uninspiring past

Reliance Capital is a non-banking finance company focussed on funding the infrastructure sector. Yet, the financial statements give one the feeling that it has not taken its financing mission too seriously.

The company's debt is only 1.2 times its net worth. This is extremely low for an NBFC. Even the most risk-averse NBFC would have a substantially higher leverage. Considering that the infrastructure sector has been opening up over the past few years, the low scale of operations is disappointing.

One gets the impression that Reliance Capital has merely been a vehicle for financing Reliance group ventures.

Of the total investments of about Rs 3,000 crore, almost two-thirds was invested in equity and debt instruments of the group. Bulk of the fund flows has been into the equity of Reliance Industries and the debt of Reliance Communication Infrastructure.

The return on net worth over the past five years has been abysmal, at less than 8 per cent. When adjusted for the investments in equities, the return rises to about 15 per cent. While that is an infinitely better number, it is still not impressive enough to warrant superior valuation.

The only factor in favour of the stock over the past 12 months has been the meteoric rise in the value of its investments.

The value of Reliance's holdings in four ventures — Reliance Industries, Reliance Energy, Reliance Capital Asset Management and Financial Technologies — is now far higher than the book value. The total book value of these investments is about Rs 800 crore and the aggregate market value is closer to Rs 2,400 crore. The stock, however, now factors in this windfall too.

Growth and acquisitions

If one considers the expansion in net worth and equity due to the preferential allotment of Rs 3,000 crore at Rs 228 per share, the book value per share works out to Rs 171.

If the gain in market value is considered, the value per share works out to Rs 240. The stock now trades at 1.4 times this value. This is premium valuation considering Reliance Capital's past performance.

The sustainability of the premium valuation may well depend on acquisitions. This is because, for organic growth, the infusion of Rs 3,000 crore is several times more than what is necessary, considering that the company is already under-leveraged.

The cash infusion would enhance Reliance Capital's net worth to about Rs 4,400 crore, which would then be larger than that of many of the public sector banks, even higher than that of HDFC and closer to the net worth of HDFC Bank.

It is, however, difficult to comprehend an equally massive increase in the risk assets of Reliance Capital merely through organic growth.

It, thus, stands to reason that the funds would be utilised to acquire assets, most likely in the asset management and life insurance space.

These acquisitions would decide the company's future profitability and also keep the investor's interest alive in the stock. That is a good enough reason to hold on to a part of your holdings. Fresh investments, though, appear unjustified.

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