RIL needs to step up research and development to consolidate its growth

Reliance Industries (RIL) seems to be on a sticky wicket, appearance running ahead of reality. Even before Moody’s ‘credit-negative’ diagnosis, the company’s annual results had disappointed.

The net profit margin, or net profit as a percentage of revenue, has fallen to 5.9% in 2011-12, which is a 10-year low. The operating profit margin is down to 11.7%, the lowest in 20 years. Its stock market capitalisation has fallen in tandem.

Reduced volumes play and lower top line growth are to blame. The fall in natural gas production in the Krishna-Godavari basin has hurt. The continuing scenario of high crude oil prices has led to a squeeze on margins in refining, which accounts for two-thirds of RIL’s net sales.

RIL needs knowledge-based growth and innovation, especially in its petrochemicals division, to rev up value addition and margins. RIL needs to chart a multi-year strategy to boost its research and development, and invest in proprietary knowledge to shore up processes and product offerings so as to improve realisations.

Global majors in chemicals and petrochemicals — BASF, Dow, Mitsubishi Chemicals et al — have all profitably pursued research-based growth, and have products and solutions that are differentiated from commodity petrochemical items.

Now, RIL has traditionally bought technology off the shelf to drive growth. But now that it has its presence right along the value-chain in petrochemicals, it can well chart a more knowledge-based path.

Petrochem is already a relatively high margin business: while its petrochem revenues are less than a third that of oil refining (and marketing), the quantum of profits in both divisions is almost the same.

Looking ahead, there would be ample scope for innovative growth in petrochem, emergence as a knowledge-intensive company and consequent rise in valuation. If BP’s $7.2-billion investment in India’s hydrocarbon sector pays off, its partner RIL cannot but benefit.

Its forays into retail, telecom, hospitality and media are risky but bold bets on the India growth story. RIL’s shift from Sensex proxy to long-term play is evolution, not disaster.